Vijay Kumar Gaba

 Thankfully, the impromptu protests against the scheme for recruitment of short term soldiers in the Indian armed forces have subsided in a few days and the armed forces are reporting enthusiastic response from the youth.

I see this scheme as an extension of the fast growing gig economy in the country. Most industries in the country are increasingly relying on gig workers to perform their business to maintain a lean and flexible cost structure for their enterprises.

Recognizing the trend, the government has accorded legal recognition to the gig workers. The Code on Social Security, 2020, (CSS2020) that shall, in due course, replace nine extant labor laws and establish a single comprehensive legislation to extend social security benefits to all employees and workers irrespective of belonging to the organised or unorganised sector. The Code on Social Security, 2020 brings, within itself the self-employed workers, home workers, wage workers, migrant workers, the workers in the unorganised sector, gig workers and platform workers  for the purpose of social security schemes, including life insurance and disability insurance, health and maternity benefits, provident fund.

In general ‘gig workers’ are defined as independent on-call or temporary workers engaged by online platforms and contract firms. Usually, gig workers enter into formal agreements with employers to be available on-call to provide services to the employer’s clients. CSS2020 defines the term gig worker as, “a person who performs work or participates in a work arrangement and earns from such activities outside of traditional employer-employee relationships”. Thus even a part time teacher and doctor attending patients in OPD of a hospital could technically fit into the spectrum of gig economy.

The NITI Aayog expects the gig workforce in India to expand to include 23.5million workers by 2029-30. This will be 6.7% of the non-farm workforce. Considering the growing contribution of the gig economy in overall GDP growth, NITI Aayog recently prepared a report titled “India’s Booming Gig and Platform Economy  - Perspectives and Recommendations on the Future of Work”. The report is based on a study undertaken with the objective to understand the significance of this sector to the economy, to employment generation and suggest measures to encourage employment in the sector, along with initiatives for social security. The report offers a scientific methodological approach to estimate the job creation potential of the gig-platform economy as well as provides wide-ranging perspectives and recommendations on the gig-platform economy in India.

The following points highlight the current state of gig workers in the economy:

Gig economy is growing fast

It is estimated that in 2020-21, 77 lakh (7.7 million) workers were engaged in the gig economy. They constituted 2.6% of the nonagricultural workforce or 1.5% of the total workforce in India. The gig workforce is expected to expand to 2.35 crore (23.5 million) workers by 2029-30. The gig workers are expected to form 6.7% of the non-agricultural workforce or 4.1% of the total livelihood in India by 2029-30.

Employment elasticity of gig economy is higher

The employment elasticity to GDP growth for gig workers was above one throughout the period 2011-12 to 2019-20, and was always above the overall employment elasticity. The higher employment elasticity for gig workers indicates the nature of economic growth, which created greater demand for gig workers while not generating commensurate demand for non-gig workers.

(Also see Make growth employment elastic)

Gig work is expanding in all sectors

In terms of industrial classification, about 26.6 lakh (2.7 million) gig workers were involved in retail trade and sales, and about 13 lakh (1.3 million) were in the transportation sector.

About 6.2 lakhs (0.6 million) were in manufacturing and another 6.3 lakhs (0.6 million) in the finance and insurance activities.

The retail sector saw an increase of 15 lakh (1.5 million) workers during 2011-12 to 2019-20, transport sector 7.8 lakhs (0.8 million), manufacturing — 3.9 lakhs (0.4 million). d. In the education sector, the expansion was from 66,000 to more than one lakh (100,000) by 2019-20.

Gig work accentuating skill polarization

At present about 47% of the gig work is in medium skilled jobs, about 22% in high skilled, and about 31% in low skilled jobs.

Trend shows the concentration of workers in medium skills is gradually declining and that of the low skilled and high skilled is increasing.

Within gig economy platform work is more substantial

Gig and specifically platform workers exhibit characteristics beyond the formal-informal dichotomy. While gig work is a larger concept with many undefined aspects, platform work within it is more substantial.

In a platform economy, any individual armed with an internet-enabled smartphone and tangible or intangible assets can monetise these assets at will, to become a platform worker. Thus, beyond its potential to provide a wide spectrum of services to consumers, the platform economy can also offer livelihood opportunities to different sections of workers, including women, migrants, Persons with Disabilities (PwDs), and the youth.

Challenges faced by gig workers

Lack of job security, irregularity of wages, and uncertain employment status for workers are significant challenges in the gig and platform sector. The uncertainty associated with regularity in the available work and income may lead to increased stress and pressure for workers. Platform workers are termed as “independent contractors”. As a result, platform workers cannot access many of the workplace protections and entitlements.

The report makes some significant recommendations to strengthen the gig work economy that I would discuss in a later post.

 In the past couple of months there has been a visible rise in the reports expressing fears of an implosion in Japanese, Chinese and Russian economies. The reasons behind these fears are quite diverse. Of course there is nothing new in these reports. Experts have been predicting an implosion in the Japanese economy since the early 1990s’ in the Chinese economy since 2008 and the Russian economy since 1917.

Personally, I do not subscribe to any of the theories that forecast implosion in the Japanese, Chinese and Russian economies in the near future. Nonetheless, I believe that the study of the growth, fiscal and indebtedness profile of Japan is important from two viewpoints, i.e., (i) impact on the global economy, should the BoJ losses control over the situation; and more importantly (ii) impact on the global economy if the US economy (consumption, growth, fiscal profile, etc.) follows the Japanese economy and gets trapped in this vicious cycle of high debt and low growth; and the consequences if USD loses its prominence as the global reserve currency.

I noted a few pointers for this study from some recent reports relating to Japan. These simple and most visible pointers indicate where the US economy could head if a new set of innovative monetary and fiscal policies are not implemented soon. This would be as imperative as the first set of innovative monetary and fiscal policies implemented in the wake of the global financial crisis.

Japanese Debt – the vortex

As per some recent reports the Bank of Japan (BoJ) now owns over 50% of $12.2trn debt issued by the government of Japan. The public debt of Japan is now 266% of GDP. The Public Debt to GDP ratio of Japan has consistently worsened since 1992, when it was below 70%. Considering that the GDP of Japan is rising at a snail pace of 1-1.5%, and the debt is growing at a faster rate, it is most likely that the debt situation may worsen further.

The sharp rise in debt has not been much of a problem so far as it has been accompanied by consistent fall in bond yields. In fact the yields have been negative during 2015-2020. Moreover, since most of the government debt is bought by BoJ and local banks and funds, Japanese yields have been insulated from global trends for the past 3 decades. Even during the global financial crisis, the Japanese bond market remained mostly unaffected by the global turmoil.

The BoJ has been struggling with persistent deflationary pressures for most of the past three decades. For most part of the past two decades, the inflation in Japan has been in negative territory. Inflation has persisted below the target 2% rate, except for a brief violation in 2014 in recent months.

Though the BoJ has not taken the path of monetary tightening to ward off the inflation, the local bond yields have risen to positive territory. Moreover, the reversal in the monetary policy of the global central banker has materially widened the gap between the Japanese and global bond yields. Nothing new in this, but the questions about sustainability of Japanese public debt are hitting the headlines again. Recently, it was reported that “The Bank of Japan may have been saddled with as much as 600 billion yen ($4.4 billion) in unrealized losses on its Japanese government bond holdings earlier this month, as a widening gap between domestic and overseas monetary policy pushed yields higher and prices lower.”

In recent years, the household debt in Japan has also started to rise. Household debt in Japan had reached a high of 78.7% of GDP in 2000. It subsequently declined to a low of 59.9% in 2015. As per the latest available data, it had again reached 67.4% of GDP in December 2021. Japanese households owe a debt of US$3.2trn; which is 23% of total domestic credit of US$13.5trn. A rise in lending rate could further slow the economic growth in Japan; besides enhancing the stress at household level.

 In March 2009, Tata Motors, the largest automobile manufacturing company in India, rolled out an inexpensive small car from its plant in Sanand town of Ahmedabad district of Gujarat. The car was metaphorically named Nano, which means dwarf in Greek and Little in Gujarati. The ambitious project of the Tata Group chairman Ratan Tata, is remembered for multiple reasons.

First, the plant to manufacture Nano was planned to be set up in Singur town of Hooghly district of West Bengal. The then Left Front government acquired the farm land for the project and handed it over to Tata Motors. The then leader of opposition in West Bengal, Mamta Banerjee organized a massive protest that turned violent against the project, alleging that the land of farmers had been acquired inappropriately. Many activists and celebrities supported Ms. Banerjee’s protests and Tata Motors was finally forced to withdraw the project from the state of West Bengal. The then Chief Minister of Gujarat, availed the opportunity and invited Tata Motors to set up the plant in Sanand.

The event established Ms. Banerjee as champion of farmers’ cause and helped her demolish the Left Front fortress in West Bengal. The 35yr old Left Front regime ended in West Bengal in 2011 and since then Ms. Banerjee is ruling supreme in the State.

The event also catalyzed the development of a fourth major automotive manufacturing cluster in Sanand, after Chennai, Pune, and Gurgaon in the country. This also cemented the position of the then Chief Minister of Gujarat, Mr. Narendra Bhai Damodardas Modi, as champion of industrial development and economic reforms. This image eventually catapulted Mr. Modi to the center of Indian politics, making him the most popular political leader and the prime minister in the country in 2014.

The Lakhtakiya car (Rs. One lac car), Nano, however miserably failed to recreate the magic of the Maruti800, the first “common man car” introduced in India in December 1983. Maruti800 remained the best-selling car in India for over two decades. In fact its later variant Maruti Alto is still one of the most popular cars in India. Nano could not last even for one decade. Nano was put to rest in 2018, as Tata Motors decided to cut the losses.

The day Nano was launched and declared a revolution by the media, I intuitively knew that this product was destined to fail. Tata Motors was trying to reinvent the Maruti800, without giving any consideration to the evolution of Indian socio-economic character in the past 3 decades.

The Maruti800 was launched at a time when the Indian middle class was starved of everything, especially quality. “Car” was still a luxury. The economic setup was overwhelmingly socialist and the Maruti800 was actually a public sector product – aimed to provide an affordable mobility solution to the urban middle class population that depended mostly on public transport or two wheelers for commuting.

Tata Nano, on the other hand, was launched at a time when free market has taken so much deeper roots that even communists agreed to acquire farm land to allow Tata Motor to set up a “Car” factory in West Bengal. Tata Motors positioned Nano as an aspirational product to the lower middle class people, emphasizing on Rs one lac cost as a primary selling proposition. The company failed to realize that no aspiration lower middle class family would want to spend Rs one lac, only to be ridiculed by neighbors and relatives as owners of a “cheap” car.

In my view, Nano could have been a successful product, if it was positioned as “convenience”. It could have done well, in my view, if positioned as the second car for shopping in crowded markets, or commuting to school and colleges, or even to be used as a replacement for auto rickshaw etc. I therefore feel that Nano was more of a marketing disaster than an engineering failure.

Applying this analogy to the recent two policy disasters, i.e., Farm Laws and Armed Forces short term recruitment schemes. The three farm laws were well intended and much desired reform measures that had to be abandoned because the government did not market it well. Similar is the case with Agnipath scheme that allows youth a short term (4yr) stint with armed forces. I find that the government could have packaged the scheme better and position it differently. Surprisingly, the Prime Minister Modi, who had firsthand witnessed the Nano fiasco as the Chief Minister of Gujarat, did not apply his learnings to these cases of policy disaster.

The template of NRC/CAA and farm law protests is being used in the latest protests also. If the situation worsens further, and the government is forced to withdraw the Agnipath scheme, before the elections in Gujarat and Himachal Pradesh, scheduled to be held later this year, it will set a dangerous precedent for future reform measures.

 The latest issue of Sarvekshna (March 2022), the periodic journal of National Statistical Office (NSO), presents some important insights into assets and indebtedness of the Indian households. Some of the data is actually contrary to the popular perception. I find this data important since it defines the limits of potential domestic inflows into the financial markets; and the challenges the household face in a persisting negative interest rate environment.

The key highlights of the NSO presentation are as follows:

Asset ownership pattern

·         96.6% of Rural households own some financial asset. This percentage is lower (94.7%) in case of urban households.

·         Average value of financial assets held by a rural household in India is around INR73,000. For an urban household, this value is much higher at INR2,52,000.

·         About 91% of rural households asset value comprises of land and building (69% land and 22% building). For an urban households this proportion is not very different at 87% (49% land and 38% building).

·         Rural household have put 5% of their asset value in Deposits; whereas for urban household this percentage is much higher at 9%.

·         Other assets comprising livestock, vehicle, agriculture machinery/business equipment and shares comprise 4% of assets for both rural and urban households.

·         In rural areas, cultivator households’ average asset value is INR2.2million; while non cultivator households own much less at INR0.8million.

·         In urban areas, self-employed households own INR4.1million worth of assets; whereas for the other households this value is much lower at INR2.2million.

·         The average value of assets owned by the poorest 20% of urban (INR0.96million) and rural (INR0.76million) households is not much different. But for other quintiles the average value of assets owned by the urban households is almost twice as much as the rural households.

Indebtedness

·         35% of rural households have some cash loan outstanding; whereas only 22% of urban households have outstanding loans.

·         Average outstanding debt of a rural household is INR59748; whereas for an urban household the amount is twice as much at INR120,336.

·         More Cultivator households (40.3%) and self-employed households (27.5%) have some debt outstanding as compared to non-cultivator (28.2%) and other urban households (20.6%). Obviously, there is a strong correlation between asset ownership and indebtedness. It would be interesting to find the cause-effect relationship between debt and assets.

·         Andhra Pradesh and Kerala are the most indebted states. Delhi and Meghalaya the least.

·         The debt to asset ratio for rural households (3.8%) and urban households (4.4%) is extremely low by global standards.

 Inference

·         The preference for land and building ownership continues to be high across the country.

·         Financial assets (other than deposits) constitute miniscule part of total assets for both rural as well as urban households.

·         More rural households have debt outstanding. The households owning more assets have more debt outstanding.

·         Much more urban households prefer deposits to shares and mutual funds than rural households.

·         Theoretically the potential for growth of household credit and household investment in mutual funds and shares is immense. But over the past 32yrs of reforms, this potential has remained just that. Hardly any change is visible in the household preference for financial assets (non deposit) over physical assets.

·         Gold does not figure separately in the asset ownership pattern. It is part of the 4% “Other Asset” bucket that includes personal vehicle, shares & MFs, business/agriculture machinery etc.

The Federal Open Market Committee (FOMC) of the US Federal Reserve decided to hike the benchmark bank rate by 75bps to 1.5% - 1.75% on Wednesday. The Committee also reiterated that the Fed will continue to shrink its balance sheet by US$47.5bn till August 2022 and from September the unwinding will be stepped up by US$95bn/month. The FOMC noted that there is no sign of broader slowdown in the economy, while lowering its GDP growth forecast for 2022 to 1.7% from 2.8% earlier. The FOMC statement reiterated the strong commitment to achieve the 2% inflation target. The Fed Officials projected raising it to 3.4% by year-end, implying another 175 basis points of tightening this year. The projection shows a rate cut in 2024.

In the post meeting press meet, Chairman Powell commented that “Either a 50 basis point or a 75 basis-point increase seems most likely at our next meeting. We will, however, make our decisions meeting by meeting.” The Chairman added that ““It does appear that the US economy is in a strong position, and well positioned to deal with higher interest rates.”

The US markets reacted favorably to the FOMC decision. The benchmark S&P500 ended 1.46% higher and 10yr benchmark yields fell 3% to 3.29%. 

Lately, I have been reading a lot of views and opinions about the likely outcome. There are strong arguments for a long corrective phase in the US Economy, just like Japan witnessed post the fiscal and monetary profligation of the 1970s. This Volckerish view anticipates a hard landing for the US economy; tremors across the world and gradual decoupling of global markets from the US markets. The other, equally stronger view is aggressive Fed hikes and tightening taming inflation but not without material demand destruction (recession) followed by a deflationary cycle. This Greenspanish view implies a soft landing for the US economy, premature end to Fed tightening and restoration of “Fed Put” for quick market revival.

Besides, there are multiple views that completely deny the independence of the US Fed from domestic politics and geopolitics. One view, though not convincing enough, portends that the US Fed will be forced to abandon its tightening stance before the mid-term polls begin in the US. The other view is that the inevitable end of current hostilities between Russia and Ukraine would mark the end of the global supply chain woes, resulting in reversal of cost pushed inflation; and the global central bankers’ focus will return to financial stability and growth.

Honestly, with each page of additional reading my confusion has compounded exponentially. In fact, I am confused, like never before, about the basic economic concepts like interest rates, inflation, free markets etc.

What I studied in school was that “inflation” is the rate of rise in prices of goods and services over a defined period. For example, if I could buy a basket of groceries for Rs1000 in June 2021; and I have to pay Rs1100 for the same basket in June 2022; the rate of annual inflation for June 2022 is 10%. If the same rate of inflation persists, the price I would need to pay for the same basket in June 2023 would be Rs1210.

If my income grows at the same rate during this period, I will continue to buy the same basket and there would be no change in my lifestyle (just for example). If my income does not grow by 10%, I will have to cut my consumption or borrow money to maintain my lifestyle. In the first case, the demand for groceries would fall and the seller will be forced to cut prices and the inflation will come down and I will be able to afford the same basket of groceries after some time. In the second case, the inflation for groceries will not come down as the demand sustains; but the demand for money (credit) will rise resulting in higher price for money (interest rates). This means in a simple environment higher interest rates and higher inflation could have positive correlation and move in tandem.

However, the inflation-interest rate correlation will turn negative if (in the above example) I borrowed money in the year 2021 itself and I cannot make additional borrowing to meet higher cost of groceries. In this case, even if my income grows to match the grocery inflation, I will have to cut my consumption to meet the rise in my interest expense.

This implies that other things remaining the same, and it being a free market economy, the correlation of inflation and interest rates would depend on the extent of extant leverage in the economy.

The situation however gets complicated when the largest consumer and borrower (the government) is in a position to control the price of money (interest rates) and/or goods & services. For example, if the government (or central bank) increases money supplies and also cuts the price of money (interest rate) the consumption demand could become artificially high, resulting in higher consumer price inflation. The problem gets further complicated if the government is able to manipulate the purchasing power of the currency (exchange rate) and thus also artificially contain the consumer inflation.

The present situation in the US, as per my understanding, is like this:

The US Fed has increased the money supply (M2) by more than ~3x in the past 13years; while maintaining the price of money (interest rates) close to zero. The exchange rate of USD (DXY Index) has appreciated by about 25% during this period. The inflation was therefore artificially suppressed for over a decade.

The “shutdown” of the global economy in the wake of the pandemic breakout, made the cheaper money and expensive currency irrelevant as the real goods and services were in short supply. The war in Europe further complicated the situation of goods and services supply.

Now, the US central bank is trying to find a lower demand-supply (price) equilibrium by (a) reducing the money supply; (b) increasing the price of money (to contain the consumption demand) while (c) maintaining the currency exchange rate at high level (to ensure cheaper imports).

The debate now is about the trajectory of (i) consumption demand destruction; and (b) improvement in supply of goods and services. A steep fall in demand and steep improvement in supply chains could normalize the situation without much damage to the basic fabric of the economy. However, if the trajectory is flatter, the pain may linger on for years or may be decades.

The other solution could be to control the consumption and prices of goods and services also (Marxist model). This will obviously destroy the basic fabric of the US economy as it stands today.

Insofar as India is concerned, our situation is fairly simple. We have limited leverage and the government intermittently controls the prices of money as well as goods & services, especially during the period of crisis. We just need to pray to Lord Indra for good rains and pray to Lord Ganpati for giving some sanity to Mr. Putin and Mr. Zelenskyy. If these two prayers are answered favorably, we shall be in a position to decouple from US markets and charter our own course (or find a more favorable benchmark to follow). Rest all is ok.

As I suggested yesterday (see A perfect storm), “the best strategy under the present circumstances would be to (a) hold nerves and not panic; (b) review the portfolio for any corrective action that may be needed once the storm passes and the sea becomes calmer.”

To add further to that, I may suggest that the following points may be pertinent to note while reviewing the portfolios:

1.    The higher cost of capital (interest rates) would result in lower fair valuation for equities in general. The growth companies that have debt on balance sheet or need to borrow for capex; and/or where the free cash flows are mostly back ended may see much sharper cut in their target multiples. In fact we have already seen 20% derating in Nifty PE Ratio over the past eight months.

2.    The market consensus was working around 18% CAGR for Nifty earnings over FY23-FY24. The realized earnings growth may be much lower than this. My personal assessment is that we may end up with ~10% CAGR over FY23-FY24.

3.    The popular trades of the previous market cycle (2018-2021) may continue to see sharper valuation rationalization over the next couple of years. Many of these stocks may therefore not participate in the next market cycle.

4.    Monetary tightening, growth slowdown and consumption demand destruction shall essentially result in deflationary conditions in 2023-24. The strong earnings cycle for most non-food commodities may therefore not last much longer. The metal and energy stocks may therefore see sharper correction in multiples and fair value targets.

5.    A new market cycle is mostly led by the market leaders, till a new theme(s) emerges and the stocks from that theme(s) catch the fancy of the market participants. It is therefore always better to be positioned in a large cap basket during the twilights of a market cycle.

In my base case assessment, the risk reward in Nifty from one year perspective is positive at the current levels.

The benchmark Nifty is down about 15% from its October 2021 closing high of 18477. A broader gauge of the market performance Nifty500 is also down by a similar proportion. However, anecdotally I find that damage to the investors’ sentiments is much worse than what this extent of correction in these indices might be suggesting. There could be multiple reasons for the investors’ despondency. For example—

·         Most of the popular trades of 2020-21 that have attracted a whole lot of new investors/traders to the equity markets have lost materially. The Covid trade (Pharma, healthcare); New listed IT enabled businesses like ecommerce platforms and Fintech; popular disinvestment candidates; PLI beneficiaries; self-reliance and import substitution (Specialty chemicals, electronics) have sharply underperformed the markets. A large number of these stocks have corrected 25-75%.

The non-institutional investors have a tendency to chase popular trades. The beta (correlation with the benchmark index) of their portfolios is therefore much higher than a well-diversified portfolio. Obviously, the losses to their portfolio may be much higher than the extent of fall in the benchmark indices. To make the matter worse, the visibility of recovery of their losses is much lower, as the rationalization of the valuations in the popular trades may be more permanent in nature. We might not see loss making new age businesses; commodity chemicals; generic pharma and API makers; and electrical appliance assembly units etc. trading at crazy multiples in the next few years at least.

·         Most equity and debt mutual funds have yielded negative or nil returns in the past 6 months. The real return on bank fixed deposits has also been negative for the past six months. The global and domestic markets are indicating that the probability of any reversal in this trend is very low for the next few months at least. The New investors, who have not experienced a genuine bear market (e.g., 1990s) may be feeling nervous about losing their hard earned wealth.

·         Nifty Smallcap 100 has lost close to 28% from its January 2022 high; almost twice the losses in benchmark Nifty50 or Nifty500. The actively managed portfolios that have more smallcap stocks (high growth at reasonable valuation) may therefore be suffering more damage than what the benchmark Nifty is indicating.

·         The macro environment (both domestic and global) has deteriorated in recent months, especially after the war broke out between Russia and Ukraine. It appears that the measures adopted to arrest the macroeconomic deterioration may be friendly to the equity valuations. The rate hikes, liquidity withdrawal, fiscal tightening etc. have diminished the visibility of growth capex. There are early signs of consumer demand destruction in discretionary spending due to inflation and higher rates. The investors may be fearing even deeper correction in sectors like cement, metals, consumer electronics etc.

It is important to understand that the markets are caught in a perfect storm – (i) Liquidity is shrinking; (ii) cost of capital is rising which requires target valuations to moderate; and (iii) growth environment is clouded which requires earnings forecast to be downgraded.

The best strategy therefore would be to (a) hold nerves and not panic; (b) review the portfolio for any corrective action that may be needed once the storm passes and the sea becomes calmer. It may not be a good idea to go out on the deck and try catching some fish.

What would be the first thought that crosses your mind, when you hear a veteran fund manager betting his shirt on Nifty falling 30-40% in the next 6months! Yes, you heard it right. Last week, a former CEO/CIO of a large AMC, confidently told an audience composed of top bankers and HNIs that Nifty is bound to come to sub 10000 levels in next 6months and gold is the only safe haven under the present circumstances.

In its latest meeting (6-8 June’22) the Monetary Policy Committee (MPC) of RBI unanimously decided to hike the policy rates by another 50bps. Last month, the MPC had announced an unscheduled 40bps hike in rates. With this hike, the policy Repo Rate (rate at which RBI lends short term money to banks) is 4.90%; Standing Deposit Rate (rate at which banks can park their surplus funds with RBI) is 4.65%.

A recent media report highlighted remarkable reduction in the infant mortality rate (IMR) of India. India’s IMR improved from 47 in2010 to just 28 in 2022, bringing it closer to the global average of 27. (see here)

A lot of the recent macro research effort of stock market participants has been devoted to the state of rural demand in the country. In their latest commentary, most consumer goods companies have reported continued pressure on rural demand. Even though many market economists and analysts have forecasted imminent recovery in rural demand, the corporate commentary did not sound that much sanguine. Nonetheless, higher food prices and expected good monsoon are expected to help the rural economy to some extent.

The prices of publicly traded financial assets like equity shares and bonds etc., is materially influenced by the sentiments of fear and greed amongst the market participants, at least in the near term. The sentiment of greed drives the participants to bid higher prices for a security, even though the economic fundamentals underlying that security may not fully justify such price. Similarly, the sentiment of fear prompts the market participants to offer the securities held by them at relatively cheaper rates. The equilibrium of sentiments of greed and fear keeps the markets stable & healthy; whereas dominance of either sentiment induces excessive volatility and irrational pricing in the markets. Extreme dominance of either sentiment usually marks the peak or bottom (as the case may be) of a market cycle.

If we examine the current equity market behaviour, it appears that the sentiment of fear is gradually becoming dominant amongst the market participants. The following five signs, for example, indicate that relatively weaker participants might be moving to sidelines or even withdrawing from the markets. This is usually indicative of the beginning of the process of a market cycle completing its downward journey. The actual bottoming though may take some time and further downward move.

Market activity shrinking

In the past six months, the market activity has cooled down conspicuously. The volumes in INR terms as well as in terms of shares traded and number of trades executed have remained on the lower side, indicating shrinking participation in the market.

At peak of the market in October 2021, the average traded volume in Oct’21 was over INR4000bn; however in May’22 it contracted to was below INR2800bn. Similarly, the number of trades in Oct’21 was over 130bn; whereas in May’22 only 108bn trades were executed on NSE. In terms of number of shares traded – in Oct '21 83.58bn shares were traded on NSE. In May’21 the number had contracted to 43.91bn, almost half of Oct’21.

 

Volatility persisting at higher levels

Since the benchmark Nifty recorded its all-time high level in October 2021, the implied volatility (popularly called the fear index) has persisted at higher levels; even though it has eased in the past 10 days.

Broader markets underperforming

The market breadth has remained negative in eight out of the past twelve months. The market breadth on NSE was worst in at least the past twelve months. In fact the market highs in October 2021 were recorded with a negative market breadth and high volumes; indicating a distribution pattern in the technical analysis parlance. Nifty50 has corrected ~10% from its latest closing highs; whereas Nifty Smallcap 100 index is down ~23% from its latest high levels; even though the smallcap high (January 2022) was recorded 3months later than Nifty (October 2021).

Sector wise also YTD 2022 only Financials (1%), FMCG (1.5%), Auto (5%) and Energy (14%) sectors have yielded positive returns. IT Services (-22%), Realty (-15%), and Pharma (-12%) have been the worst performing sectors.

 

Valuations are now more reasonable

As the sentiment of fear has started to dominate the markets, the valuation excesses are now correcting. The 12month forward PE Ratio of the benchmark Nifty Index is now closer to 5yr average level. The price to book (P/B) ratio for Nifty has also corrected sharply from the higher levels seen in October 2021.

The valuations are now closer to “fair value” zone, a pre-condition for completion of the down leg of a market cycle (bottoming). It is however important to note that in many cases it has been seen that the earnings estimates are materially revised lower. In that case the “fair value” curve may shift sharply downward. 

Global markets – sentiments most bearish since March 2020

As per the Bank of America’s (BofA) proprietary Bulls and Bears Indicator, the global fund managers were most bearish in May 2022, since the Pandemic outbreak (March 2021).