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Tightrope Walk

Stock markets to be under pressure for a few quarters, but buy now for decent gains in the long run

  • Delhi,  December 15, 2016  
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Tightrope Walk
Tightrope Walk

In the past few weeks, equity markets have been struggling to keep pace with the big changes around the world - be it Donald Trump's election as United States President or the clampdown on black money by the Central government.

Both these developments have thrown stock markets off-guard. Both the Sensex and the Nifty fell 6.8 per cent and 7.34 per cent, respectively, in just weeks in November after the news of demonetisation and Trump's victory hit the headlines on November 9. The demonetisation is expected to hit businesses, especially the consumption-driven sectors, and affect economic growth for at least one-two quarters. Trump's win, say experts, means a lot of uncertainty for global markets, as he is expected to change a lot of policies of the earlier administration. He has also been talking against immigration; any action on this front will hit a lot of Indian IT companies. His win also increases the chances of a rate hike by the Fed in December. This will lead to exodus of a lot of foreign money from Indian markets.

Does this mean that the bears are going to tighten their grip on markets over the next few quarters? Is the huge selloff by foreign investors an indication that the India story is not attractive anymore?

Tough Call

Both demonetisation and Trump's victory have brought in volatility, price swings and fear. Equity investors are worried about the likelihood of sudden policy changes and their impact. Foreign institutional investors, or FIIs, sold shares worth Rs 18,103 crore between November 9, the first day of demonetisation, and November 30.

"Fundamentally, there has been a significant change at the macro level. India Inc.'s balance sheet will see a dramatic change due to demonetisation and rollout of GST (goods and services tax) and their subsequent impact on GDP," says Shilpa Kumar, MD, ICICI Securities.

The move to control the parallel economy has put immense pressure on stock markets. Most experts say many sectors will face disruption but the move will set the stage for a robust economy in the medium to long term.

Short-term Impact

So far, the move has been bad for stock markets and may continue to be so until the end of the financial year. Former Prime Minister Dr. Manmohan Singh said in a parliamentary debate that the move would hit GDP growth by 2 per cent. He added that this was an underestimate. This is bound to hurt companies as well as the agricultural economy.

However, some say this is a short-term trend. Dipen Sheth, Head, Institutional Research, HDFC Securities, says the cash shortage is a "temporary shock and barring a bad rabi crop and poor monsoon in 2017, we should see rural India continue to do well. Besides, the government is likely to unleash a fiscal stimulus directed at rural India."

Most agree that, in the immediate term, some large sections of India Inc, such as fast moving consumer goods, or FMCG, companies, will be hit badly as people struggle to get cash to spend. "There may be selective shrinking in the October-December quarter. In any case, many of them (FMCG companies) are trading at multiples of 30-40-plus and are unattractive, with ITC being an exception," says Sheth.

The effect of this crackdown on black money can also be felt in sectors such as real estate and jewellery (where cash use is high), apart from automobile and consumer durables (which people can afford to postpone spending on).

While real estate and jewellery are undergoing maximum pressure, Ramdeo Agarwal, Joint MD, Motilal Oswal Financial Securities, says the automobile sector should bounce back by the quarter ending March. It is only in the October-December quarter that a little impact may be felt. Many others say that more than the demonetisation, it is the uncertainty related to the impact of the GST on vehicle prices that is a cause of worry for the industry.

Long-term benefits

The crackdown on black money may improve the government's fiscal position as the cash economy shrinks and more people come into the tax net.

The sudden flush of money into banks may make its way to bond markets. So, yields might fall further, lowering borrowing costs for companies and individuals and helping stock markets recover. But the inflow of cash into people's bank accounts will translate into a spike in the deposit base and this may compel banks, especially large PSU banks, to reduce lending rates. Kumar of ICICI Securities says GDP will show sharp growth with the implementation of GST.

Equity boom?

The push towards making India a digital economy has begun. Dalal Street analysts say this makes the financial sector attractive. U.R. Bhat, Managing Director, Dalton Capital Advisors (India), says, "Demonetisation is not as alarming as it appears. Banks have got a window to write off some past losses. This may also help the Reserve Bank of India extinguish a part of its liability."

With stock indices plunging, market cap erosion across sectors is real. But market experts say this is a great opportunity to shop aggressively. Ramdeo Agarwal is hopeful that with a lot of money coming into the formal financial system, equity allocations will improve in the near future.

So, what should small investors do? Sheth of HDFC Securities says, "Run your SIPs (systematic investment plans) from your monthly savings. Don't stop them. Don't try to time the market. Be selective, park money in large-cap funds, and keep equity exposure at less than 50 per cent."

One must also factor in the global uncertainties. After Trump's election, there are concerns about the damage his protectionist policies will cause, strengthening the greenback and increasing bond yields. However, Dipen Sheth of HDFC Securities says Trumponomics may not harm IT and pharmaceutical sectors, as is being feared. They, therefore, look like good bets, especially after their recent underperformance, he says. A few on Dalal Street, such as Ramdeo Agarwal, say with Trump's victory the global corporate tax rate could fall, triggering a cut in tax rates back home.

Watch Out For

The key event would be the Union Budget on February 1. A lot of stringent measures to curb black money are on the cards, be it on benami properties, foreign wealth, money laundering or corruption in government tenders, say experts. Other than this, UP elections will be crucial, as it will be the first litmus test for the government after the recent move to end the parallel economy.

Shilpa Kumar is confident that India will remain attractive for both debt and equity investors. These positive disruptions in emerging markets mean the country will outperform.

The banking sector, a consistent laggard, is finally seeing some light due to falling interest rates and possible lowering of non-performing assets. "Low inflation, better compliance, improved tax collections and energised bureaucracy are set to change the way we think and execute," says Ramdeo Agarwal.

So, while until March, policies will be clouded and plans undefined, investors should look at the silver lining and buy quality stocks in finance, IT and pharmaceutical sectors.