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Fighting Bear Attack

A fierce bear attack has hammered investor confidence. Now the markets are tentatively poised as bulls try to hang on to liquidity flows

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As all financial markets go — and have gone in the past — nothing is certain. Nothing. Just a bare couple of months ago, markets were merrily making new highs. Huge inflows into mutual funds kept bellwether stocks spiraling upward into higher and higher terrain, and scaling peak after peak. Things changed, though, almost overnight. The falling rupee and rising crude oil prices put a halt to the raging bulls.

The stock markets now spiralled downward as sellers cashed in their (blue) chips and markets caved in, shrinking 10 per cent in quick time. The Nifty nosedived over 1700 points in a mere two months, sending the bears into overdrive and the bulls scurrying for cover. Some of the big questions in most investors’ minds are now: Is this but a short-term drop or do we have to battle the bears through another winter of our discontent? When will we see a rejuvenating uplift in small- and mid-cap stocks?

Depending on whom you ask, the stock market could be faced with more turbulent times as the rupee struggles to hold its own against the dollar and the dire liquidity crunch in NBFCs stifles and chokes economic growth. However, the good and comforting news is that the bearish charge is soon expected to peter out. Veteran emerging markets expert, Mark Mobious, says that stock market corrections have rarely lasted more than seven months. But the Indian market has been far more resilient. “Emerging markets are down 20 per cent. The Indian markets have done rather well. A bear market means a fall of 20 per cent. The Indian markets could see a further drop, but it will not be much further down,” says Mobius, Founder, Mobius Capital Partners.

Still, the market is not in a very obliging mood for the bulls to stage a major comeback. Such is their slothful state that an ex-CIO of an MNC mutual fund, who started his own wealth management firm, has been turning down opportunities to accept foreign monies to start an India fund. Instead, the fund manager has diluted his position in Indian stocks in favour of fixed deposits because he believes that the Indian markets are still firmly encompassed in a bear hug.

The turbulence has taken a heavy toll on stock prices – and on the confidence of investors, who seem to have bought into a raw deal, and getting worse by the day. Mid- and small-cap stocks have tumbled more than 17.6 and 31.1 per cent, as compared to the Nifty’s 0.6 per cent positive returns.

A falling market, naturally, turns out to be a boon for value seekers. But market watchers say there are not many now. Many investments have been charred in the mid- and small-cap devastating carnage, and that’s keeping investors well away. According to experts, direct investors are looking for any small upticks in the market to be able to recover at least some of their losses.

So a full-fledged recovery seems some way off. The markets are now looking at overshadowing events such as state government elections, which are expected to cast an ominous overhang on the stock gyrations. In some states, the electoral mandate could be not a little mixed.

Second, the rupee has been consistently testing levels of Rs 73. When the currency has fallen below Rs 73, the stock markets have gone into a tailspin. If the rupee does not recover some lost ground soon enough or does not stabilise at these levels, stocks could again come under huge downward pressure.

One indicator that seems to have come charging to the rescue of the bulls is that crude oil prices seem to have finally come off the $80 a barrel highs of only a few months back. However, they have not eased sufficiently to soften the enormous pressure piling up on the balance of payments, and get the bulls thundering back. Still, the bulls are holding 10,000 levels on the Nifty quite well, showing that a trickle of investors are yet not hesitating to “buying the dips”.

Judging by the way that the markets are shaping up, in the better part of the rest of the year 2018, they could meander sideways, awaiting the next little leg up. One big reason for this is that earnings growth — the ultimate driver of stock prices — has not yet seen the huge revival everyone had been apparently hoping for. In the second quarter of FY19, net profit grew about 5.2 per cent year on year, a slightly brighter showing than the previous year’s performance, though not yet good enough to spin the wheel in the direction of the bulls.

By contrast, in the first quarter of FY19, net profit growth was flat, comparatively. The operating profit margin in Q2 FY19 was only slightly lower, at 19.1 per cent, than the 21 per cent of a year ago.

Says Swati Kulkarni, Fund Manager, UTI Mutual Fund: “One of the big drivers for the markets is earnings growth and that has not been visible in the past few quarters. Stock markets could sway sideways till a clear earnings pickup is visible.”

Banking on Valuations

The only good factor is that the Nifty’s valuation has slipped from a high PE of 28 times to about the apparently reasonable present level of 25 times. Nevertheless, even going by past standards, the valuations are still above average. So, experts say that unless earnings growth picks up pace in a huge way, the valuations will undoubtedly not look appealing nor reasonable to investors any time soon, and definitely keep value-seekers at bay.

“While the Nifty is off its all-time highs, valuations have come down and most of the major challenges on the macro front are abating. While all these interlinked factors suggest that one should go all out into the equity markets, the reality is that stock picking and sector allocation will be very crucial factors in this uncertain and dicey environment. Stocks that have been beaten down severely and now seem very attractive may not be the right ones as the current bounce back could be ephemeral,” says B. Gopkumar, ED & CEO, Reliance Securities.

Volatility has also stepped up quite a bit. In the past few months, the Nifty has seen swings of more than 500 points either way in a single day. This perhaps means that the markets may not yet be ripe for meaningful re-rating from the present levels, and that the current valuation multiples are likely to persist or even slide further down from levels now. Some quality stocks, though, have held up considerably well despite the overall increase in froth levels.

Says Gopkumar, “We continue to expect the Indian equity market to be volatile, with a downward bias, against the backdrop of political gyrations and macro uncertainties. In such a scenario, investors are advised to exercise a bottom-up approach in investing with those companies with a proven track record and valuation comfort.”

The Risk of Global Yields
Also, US Treasury yields are another huge factor weighing down on markets. The 10-year Treasury yield is now nudging 3.3 per cent, while the US Fed is expected to keep raising interest rates further in the coming year due to the broad and muscular US economy. If yields step up any higher, investors in the US will seek the relative safety of a high-yielding bond rather than foolishly risking investments in emerging markets. Also, with inflation less than 2 per cent, and interest rates hovering at around 3.3 per cent, the appeal of better real return in the US is indubitable. Overall, this tends to drive more and more investors towards fixed-income investments and shying away from the more riskier equity assets.

This is also one of the reasons why foreign investors have pulled out massive sums from the domestic markets. Since April this year, they have hurriedly withdrawn more than Rs 70,000 crore of investments in a risk-off trade that has kept the Indian markets drunkenly reeling under the selling pressure.

Says Gopkumar, “Foreign institutional investors (FIIs) have been a lifeline for the Indian market, particularly for Indian equity. But they are grappling with a new challenge to deliver returns in their own currency. While domestic factors have been the prime concern, the chief reason for the weak Indian rupee is the persistent strengthening of the US economy.”

FII selling may perhaps ease in coming months if the rupee stabilises at current levels of between Rs 72 and 74. But the damage has already been done, and how!

On the other hand, nowadays it is the domestic investor, instead, who has been throwing the much-needed lifeline to the markets, small though it be. Domestic investors have been pouring nearly Rs 7,727 crore into mutual funds through systematic investment plans in September 2018. Another shot in the arm for the Indian markets is the steady and regular purchases by domestic investors. In the last six months, Indian mutual funds have purchased shares worth more than Rs 80,000 crore, countering the heavy selling of FIIs, rupee for rupee, and some more.

On the other hand, the liquidity crunch in the NBFC market is showing. Most NBFCs have stopped home loans until they can clean up their balance sheets and fix their asset-liability mismatches. NBFCs have to redeem and roll over nearly Rs 1.5 lakh crore of commercial paper in the next one month. With a lack of alternative sources of funds, they have been compelled to cut back on retail lending.

This has taken a huge toll on the Indian market. Public offers or IPOs, that were once heavily funded by NBFCs and which accounted for the bulk of over-subscriptions, have dried up. Says Ajay Bagga, veteran market expert, “NBFCs’ liquidity crunch has seen a reversal in the market. As long as the situation isn’t resolved, there are very few drivers for the market.”

The bulls are hanging on to the shreds of liquidity flows. But unless the NBFC situation is resolved and earnings growth kicks in, bulls will continue to face testing times.

We hope that things don’t go down to the wire.

Raamdeo Agarwal, Motilal Oswal Financial Services

Motilal Oswal Financial Services recently released its 23rd Wealth Creation study which points out that two key drivers of intrinsic wealth are ROE and earnings growth. Current market valuations are factoring high earnings growth, which has been elusive, so markets could remain soft.


On what are the differentiating factors in valuation
We all know what is a good company, or a bad management, or about the importance of compounding. We also know how to value a company. But how do you price it? Basically, you are looking for inefficiency in valuations. If something can correct 40-50 per cent, then where is the science of valuation? But there is some method in the madness. It is an approximate science and approximations at times are gross. So we have to look at 15-20 years, and what makes companies like TCS and HDFC Bank tick. And also, what is the future of TCS and HDFC Bank for the next decade or so.

On ROE versus growth; when one is better than other
There are two basic drivers: return on equity and earnings growth. If you want to invest, and you want 8 percent return, you will go to the bank. So typically, you would want 5 per cent more from equity. Since the Sensex started on 1st January 1984, the returns have been 13 per cent CAGR, which is the cost of equity plus 5 per cent typically. If a company is earning less than 13 per cent, do you think there is any value in it? The market should not give much value to a company that does not have a return on equity which is higher than the cost of equity.

On what the market is pursuing now
What this market is doing right now is relentlessly pursuing growth. All finance companies are earning 11-12 per cent, and when one is giving a price-to-book value of 4-5 or six times, that is a problem. Even if markets love growth, we should not give any price. Growth from Bajaj Finance is very different from growth from other finance companies. So I would say that getting growth before establishing profitability is not valuable. Market does not value it. Establishing a high ROE for a long time is the biggest sign of success, and it is very rare.

On capex required for growth

Growth requires capex. Low ROE companies will require high capex. Those with high ROE will require low capex. In the short run, market makes a pricing mistake. Only companies whose ROE is higher than the cost of equity are entitled to grow.

Second, low ROE companies should focus on increasing ROE, and high ROE companies should focus on increasing growth. The moment your ROE is lower than the cost of equity, then you should not grow, because you destroy value.

On where we stand on total valuations
When it comes to peeping into the future, market is inefficient. The average PE of the market stands at 17, but the market is trading at 24 PE, after removing the banks. This is for all the 1,500 companies that are trading in the market, after the correction. It shows that corporate profit is not to the potential of the economy, while the market value of the stocks is still at 73 per cent of GDP. So profits have to come, or investors may start to get impatient.  

Mark Mobius, Mobius Capital Partners

Mark Mobius was recently on a whistle-stop visit to the Morningstar Investment Conference in India. On its sidelines, he spoke to Clifford Alvares on a host of things from elections to NBFCs to where the rupee is going.


How long do bear markets last?
I don’t think that bear markets in India last for very long, because things are moving very fast, and then you got a young population. So I think any bear market here would may be last no more than a year and the average is less than that.

Bear markets are really hard on sentiments?
People got to realise that bear markets are an opportunity not a problem. They’ve got to look at companies very carefully, try to find companies with strong balance sheets that have dividends that are growing and invest. Don’t wait because that’s a great opportunity. When people are very bearish and very concerned about the market it’s the best time to invest.

Investors see the falling tickers and begin to worry. What should they do?
The best thing to do is you know the company and if you are convinced the company is good then average the cost. Go in slowly and put 10 per cent in this month and 10 per cent the next month. Provided that you are convinced the company is good, that should be no problem. It’s like systematic investment. In a down market, it’s a very important. Usually, it is not a good idea to wait until there is a change on the upside, because once you do that, you will probably miss out.

When the recovery comes, where do you think it will come?
The first thing you’ll see is recovery in the consumer sector. You see consumption moving up, you will see prices begin to recover in a lot of areas.

Are you launching any India-targeted funds?
We are still waiting for permissions to invest in India. We have about $160 million in our new fund, and India would be probably getting about 20 per cent of this, provided we can invest.

So how do you see the Indian elections next year? 
Modi will probably still be in office. But he will probably have to accelerate the reforms programme, and also make the foreign investment process a lot easier.

Do you think the NBFC sector story is over?
No, it is not over. You got to see the liquidity situation improving, and it is probably going to get worse before it gets better. You got to invest in NBFCs selectively.

How far do you see the rupee falling?
It could get weaker, but a lot of it is already in the market.

Gold has been a silent spectator. How do you see it now?
I believe in gold, and that everybody should have gold in their portfolio. Gold is a store of value, more than anything else. At the end of the day when things begin to fall apart, and Indians are very aware of this situation of declining currency, gold over the long term is really good.  

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