We have
again reached a point where attempting to explain an utterly irrational market,
in which sentiments turn quickly overriding any fundamental news flow. With stocks
reacting like petulant, schizophrenic children, fundamentals are totally
meaningless: rally of over 800 points on Sensex in last 3 days has become
perfect example- as unchanged credit rating by Moody’s and bullish note by
leading broker, both said absolutely nothing of improving business/economic
environment - have been enough to override last 1.5 years of actual deteriorating
fundamental data.
Despite
GDP growth slumping by over 250bps in last 1 year reaching the lowest point since
2003 in Q2FY13 at 5.3%, inflation remaining stubbornly high, current a/c deficit
at levels difficult to imagine and fiscal deficit showing no sign of improvement;
equities have clearly given all a miss rising by over 20% in YTD12 hitting
19400 on Sensex.
In the
meantime all the sell side firms are turning overtly bullish on outlook for
2013, for reasons they themselves fail to explain and have contradicted in the
past. I wish I can repost all my collection of Outlook for 2012 published last
year by leading brokers; needless to say they were all cautious or bearish when
Sensex was at 15500. I don’t mean to demean these institutions bcoz they have
been very successful for spotting new trends, stock ideas and market movements
in the past. Could it be that they were just lucky–in an up market? I think in
estimating future, there are only good ideas, bad ideas, and luck. And really,
it’s mostly luck.
Nasim
Taleb in his books Black Swan and Fooled
by Randomness has addressed this issue brilliantly. His basic premise
is that financial experts underestimate risk. As such they are caught by
surprise when some significant unforeseen event occurs. Taleb’s conclusion is
that the success of most traders in hedge funds and investment banks are mostly
the result of luck. Their investment philosophy just happened to coincide with
the market at a given time.
Honestly,
the rally has taken me by surprise and I have a strong left-out feeling for not
investing in market after crossing 18400 in September. Therefore, I have decided
to consciously review the current scenario and have unbiased expectation for
future to decide next course of investments. Many experts believe that current
downtick in GDP/ fundamental data is similar to Tech bubble of 2000-02 and is a
therefore good entry point for investors who missed out on 2003-07 super rallies
as we could see a similar rally in coming years as data improves. An extension
to this thought to which I also readily agree is that while GDP has fallen to 9
yr low, the rate of fall (second derivative of GDP growth) is decreasing and we
have likely seen the bottom of GDP / investments and will see improving data
points from next qtr.
Yes,
current economic situation is very similar to FY01-03 period when GDP had
dropped sharply along with strong rupee depreciation. The corporate sector
going into 2000 was not too dissimilar from what it has been going into 2012.
Balance-sheets were extended – leverage was high, margins had fallen and ROEs
were modest. Sales growth was beginning to slacken, high interest costs were
hurting, and asset risks for the broader banking system were high.
As the
table above highlights, over the three year period, when growth was low and
below its previous averages, there was a positive reversal in most macro parameters.
Inflation moderated materially, interest rates stepped down structurally as
banks hoarded capital and moderated risk, banking sector liquidity rose substantially,
and the current account turned into surplus.
Now to
have a rally similar to 2003-07 post crisis periods, we need to see these data
improving like it did in 2003. Therefore, the next big question is- are we at a
similar starting point for reversal of economy?
Inflation
unfortunately shows no sign of improvement- thanks to easy money policy by Fed
which has kept crude prices at high despite falling demand; interest rate
though likely to come down in next 6 months has failed to meet expectations of
sharp climb down. Current a/c deficit cannot improve in short run as we fail to
exploit the advantages of weak rupee (at Rs56 now) when countries like China,
US and Japan are striving hard to keep their currencies artificially low and
promote exports. In fact the big difference that I see between 2003 and now is
emergence of Indian IT industry on a global scale which contributed substantially
to GDP growth as well as building foreign reserves. My imagination fails to see
the next big league of industry/service that will bring dollars back at home.
On valuations,
despite macro data disappointments and downgrades, Sensex is now trading at 14.2x
forward earnings which is slight discount to its long term average (LTA) but at
significant premium to its previous down cycle years. I think we should not
rest our case on LTA as we are unlikely to see 9% GDP growth in near future and
tail risk for global economy also exist.
Therefore in my
opinion, street is pricing in too many optimistic outcomes and downside risks
remain high on slight disappointments. Importantly, we do not have global economy
support which was omnipresent during FY03-07 period (it was not just India that
did well during this period but all major economies including US,BRICS, PIIGS
have seen strong equity rallies during this period and we were not very different
from world as perceived by many). Fiscal cliff in US and Greece/Spain bailout
outcomes can see sharp downside cuts in coming weeks and will therefore invest only
at declines. I know by waiting on sideline, I could miss out on a big rally but then I am a "Thinking Analyst" and not a gambler who wants to double the money quickly. I dont mind buying at higher levels when data shows some sign of improvement rather than buying in the hope that things will change for reasons unknown to us now.
