Stock market which had seen a rampaging bull market during 2016-17 has seen significant correction starting 2018 and it continues relentlessly. Small cap index has been hammered down by around 40% from its peak in Jan 2018. While large cap has been relatively unscathed, everything else apart from top 50 stocks have fallen like a pack of cards. As per data, around 65% stocks have fallen more than 50% over last 18 months. Only less than 10% stocks have fallen less than 20%. This means majority of stocks irrespective of the industry, balance sheet health, growth rates, have fallen during this period. A question which is often asked in times like these “Are we at the bottom?” There is no easy answer to this question. It is all about probabilities. Still based on economic patterns, one can get a logical and rationale view on it. To reach there, we need to first understand the reasons behind this downfall.
The Rise of Stock Market: 2014- 2017
Below points contributed to the rise of stock market during the early days of the last bull cycle.
- Brand New Government: In 2014 when new government came to power, people had put a lot of hopes and expected that Modi Government has a silver bullet to fix all problems. This fueled investor participation in stocks market.
- Benign Valuations: During 2014, mid and small cap stocks were trading at a big gap when compared to large cap stocks. It was overdue for reversion to the mean.
- Easy Money: Worldwide, central bankers were still printing free money which was largely lapped by big investment firms to deploy overseas emerging markets including India.
- Favourable Oil & Gold Prices: 2014-15 was a period when oil prices crashed while gold prices also saw a mini revision downwards. This reduced gap for India’s fiscal deficit and allowed some room for new government to spend on infrastructure etc.
At the Peak: Sep’17-Jan’18
- Super High Valuation: Three years of bull market had pushed market valuation at skyhigh. It was only a matter of time when it would normalize. However, such was the optimism that analysts started to value stocks with forward 2 to 3 years earnings estimates to justify valuations.
- US Fed Signaled Rate Hike: During this time, US Fed announced that it is going to hike interest rates slowly to bring them back to normal levels of 2.5% from 0%. This was the first indication of a looming crash as foreign money inflow into the stock market was largely helped by cheaper interest rates.
- Rise of Domestic Investors: By this time, we had significant money flowing into the stock market via SIPs. While FIIs were fleeing away after US Fed led rate hike started, domestic inflows kept market at elevated levels. However, with one of the driving force (FII) now dragging the market, it was only a matter of time when impact was to be seen.
- Rise in oil prices: After hovering at $30-45 per barrel, oil also started to boil due to conflicts in middle-east, sanctions on Iran oil, etc.
Crash seems inevitable if we look back at above factors which were at play during Jan’18. Hide sight analysis is easier but also a great teacher. Economy was not moving at the pace predicted by the government & analysts. It was only a matter of time that domestic flow will crack, leading to downgrade of the market.
Downhill from the top: Jan’18 till present
- Economy is still slumping: During past 18 months of market correction, the valuations have descended down to sane levels however it was now economy which played a spoilsport. With earnings falling down, the possibly benign valuations went up without any increase in stock price. Thus more correction follows.
- Oil & Gold Price on elevated levels: Oil has stayed around $55-65 per barrel and refuses to come down as OPEC cartel have learned their lessons in 2014. This put limitations on government spending power as it has to first fix the gap in fiscal deficit.
- Fed rate hike has peaked: The current interest rate at 2.25% seems to have peaked and it is making dollar costly, resulting in FIIs continuing to exit emerging markets like India.
- Government Decisions: Government has decided to impose new taxes on super rich and FPIs. These decisions on an already slowing down economy is only going to hammer down the market. While tax collection is not a bad thing but it has to be be introduced gradually by consulting impacted parties. Most of the decisions of the government has been down in isolation, leading to sudden chaos in the market. One prime example is the long term taxation on equities which woke up the bears.
- PSU Bank & NBFC crisis: Just when India needed liquidity to expand businesses and economy, there were two interruptions to liquidity. One during demonetization which crippled growth for a year. Another one came exactly after an year, the default of IL&FS & NBFCs. PSU Banks who serve majority of the banking requirements in India is cash strapped due to high NPAs. So overall even if economy could have possibly grew this stage, there was no fuel for growth.
- Trade War: Another global factor hindering economic growth globally is the US-China trade war perpetuated by Donald Trump administration. This is hurting both economies in general while certainly few US based businesses will be enjoying it since they are getting US market share back from China. Overall, people of United State will likely suffer in near term as there will be a slowdown amidst costlier products, produced locally in US.
How to get bulls back?
Based on the above factors, we can analyse what it takes to bring back the bulls.
- Liquidity Easing: Government & Private sector needs liquidity to take new initiatives which can kick start our economy. Government can choose to do so by lowering interest rates, which it is doing but the impact of cheap rate is not reflecting in the market due to poor health of PSU banks. They are not passing the entire benefits to the customers. This leaves onus of growth on private banks like HDFC, ICICI, Kotak to fund country’s growth. It is going to take some time. Another way is if government can infuse fresh capital in PSU banks. However, in our opinion PSU banks are terminally ill and mere liquidity doses will not help. Pockets of PSU bank are torn and any money provided to them will sink into the blackhole of NPA. It needs restructuring and probably merger into a single nationwide PSU bank. Simplifying PSU banks holds the key. Just like Singapore did by keeping just one national bank to avoid duplicacy of efforts from government banks competing with each other. With just one or at max a handful of national banks, it can be managed more efficiently by the government.
- Trade War Resolution: Global economy will still be in doldrums till either Donald Trump stops trade-war by reaching to a conclusion or he looses next US election. Due to anti-incumbency factors, it is likely that next US president will pretty much undo what Trump is doing at the moment. So next US presidential elections in Nov 2020 holds a big significance to world economy.
- Moderation in oil prices: Oil prices need to moderate so that pressure on India’s fiscal is reduced thereby allowing more elbow-room for government spending. Giving incentives and promotions to electric vehicle can be a way out of our dependency on petroleum. However, there is a strong resistance from auto lobby and government must find a way to push electric vehicles by providing incentives and infrastructures.
- Reignite government & private capex: Due to shortage of funds in the hands of banks and government (due to fiscal deficit), the credit borrowing has come to a halt which has a ripple effect on overall economy. This needs to be re-ignited. One of the ways can be to push manufacturing sector by tax incentives like SEZ structure. The problem India has is that we have graduated directly to service based economy bypassing manufacturing. In the coming years, service based industry will remain strong in India but it needs skilled manpower which is missing due to lack quality education to the masses. Manufacturing can fill this gap as it needs both semi skilled & skilled workforce.
The problem that we are facing are structural in nature. These are not short so it will take sometime to navigate through them. Onus lies on government to stimulate growth engines of the economy. As per our analysis and on the ground observation, we don’t think Indians have suddenly started to consume less and thereby pushing back domestic growth. The salaried class which is a key component of the market, keeps on getting salaries every month. They will invest sooner or later in different asset classes, be it equity, debt or gold.
Auto sales are down not because of affordability but convenience. With Uber & Ola, coupled with so much traffic on Indian roads, no one enjoys to own a car and drive it all the way. There is a natural tendency to seek convenience of shared cabs, metro rides, etc. Even in such a damp auto market, interesting products are still selling like hot cakes. For example Kia Seltos which is seeing a beeline of buyers. Real estate is a dampner as it struggles to overcome the damage done by greedy & corrupt builders. Consumer durables & discretionary spend will keep up the pace in times to come. IT is nearing saturation in terms of new employments. However, with so much youth joining the workforce every year, there is a need for new sectors to come up and absorb the excess workforce.
Coming back to the main topic, are we at the bottom of the market? The logical answer by looking at the current economic conditions is NO. We may see more downside from here. There is a lot of hope that upcoming festival period will uplift the consumption. We need to wait till Dec’19 to see its impact. Lack of other stimulus means, condition may remain as it is for some more time. Of course, government can always make a mid-way course correction. By the time this article is published, you will know if Finance minister has announced some much needed perks for the investor community.
What should investor do?
If you are a long term investor who is atleast 6 or more years away from realizing financial goals, this bear market is tailor made for you. Make most of bargain prices on offer via mutual funds or direct stocks route. Either way you will be handsomely rewarded when tide turns back.
If you are in big losses in stocks, do a review on top loss making stocks. You can do an average down in stocks where future is still promising. Again deploy money into stocks slowly. To achieve this, prepare a list of stocks worthy of keeping and make monthly or quarterly investment to average down. For junk stocks, we hope you have invested only a tiny portion of money, it is better to square off that deal. Such stocks may never bounce back. No point in wasting money on them.
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