February 2015: All time high amidst optimism of further gains!
January 2016: 20-month low with fears of a further crash!
That's how dynamic situations and views are. A lot would have been written and said, listing reasons for the same. The Indian equity market is now back to the levels of May 2014, when in a historic verdict, Narendra Modi was sworn in as India's Prime Minister. Extreme optimism led to the markets hitting an all-time high of 9100 (source Bloomberg) for the Nifty. Who would have imagined that in a span of just 20 months, various factors would lead to the Nifty falling back to the pre-election levels of 7300, with extreme pessimism being the order of the day?
This is an attempt to present our take on the same in a very simplistic manner. We start with a simple chart displaying the factors that have had a negative impact on the markets. After discussing the same, we again use a chart displaying the positives over the last 20 months.
The conclusion is clear: The Indian economy has faced multiple challenges and headwinds. Nevertheless, there have been more structural positives that India has been blessed with over this period. As soon as financial stability returns in the global markets, the balance-of-scale, heavily tilted in favour of positives, will come to work and lend stability and positivity to Indian equities.
See table: The Negatives
The Chinese economy has slowed to its lowest level in 25 years. Fears pertaining to the possible hard landing in China are reflected in the sharp drop in the stock market. In line with efforts to make the currency more flexible, the PBoC has depreciated the CNY 4-5%. The fear of hard landing and sharp devaluation of CNY has caused panic in the global market.
Our take: The Chinese economy is rebalancing as it is becomes more inward looking rather than export dependent. In this adjustment process, a much better foreign exchange policy is needed. The right efforts are being made and the worries related to sharp devaluation in CNY and/or hard landing in China may be overstated.
The persistent weakness in oil prices continues to exert its negative influence on all markets, especially credit. It is also leading to short-term withdrawal of financial investments by oil producing Sovereign Wealth Funds.
Our take: Prices have sharply fallen to $27 per barrel which is below the cash cost of a number of major producers. Thus, at these levels we begin to see significant production capacity going offline, which should then set the stage to stabilise the energy sector. Stable and rising energy markets should be positive for the global risk environment. Also for India, lower crude is eventually beneficial as compared to higher crude prices.
- S. Federal Reserve tightening
The U.S. central bank eased its policy by 25 bps in December, reversing the 7 years of monetary support. Markets are worried about any sharp policy tightening by the Fed, which can put pressure on global cost of capital.
Our take: While the U.S. economy is doing well, the recent bout of risk aversion and deflation would mean that the Fed could postpone the incremental tightening as financial conditions have materially tightened in the U.S. as well. Any delay in Fed tightening would be taken as a positive surprise. Also, other central banks such as the ECB, PBoC and BoJ could soften their policy stance as deflation fears mount.
India has had two back-to-back, sub-par monsoons leading to rural slowdown.
Our take: Outlook for monsoons in 2016 is positive as India has never seen three consecutive years of drought. Meanwhile, global forecasters such as the Japan Agency for Marine-Earth Science and Technology said there was a probability of La Nina developing in 2016. Historically, La Nina results in better than normal monsoon in India.
After a dream run till 2014, the BJP suffered two meaningful defeats in 2015 in the Delhi and Bihar elections. Investors now worry about the difficulty that the government faces to push the reforms agenda forward. Due to the ongoing conflict between the Centre and the opposition, there has been a severe legislative logjam. This has made the reform process tardy leading to disappointments.
Our take: The government has displayed a resolve to continue with the reforms agenda despite legislative hurdles. Further, any normal functioning of the parliament would be considered as a positive surprise by the market. Also, in FY17, there are no critical state elections for the BJP, so they may use this slack period to improve upon the reformist agenda.
Efforts have been expedited by the authorities to recognise bad assets (NPAs) for a long pending overhaul of the banking system.
With a view on the parallel economy, there is a clear intent towards bringing more transparency into the system. This has affected near term sentiment as well as the growth momentum.
Our take: While this is hurting growth in the near term, it is likely to considerably improve the quality of India's macroeconomic profile over the medium term. The share of organised sector shall improve. Once the system becomes lean and transparent, the eventual recovery is likely to be far more sustainable.
See table: The Positives
Over the last 20 months, there have been various positives in the form of progress made by both the government as well other favourable developments. Once the dust settles, these positives could come to the fore and redeem themselves through superior market performance.
It is interesting to note that India has added over Rs 16 lakh crores in GDP over the last 20 months under the new regime. Yet India’s market capitalization to GDP has declined from 70% to 68% in the same period.
What can go right over the next 24 months?
There are a number of reforms/developments which are already in place and it’s just a matter of time when they will start to come into play.
- Two key legislative bills: Good and Services Tax (GST) and Bankruptcy Code. It is the question of "when" rather than "whether"
- Dedicated Freight corridor (DFC) and Delhi Mumbai Industrial Corridor (DMIC)
- Skill India / Digital India / Start-up India: All these measures will push forward ‘Make in India’
- Reduction in corporate tax rate from 30% to 25%
- Reduced interest rates
- Ease of doing business – Cutting down on red tape
- Curtailing the parallel money and boosting the organized sector
- Full benefits of lower crude, leading to long-term competitiveness for the Indian manufacturing sector, besides a strong country balance sheet with lower twin deficits
- Normal monsoon, leading to rural economy adding to GDP growth
- Visible impact of huge government spending in areas of railway, defence, roads, power, etc
- Cleansing of bank books, removing the overhang and uncertainty, and allowing banks to focus again on core credit growth
- Expectations have toned down meaningfully and any uptick might lead to big surprises and reaction
- A possible development and growth focused Union budget on February 29, 2016
There is a possibility that most of these factors will coincide together in a few quarters resulting into a virtuous cycle. None can deny that the intention from the government is very strong. It's a matter of time that the "talk" gets converted into "walk".
Also, history suggests that a sharp fall in the market has proven to be a good opportunity for the long term investors, as subsequent returns have been quite favourable over the next 1-2 years. The below mentioned table substantiates this.
| 2-year return after a major fall in the Sensex |
| Peak |
Bottom |
SensexHigh |
Sensex Low |
% fall from high |
1-year return |
2-year return |
| Feb 2001 |
Sep 2001 |
4,462 |
2,594 |
-42% |
16% |
60% |
| Feb 2002 |
Oct 2002 |
3,758 |
2,828 |
-25% |
66% |
100% |
| Jan 2003 |
Apr 2003 |
3,416 |
2,904 |
-15% |
93% |
124% |
| May 2004 |
May 2004 |
5,772 |
4,227 |
-27% |
47% |
189% |
| May 2006 |
Jun 2006 |
12,671 |
8,799 |
-31% |
66% |
83% |
| Jan 2008 |
Mar 2008 |
21,206 |
14,677 |
-31% |
-41% |
14% |
| Oct 2008 |
Oct 2008 |
13,203 |
7,697 |
-42% |
123% |
166% |
| Jan 2011 |
Dec 2011 |
20,664 |
15,135 |
-27% |
28% |
38% |
| May 2013 |
Aug 2013 |
20,443 |
17,448 |
-15% |
46% |
62% |
| Mar 2015 |
Till Jan 2016 |
30,024 |
23,962* |
-20% |
- |
- |
* Price as of Jan 21, 2016 / All % changes are absolute and not compounded / Source: Bloomberg
While there are multifold challenges, there are more than enough positives which will enable the growth to meaningfully recover in the coming quarters. In these volatile times, investors tend to look at glass half empty rather than half full. The positives outweigh the negatives and provide an excellent opportunity to increase allocation in equities from long term perspective. As legendary investors always say, "BUY when there is blood on the street".
BE POSITIVE.
The above column has been taken from the online publication of India Markets Observer. To see the outlook for various asset classes, perspectives on the industry, investing insights, and the entire list of contributors, click here.
