Uncle Sam faces grave 'Economic Crisis': Will it go the Russian way!

While going through the history of 'Business cycles', we stumble upon an interesting fact: An 'economic crisis' or 'recession' repeats itself every 7-8 years on an average. Consider the historical evidence: Ever since the 'Great depression of 1931', the world has undergone a crisis situation at regular intervals. The last two crisis are still ripe in our memory: The crisis of 2001 (known as 'Dot-com bubble'), and the 2008 crisis (known as 'Sub-prime mortgage crisis'). This theory points towards another impending crisis in 2016-17. 

With the stock markets world over in the midst of an unprecedented 'Bull run', it is virtually unthinkable that a crisis is coming. So I had to brush up my knowledge of history to pin-point from where this crisis would emanate: Would it be Greece, China, Britain or any other country. The financial markets have braved all the negative news: be it failure of Greece, China's slowdown, Brexit or continuing recession in Japan, but will they be able to absorb the biggest shock that is knocking at our doorstep. Let me tell you a breaking news: 'Uncle Sam aka USA is broke' and will lead the crisis of 2016. I have been consistently warning my readers that the markets are over-heated, but the markets have continued to defy all logic in the recent past. I am happy that now people are giving heed to these sane voices. Here are a few statements, about American markets, recently made by some famous market experts:

•  “A $68 trillion ‘Biblical’ collapse is poised to wipe out millions of Americans.” - Jim Rogers
•  “Investors are on the Titanic” and stocks are about to “endure a gut-wrenching drop that would rival the greatest crashes in stock market history.”  - Marc Faber
•  “U.S. stocks are now about 80% overvalued.” - Andrew Smithers
• “Sell Everything” because “in a crowded hall, the exit doors are small.” - Royal Bank of Scotland

These American seniors have been worried about their nation's ability to pay out social security. Let us understand the reasons for their grave concerns about the future of American economy:

1. US is staring at mind boggling debt of $19 trillion, and an unmanageable fiscal deficit of $200 trillion
2. Inflation and Falling Real Wages: Retail inflation is higher than the figures declared by the Federal Govt., leading to an erosion in the real wages earned by a majority of Americans
3. American's have little or no money set aside for emergencies. According to a survey almost half (47%) said their savings would cover their living expenses for 90 days or less
4. The Federal Reserve’s fund rate has been coming down for more than 30 years, any hike would cripple the budget of an average American
5. US companies are increasing relying on foreign sales for survival, with global recession looming large these companies will find it hard to remain profitable
6. With the west losing its supremacy in the global sales, the world is looking with suspicion at US$ as the 'Reserve currency'. The recent decision by IMF to declare 'Rem nimbi' as an additional Reserve currency will add to the woes of US$.

These conditions are pointing towards a grim reality: The crash of US$ and the US stock market. To avoid this catastrophe US Federal Govt. may impose a 'Financial Martial Law' to shore up its resources, which means bad news for American citizens. At the same time US is also facing two more challenges: The US presidential election (The campaign so far has been reduced to a non-serious business with personal vendetta to the fore and major issues in the back-ground), and the chances of a full fledged war with Russia over Syria - as Russia has decided to challenge any diktat from USA or the NATO. Financial Emergency was last invoked in USA by President Nixon in 1973.

Will USA go the USSR way? The answer is 'No', because USA has a Federal Structure where states enjoy sweeping powers, and the US President is 'All Powerful' in the sense that he can be ruthless with the enemy as well as its own people in times of 'Emergency'. USA has enjoyed the status of the 'Sole World Super power' ever since the end of the cold war. But if the simmering discontent among the common US citizens spreads to the streets it may pose a serious threat to the Presidential form of Govt. in its present form. Will USA come out ever stronger as it did after the 'Nixon shock' of 1973, or will its supremacy as Sole World Super power threatened, and Barak Obama going  down in history as the last strong US President? Only time will tell, but the world is definitely moving towards a tectonic shift in the 'Balance of Power'.

Based on the above, my prognosis is: USA will lead the world into a deep economic crisis sooner than later. Investors are advised to reduce their holdings in risk assets like equity and real estate, and focus on alternate investments. An increased proportion of Debt and Gold in the portfolio would be a better option. If US markets are expected to crash by 30-40% as per estimates of analysts, Indian equity markets would also bear the brunt, although to a lesser extent,

Markets enter a short-term downtrend: Prepare for 'Bargain Hunting'

Indian equity markets have got the trigger, which they were looking for, to start an intermediate downtrend in the garb of 'Surgical strikes' by our armed forces in 'POK'. As pointed out earlier, our markets had moved far ahead of fundamentals, and a meaningful correction was long overdue. The correction is now underway and we may witness the markets sliding gradually to reasonable levels during the course of next 2 months or so. But at the same time it would be prudent to be flush with cash, as there would be opportunities galore for picking up blue chips at 'bargain prices'. As the festival season unfolds in India, companies would be launching mega sale of their products, similarly this year stock markets would also be offering bargain sale of blue chip shares of companies for the long term investors.
Those of you who have booked profits in shares, as advised in these columns earlier, can enjoy the festivities with purchase of your favourite products or take a dream holiday to your favourite destination. But do keep some profits aside to be re-invested in equity markets as they correct reasonably to give a better risk-reward ratio to long term investors.
Let us analyse the factors that are responsible for the on-going correction in equity markets. Let us first analyse the 'Geopolitical risks' prevalent in the world at this juncture:

• The diminishing role of US in the world affairs, will lead to escalating conflict in the middle-east, with Russia playing the role of a spoiler.
• Post 'Brexit' a closed Euro zone will face an enormous challenge grappling with the twin problems of economic stability and refugee influx due to terrorism.
• The economic instability in China looms large as it grapples with the 'Debt bubble' which could have far reaching consequences for the global economy.
• The 'Oil shocker' could escalate the war for supremacy in the middle-east, especially after lifting of sanctions against Iran, and its competitive stance against Saudi Arabia.
• The US presidential elections would keep the world on its tenterhooks till November, as it unfolds into a swinging battle between Hillary Clinton & Donald Trump.

India specific issues:

• Most positive news has already been factored in: A near normal monsoon & the effect of the 7th Pay commission arrears on consumption and inflation. The markets may get a temporary bump up if RBI announces a surprise rate cut in its October 4 policy, but it would be short lived
• Tensions across the border would give the markets enough jitters, leading to an increase in volatility.
• The 3rd quarter results may again prove to be a dampener, as most companies continue to be weighed by excessive debt, with no signs of demand pick up except in a handful of sectors.

The above factors indicate that the markets may have entered into a short-term corrective phase which may last for about 2 months, and the price correction has the potential to lead to a substantial correction in the indices: I would be comfortable with a Nifty level of around 8000 to commit fresh funds for long term. This would be the level around which I would advise investors to seek 'bargain hunting' in accumulating blue chips for the next bull run on Indian bourses.

Equity markets are overheated: Do not reflect Economic fundamentals

Indian equity markets have entered a danger zone, and a severe fall can not be ruled out once global liquidity dries up. Equity markets made new highs today with Nifty touching 8800 during trading hours. Markets seems to have discounted all the good news, however, seem unconcerned about the impending domestic & global concerns at this juncture. Most of the analysts are misleading the common investors by giving absurd targets for the indices in the days to come. I would like to caution the investors about the challenges faced by the global economy, which are likely to have an adverse impact on our equity markets.

Domestic issues: The GDP figures for the first quarter of this fiscal, released in the evening, have exposed the weakness of the economy. GDP for Q1 has slipped to 7.1% as compared to 7.9% for the previous quarter (Q4 of FY 2015-16). Industrial growth is down to 6%, Agricultural growth is down to 1.8%. The day has been been saved by Service sector growth at 9.3%. More worrying news comes from the Fiscal deficit front where the Govt. has reached 73% of the budgeted target within the first 4 months of the year, implying that it will exceed the Fiscal deficit target by a huge margin. Despite passing of the GST bill, the Govt. is not fully prepared for its roll-out from April 2017. The prediction for an above normal monsoon had been discounted by the market, but the progress of monsoon reveals that its distribution has not been up to the mark. The markets are again irrational in discounting the impact of  'Arrears paid to Govt. employees' as the same is likely to be inflationary in nature.

Global scenario: The global markets are flush with stimulus funds which are driving equity markets to crazy levels, far ahead of fundamentals. I would like to mention 3 inflection points which would lead to a negative slide in our markets:

1. Interest rate hike by US Federal Reserve: The oft postponed rate hike is now inevitable, it is likely to be announced in September. This will lead to strengthening of the US $, leading to the flight of capital from equity markets to safe havens like US treasuries, Gold & Silver. It would also have a negative impact on our already shrinking exports to developed markets

2. Impact of Brexit: As euro-zone prepares for Britain's exit, the instability would lead to drastic cut in Capex budget in the euro-zone and consequent decline in IT exports to these countries from India. New regimes in UK and US are seen moving toward stringent immigration laws, leading to a fall in global Indian companies operating in or supplying to these countries.

3. Financial turmoil in China: China's growth has been an enigma for the entire world, but now the cat is out of the hat. The next round of global instability is likely to be inflicted by China, as the country's debt has been mounting to unreasonable levels. China may resort to further devaluation of its currency to stem the rot, but it may have a cascading effect on developing markets, and India is unlikely to be spared.

In such a scenario our equity markets will need to correct substantially, to make them reasonably priced (Nifty index currently trades at a PE multiple of over 23, as against the average of 14-16). Nifty index has had a non-stop run from 6825 to around 8800 within the past 6 months. A reasonable correction from these levels would take the Nifty in the range of 7800-7900 levels (a 50% retracement of the recent rise). Investors are advised to book substantial profits at the current level, and wait for a correction to around 8000 levels on the Nifty to re-enter again. The fall in Mid-cap & Small-cap stocks could be much deeper.

India's GDP Growth: Myth & Reality

If statistics are to be believed, Indian economy has become the fastest growing economy in the world, raking in a GDP growth rate of 7.6% in FY 2015-16. What is even more shocking to digest is the GDP number of 7.9% for the 4th quarter ended March 2016. Many economists are scratching their heads in disbelief at one of the biggest 'economic fraud' of the Govt. of India. A section of media and the crony capitalists may be singing praises for the Govt., but the figures simply do not add up. Here are some bitter facts about the real economy:

• 2/3rd of the population living in rural India continues to be in extreme distress
• Salaries may have gone up in urban India, but high food inflation is keeping the folks unhappy
• Even the benefit of low crude oil prices has not been passed on to the people: Petrol is back at Rs.70 a litre
• Most corporate houses are shying from fresh investment as the profit margins have shrunk to multi-year lows
• Bank's have been unable to pass on the benefit of low interest rate to the population as they are grappling with the worst NPL crises.
• Exports, imports and remittances from abroad are sharply down
• The manufacturing PMI of 50.7% for May 2016 is the lowest in the past 5 months
• Growth in public spending, which should act as the key driver of growth, marked a sharp drop by 5.4% in fiscal year 2016 
• Employment growth plunged to a six-year low in 2015 across the eight key labour-intensive industries and only 0.1 million jobs were created last year.

The above data highlights the real report card of the present Govt., at a time when it is celebrating completion of 2 years in office. The Govt. has failed to provide any economic stimulus during the past 2 years. Private consumption has been calculated to have grown by a whopping Rs.1,27,000 crores without any evidence supporting the figures. Many economists argue that there are anomalies in the new series of GDP estimates released in January 2015. As per the old methodology Indian economy may have barely grown by 4%, or half of what has been reported recently. The economic jugglery or the biggest 'data fudging' may soon be questioned at international forums, and India may risk a downgrade in its sovereign rating.

There are 3 main culprits responsible for India's current dismal economic situation:

1. Arun Jaitley, FM: A man without a political stronghold, who never won an election and yet catapulted to the position of FM, he has failed to handle the situation effectively, despite the windfall received due to the crash in global crude oil prices. During his tenure rural demand has slipped to its lowest ever, and consequently fresh investment has struggled. He may turn out to be the most incompetent FM India ever had.

2. Subramaniam Swamy: The loose canon of BJP, who has prepared the ground for passing the buck of Govt's economic failure at the doorstep of the RBI Governor. The man chosen by BJP to counter the Gandhi family may turn out to be an embarrassment for the party.

3. TCA Anant, CSO: For doing the data fudging at the behest of his masters, Modi and Jaitley.

The Govt. may be relying heavily on the better monsoon forecasts for the current year for a turn around in its fortunes, but there are far too many other factors like the distribution pattern, which play an important role in the overall impact of the monsoon on the economy. Relying merely on a single factor for a turn-around could be asking for further trouble. A lot needs to be done by the Govt. on the economic front, before it is too late, they need to compensate for the uneventful first 2 years in office.

Equity markets on 'Tenterhooks' on Financial sector flip-flop

The short term recovery in our equity markets that brought the Nifty close to the 8000 mark, failed to sustain as Financial sector outlook remained uncertain. Nifty did make a smart come back from the levels of 6825 touched on the budget day, but the status-quo announced by Bank of Japan (BOJ) on quantitative easing took the wind out of the markets. On the other hand, weakening of the dollar (after taking ques from BOJ) stretched the rally in gold as the precious metal traded close to the 1300$/ ounce mark. We have seen a sharp decline in global equity markets towards the end of the month. Our markets have other issues to digest beyond the weak global signals.

The most important question for our markets is the Health of our Financial sector. The dilemma before the analysts is to decide whether the declaration of bad loans in the balance sheets of Banks (responding to the dictat of the Central Bank), and the corresponding hit on the bottom line, a positive development or it should be treated as alarm bell for the health of the Financial sector. As at the end of December 2015 the gross NPAs of 39 listed entities of the banking sector amounted to over Rs.4.38 trillion. And a staggering Rs.6 trillion is classified in the categories SMA 1 & 2, a portion of which will definitely find its way to the NPA category over the next financial year. 

To add to the woes of the Banking sector is the alarming situation existing vis-a-vis NBFCs (there are over 11000 NBFCs registered with RBI). As per RBI's report on NBFCs, where the norms for NPAs are less stringent as compared to banks, they have 3.5% bad assets on their books. The sectors contributing towards the stress assets are: Infrastructure, Steel & Power to name a few. 

With the economic revival still at least 2-3 quarters away, the stress on the books of Financial sector companies is only going to escalate before it begins to decline. Given the acute drought situation prevailing in the country, something more that an above normal monsoon will be needed to help the Financial sector overcome its current set of woes. The equity markets have perhaps sensed the alarming situation, and are likely to remain subdued in the immediate future. A marked improvement in the market fortunes is linked to a meaningful turn-around in the health of the Financial sector. 

Will Emerging Markets bounce back in 2016?

Emerging markets (EMs) have had a bad yearly performance in 2015. Most EMs, including India, have delivered negative returns this year. Most of these markets are facing turbulent times due to various global/ domestic reasons. Brazil and Russia have been adversely affected by the consistently falling commodity prices. China has been struggling with a readjustment in its consumption theme leading to a sharp dip in its GDP. India, though taking a positive from the sharp drop in commodity prices (especially crude oil), has received a setback due to domestic factors like high inflation and political logjam. 

Analysts are now hoping that most emerging markets would find their bottom soon, and latter half of 2016 may see their revival. The uncertainty over hike in US Fed Rate is over and most emerging markets have responded positively to the event. The Indian Rupee has appreciated a bit and is now hovering around the Rs66/ $ mark. The stability of the Rupee is a good sign for our economy. The commodity markets are close to their bottom. Although lower commodity prices may seem positive for India, indirectly they lead to lower demand for Indian exports as the commodity exporting countries loose their competitiveness. Thus any further fall in commodity prices is not desirable for the global economy.

India is better placed than most emerging markets due to the revival of its domestic consumption story. There have been some green shoots of revival of consumer demand in urban areas, though rural demand is yet to pick-up steam. The pay hike for Govt. servants may boost the economy in the next fiscal. The passage of interest rate cuts by RBI will gain momentum in fiscal 2016-17, which will be a major force in revival of the earnings cycle. The clock seemed to have turned full circle for the markets, which are likely to stabilise in the range of 7500-8000 on the Nifty, before making the next up move. Surprisingly, the broader markets have performed much better in the recent down turn, and this augers well for a market rebound, sooner than later.

In conclusion, retail investors are advised to get ready for a revival, and continue to put money in the markets slowly, SIP would be a better choice. 2016 promises to be a better year for equity investment as compared to 2015.

RBI signals the end of 'Bear Market' in India

RBI Governor Raghuram Rajan sprang up a pleasant surprise handing over a Diwali gift to the market/ investors, by lowering the benchmark Repo rate by 50 basis points to 6.75%, in the bi-monthly monetary policy announcement on 29th September. The benchmark rate is now at the lowest in 4 years. This has ushered an era of benign interest rate scenario in the country over the medium term. Although, our equity markets may swing widely based on international cues, this action will serve as the most important catalyst for laying the foundation of a long term bull market in India. 

Let us analyse the implications of the policy announcement:

• The Governor has articulated his intention for working with the Govt. to ensure transmission of the rate cuts by the Banking system
• RBI has lowered the forecast for GDP growth from 7.6% to 7.4% for FY 2015-16, focusing on an urgent need to boost investment/ growth
• Inflation projection for January 2016 has been projected at 5.8%, against the previous estimates of 6%, based on benign commodity prices
• To improve liquidity with the banks, RBI has proposed a reduction in SLR by 1%, in a phased manner.

The single most factor responsible for valuation of stocks in the market is the earnings estimates. Unfortunately, earnings growth has been muted due to two factors: Excess capacity/ low consumption and Cost escalation due to high Interest rates. The lower interest rate regime will help the high debt companies to save substantially on interest service cost. Consumption led growth will have to be given a boost by Govt. spending. The size able saving by the Govt. on Commodity/ Oil imports will help the Govt. to increase spending.

The timing of the rate cut is perfect, as it coincides the busy festival season, which is an opportunity for Corporate India to boost its sales (top line), the profits (bottom line) will improve with largess's doled out by RBI. Banks have started responding to the RBI gesture by lowering their base rates, SBI taking the lead by lowering its base rate by 40 bips to 9.3%.

I can safely say now that the bottom of our markets has been made at around 7500 on the Nifty, although, in the short term markets may swing widely between 7500-8200 on the Nifty, based on global cues and expectations of lower earnings for quarter ending September 2015. However, it is expected that the earnings growth will improve steadily from December 2015 onwards, and the same will reflect in the growth of the bench mark equity indices thereafter. Now is the time to invest in the equity markets for long term, provided investors are ready to brave the short term volatility over the next 3 months.