Do it yourself

It was summer of 2013. The mood on the street was gloomy. The stock markets had not given any return for almost three years. USDINR had crashed 28% (from 53 to 68) in a matter of four months. GDP was on course to drop to 5.5% after growing at a rate of over 8% CAGR for almost a decade. Current account deficit had worsened to more than 6% of nominal GDP (the worst in decades). The Fx reserves of the country were down to US$277bn, sufficient to meet just 5 months of net imports. The confidence in the incumbent government had completely depleted. The people were on the street protesting against ‘corruption’ and ‘policy paralysis’.

The global economy had still not recovered from the shock of the global financial crisis (GFC). The thought of unwinding of monetary and fiscal stimulus provided in the wake of being unwound was unnerving most emerging markets ((Taper Tantrums), including India.

India, which was touted as TINA (There is no alternative) by the global investors just five years back and had become a key member of BRIC and G-20; was already downgraded to “fragile five” by some global analysts. This was the time when the government of the day took some brave decisions. One of these decisions was to appoint Mr. Raghuram Rajan, former Chief Economist and Director of Research at the IMF and then Chief Economic Advisor to the Government of India, as the 23^rd governor of the Reserve Bank of India (RBI). Mr. Rajan with the full support of then Finance Minister, P. Chidambaram, took several effective damage control measures, and was able to pull the economy and markets out of crisis within a short period of one year. USDINR gained over 11%, stocks markets recorded their all-time high levels, CAD improved to less than 1% of nominal GDP, real GDP growth recovered to ~7% (FY15).

The situation today is nowhere close to the summer of 2013. Nonetheless, the feeling is that we could potentially head to a similar situation in the summer of 2025.

Worsening external situation - rising global trade uncertainties due to the US unpredictable tariff policies, depleting Fx reserves, weakening USDINR, declining FDI and persistent FPI selling, pressure on the government to cut tariff protection for the domestic industry, and rising probability of a global slowdown.

Slowing domestic growth - Prospects of a poor Rabi crop aiding pressuring food inflation and RBI policy stance, crawling manufacturing growth, limited scope for any meaningful monetary or fiscal stimulus, etc are some of the factors that suggest the probability of any meaningful growth acceleration in the near term is unlikely.

Uninspiring policy response – The policy response to the economic slowdown and worsening of external situation is completely uninspiring so far. The measures taken by the government and RBI appear insufficient and suffer from adhocism.

For example, RBI has announced several liquidity enhancement measures in the past three months. These measures have been mostly neutralized by USD selling by RBI to protect USDINR and rise in the government balance with RBI (inability of the government to disburse money quickly to the states or spend otherwise. Risk weight cut for lending to NBFCs and MFI etc. is too little and too late. The damage to credit demand and asset quality in the unsecured segment is already done, and is not easily reversible.

The fiscal stimulus (tax cut on for individual taxpayers) could support the economy if at all, from 2H2025 only. There is a risk that the taxpayers in lower income segments (Rs 7 to 15 lacs) might use the tax savings to deleverage their balance sheets by repaying some of their high-cost personal loans etc. In that case this stimulus could have a negative multiplier on growth.

The short point is that (a) we are yet not in a crisis situation; (b) if not handled effectively and with a sense of urgency, the current situation may not take long to turn into a crisis.

The government, especially the finance minister and RBI, would need to urgently take several steps to take control of the situation and inspire confidence in the businesses and investors. Leaving it to the external developments, e.g., USD weakening due to falling bond yields in the US; energy prices easing due to Russia-Ukraine truce; trade normalcy restoration due to Sino-US trade agreement and normalization of Red Sea traffic; a plentiful monsoon easing domestic inflation; etc. may not be a great strategy - even if it works this time.

As they say – “it is great to have faith in God, but always lock your car”.

Equity markets are making new highs every day. Other assets like gold, bitcoin, bonds, cash, real estate, etc., are also performing decently. Logically, investors should be happy and looking forward to a great holiday season. However, multiple interactions with investors and other market participants, over the past couple of weeks, indicate to the contrary. Investors appear stressed for a variety of reasons.

 In the past one week, I discussed the current situation in the Indian financial markets with some seasoned investors and experienced market participants. It was after almost three months that I got an opportunity to discuss the markets with such an enlightened group of people. Mood of markets definitely appears to have changed remarkably since June 2022.

After my interaction with some senior market participants (bankers and investors) I had noted that the mood was rather despondent. The consensus in June appeared strongly in favor of a slow grind over the next 6-9months. The reference point of discussion was mostly the 2008 market crash. The market participants sounded cautious about rising cost of funds and drying liquidity; and feared major defaults that could trigger a global contagion. (see here).

Reactions of the market participants this time were diametrically opposite. Most of them were in fact trying more to convince themselves about “all is well” rather than discussing the market conditions objectively. They refused to acknowledge that the global macro conditions have deteriorated materially in the past three months, led primarily by Europe and China. They argued forcefully in favor of a “decoupled India” and “TINA”. Despite no visible improvement in Indian macro conditions; below par corporate performance in 1QFY23 and dark clouds over export growth that have sustained the 1.4% CAGR for India’s GDP in the past three years.

The platitudes like “Decade and century of India”; 5^th largest economy ahead of the UK” were advanced with impunity; as if they are trying to justify change in their stance from “extreme bearishness” to “cautious optimism” and “uber-bullishness”. Some of them even claimed that they did never advise underweight on Indian equities.

The September 2020 Global Fund Managers' survey conducted by the Bank of America research team found that 58% of the global fund managers believe that global equities are now in a bull market. This percentage is materially higher than the 46% in August 2020. The proportion of fund manager who believe it to be a bear market rally has reduced in September 2020 to 29% from 35% in August 2020.

An overwhelming proportion of fund managers believe that "Long US Tech Stocks" is the most crowded trade. Though, the fund managers believing gold to be a crowded trade has reduced materially in September, as compared to August. "Short USD" trade is also seen gaining some popularity .

Continuing with the theme, JP Morgan Research (as quoted by Niels Jensen of Absolute Partners), finds that S&P500 is now pricing in almost 0% probability of a recession in US; while 5yr US Treasuries are pricing in almost 100% probability of a recession.

In his latest communication to investors, Niels warns that investors (and fund managers) may be flirting dangerously with TINA (There is No Alternative) in their chase for equities, especially US Tech Stocks. As per Niels, One of the most reliable predictors of long-term equity returns is the starting earnings multiple. When earnings multiples are in the low 20s, the best you can hope for over the next ten years is low single digit annual returns. As you can see, 10-year returns turn negative when the starting multiple is about 25 or higher.

Niels highlights that, as per Shiller's Cyclically Adjusted  P/E Ratio (CAPE), S&P500 trades at massive 32x earnings multiple, which means apocalypse may just around the corner and the investors must be running to the hills.

In a later post, I would like to evaluate where India stands in all this.