Vijay Kumar Gaba

Wednesday, March 4, 2020

Anatomy of a bear market in equities

In past seven weeks, the Indian equity markets have corrected sharply. The benchmark Nifty50 index has fallen almost 9% in this period. The gauge of fear (volatility index) has risen over 60% in this period of seven weeks.

This sharp correction in values, when everything appeared to be working normally for Indian equities has triggered an intense debate about the sustainability of present levels of equity prices. Some prominent analysts and investors have highlighted that the 11 year old bull phase in global equities that started post Lehman collapse and commencement of easy monetary policies may just about to be over. The disruptions created by spread of coronavirus (COVID-19) may have opened many fault lines in the global financial system, hitherto camouflaged by the persistence monetary stimulus by central bankers.

Many technical analysts and chartists also fear an extended winter for Indian equities this time.

Since I have recently increased my allocation to equities, by cutting overweight on gold and bonds, many readers have wanted to know my reactions to these prominent market voices.

I would not like to comment on the views of various market experts. I am sure all of them have very strong basis to form their opinions and views. Moreover, I had explained my rationale for changing my asset allocation (see here).

I would not like to entertain a "valuation" argument at this point in time, because a lot of businesses in India appear standing at the threshold of a major transition. Therefore, both the numerators and denominators in the valuation formulae could be subject to dramatic changes in next 3-5years.

I would however like to highlight a few well know facts about the Indian equities, which make me believe that the downside in Indian equities may not be significant from the current levels. Since the rate trajectory appears firmly down to me, the relative outperformance of equity looks more likely to me.

1. The Indian equities have been in a bear market for past five year at least. The advance decline ratio of the issues traded on NSE has been negative for five years now.

2. Amongst the benchmark indices, only BankNifty has matched Bank Deposit returns over past 5years. Nifty Small Cap has returned negative return and Nifty just about managed the savings bank interest.

Over past two years, only Bank Nifty has returned positive return. Small and Midcap indices have lost massive ~18% CAGR and ~8% CAGR respectively.

3. Of various sectoral indices, only financials & services, mostly driven by few private banks and NBFCs, have consistently beaten the Bank term deposits, over past five years. Many sectors like Media, PSUs, commodities, Auto, Pharma, and Infra have given negative return of ~2% CAGR to ~14% CAGR over past five years. The returns have been significantly poor over past 2years. Only Financials and IT could beat the bank deposit returns over past 2years.

I am not at all suggesting that the Small Caps, Commodities, PSUs etc that have severely underperformed in past five year may outperform henceforth.

The point I am trying to make is that (i) a blanket opinion about Indian equities, or any market for that matter, may be misleading; and (ii) there could be plenty of opportunities to be availed in markets.

Tuesday, March 3, 2020

3QFY20 GDP growth - Worrisome

The recently released data of country's economic growth once again highlighted that the current slowdown may not be entirely cyclical and it may have some element of structural weakness in the economy. In particular, the continued weakness in investment activities is worrisome. Also, sharp fall in nominal growth and poor growth in per capita income does not augur well for the midterm growth prospects. The latest PMI and employment data for February indicates that the slowdown continues in the current quarter also.

The second advance estimate for FY20 GDP growth is now 5% (vs. 6.1% in FY19). Per capita GDP is now expected to grow at 3.9% in FY20 (vs 5.1% in FY19).

In the reporting quarter (3QFY20)—

The production of coal (-4.3% yoy), Crude oil (-6.2% yoy), Natural Gas (-6.6%, yoy), and Commercial vehicles (-17.3%, yoy) recorded significant contraction.
Overall manufacturing activities contracted 0.3% yoy.
The private consumption at 62.4% of GDP in 3QFY20 was highest in recent years, while the investment at 26.1% of GDP was lowest in recent years.
Railways (-4.7% yoy) and air cargo (-7.2% yoy) recorded negative growth, while marine cargo recorded a nominal growth of 0.1%.
The Consumer Price Index (CPI) was higher by 5.8% yoy, while Wholesale Price Index (WPI) was higher by 1% yoy. Consequently, the nominal growth for the quarter was also lower at 7.7%. As per the latest official estimates, nominal GDP is expected to grow @ 7.5% in FY20 (vs 11% in FY19). This is a massive one third fall in nominal GDP growth. Per capita nominal GDP growth for FY20 is now estimated at 6.3% (vs 9.9% in FY19).

It is pertinent to note that the finance minister assumed over 10% nominal growth for FY21 in her budget assumptions, which is massive 30% growth from 3QFY20 level. The nominal GDP is important because the household disposable income, corporate profitability and government tax revenue are directly affected by the nominal GDP growth.

The foreign trade recorded sharp deceleration. The share of imports in GDP has contracted to 21.9% in 9MFY20, (vs 24.9% in 9MFY19), while exports in the same period decelerated to 19.6% from 20.9%.
Agriculture sector GDP growth of 3.5% (yoy) during 3QFY20 is a relief. This marked third straight sequential growth for farm sector. However, considering very low base (2% in 3QFY19), it may be little early to celebrate the end of rural stress.
The nominal growth of 13.7% in farm sector (vs 2.3% in 3QFY19) was even more encouraging.
The population growth trend was declining since FY14. However from the current year FY20 this trend is estimated to have reversed as the population is forecast to rise to 1.341bn by March 2020 against 1.327bn a year ago, registering a growth of 1.1% (vs 1% in the previous year). This explains faster deterioration in per capita numbers of GDP.
The bank deposit growth has accelerated in FY20 from last year. The deposits grew 9.8% in 9MFY20 (vs 7.9% in 9MFY19). The bank credit however declined materially in this period from 12.4% in 9MFY19 to 9.2% in 9MFY20.

In 3QFY20 particularly, bank credit declined to 7% (vs 13.9% in 3QFY19), while deposits grew 9.7% (vs 8.9% in 3QFY19). This is a rather worrisome trend from bank profitability as well as over GDP growth perspective.