The benchmark indices in India are now trading at their highest ever levels. In fact, in the past one year, India (+9.6%) has been one of the best performing equity markets in the world, in line with the emerging market peers like Brazil (+8%), Russia (+9%), and Indonesia (+7.5%) etc. Only a few emerging markets like Venezuela (+107%), Argentina (108%), and Egypt (+15%) have done much better.
For many Indian investors these statistics could be meaningless. To some it may actually be annoying as the performance of their individual portfolio may not be reflecting the benchmark performance. Regardless, largely the equity market returns have been reasonable, considering the challenging environment. It is therefore a moment to celebrate.
Once the celebrations are over, it would be appropriate to ask ourselves “whether at ~18700, Nifty is adequately taking into account all the factors that may impact the corporate performance, risk appetite, liquidity and financial stability in 2023?” In particularly, I would like to assess the risk-reward equation of my portfolio especially in light of the factors like the following:
Stress on discretionary spending
In the recent months several companies have rationalized (or announced the plans) their workforce. A significant number of highly paid workers are facing prospects of job loss. Anecdotal evidence suggests that the uncertainty created by a 2% workforce rationalization could temporarily impact the discretionary consumption plans of at least another 48% employees who retain their jobs.
Reportedly, IT hiring from the top colleges in India are likely to witness a 50% fall in 2023 (see here). We might see similar trends in other sectors also as most management have guided for a moderate growth in next few quarters.
My recent visits to several rural areas indicated that discretionary consumption in farmer households has already been impacted by poor income in the 2022 Kharif season. As per reports La Nina (excess rains) conditions that impacted crops for the past four seasons, are likely to persist through Rabi season, while the 2023 Kharif season might witness El Nino (drought like) conditions. (See here)
Erosion in wealth effect
On the last count India had more than 115 million crypto investors (see here). About two fifth of these investors were below the age of 30, thus having a strong risk appetite. These investors had seen sharp gains in their crypto in 2020-21m but apparently they are now sitting on material losses in their portfolio.
A significant number of new listings, especially from tech enabled businesses, are trading at material losses to their immediate post listing prices. These businesses typically have a material part of their employee compensation in the form of ESOPs. Many employees who had seen substantial MTM gains in their ESOP values have witnessed material drawdowns in their portfolio values. A few of them might be facing double whammy of material MTM losses and tax liability.
A number of small and midcap stocks that jumped sharply higher in 2020-21 have corrected significantly in 2022.
Obviously, the wealth effect created by the euphoric movement in stock and crypto prices has subsided to some extent. This submission of wealth effect shall also reflect on risk appetite, consumption pattern and investment behaviour of the concerned investors.
Tightening fiscal conditions
Lot of market participants are betting on continued fiscal support to infrastructure & defence spending, and incentives like PLI etc.
It is pertinent to note that the forthcoming budget would be the last full budget before the general elections to be held in 2024. It is likely the government chooses to increase the social sector funding at the expense of capital expenditure next year. The disinvestment program might also be slowed down to avoid adverse publicity for the government. Imposition of additional tax(es) or hike in capital gains tax could also be considered. All these events could impact the investors’ sentiment.
Rising external vulnerabilities
The external sector has been weak for a few quarters now. The trade deficit in October 2022 widened to a worrisome US$26.91bn. Exports dropped ~17% in October 2022 on slower global demand; while imports were still higher by ~6%.
Notwithstanding the efforts of the government to improve trade account by import substitution and export promotion; the exports have grown at a slow 4.3% CAGR in the past three years; whereas the imports have registered 14.3% CAGR in the same period, resulting in larger trade deficit. The external situation thus remains tenuous.
It is pertinent to note that the World Trade Organization (WTO) has projected a sharp slowdown in world trade growth in 2023. (see here) Obviously, the pressure on balance of payment will remain elevated in 2023.
Cash on sidelines may protect the downside
Overnight (liquid) funds are now yielding a return of ~5% p.a. Bank deposits are offering 5.5-6% return. Under the present circumstances, at ~18700, the upside appears limited to 8-10% while the downside could be much more than 10%. Obviously, the risk-reward equation is not favorably placed at this point in time, and the opportunity cost of holding cash is not bad. This could keep a lot of money waiting at the sidelines.
Higher cost of carry and margins have also resulted in lesser leveraged positions in the market.
The cash on the sidelines and lower leverage may keep the downside somewhat protected.
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