COME SEPTEMBER

The month of August started off with reasonable optimism backed by both domestic and international factors. On the domestic front the pick up in the Monsoon rains, lower than reported inflation data as well as an anticipation of some economy friendly measures from the government continued to support the markets. Internationally positive data points from the US economy combined with the promise of the European Central Bank to “do what it takes” in order to bring some support to the Eurozone were supportive of the markets. However by the end of the month the issues related to the Coal Mining Allocations & lack of any policy action from the government on the domestic front and doubts about the further actions that the US Federal Reserve or the ECB would take created doubts in the minds of the markets which lead to profit booking coming back to the markets.

The broader markets underperformed as the market interest continued to be in a few large cap and defensive mid cap names. Foreign Funds (FIIs) continued to put money into the Indian markets driven by India’s superior long term growth prospects. The downside risks to the market due to the European situation and higher inflation has receded significantly. However policy inertia at the Central Government level is preventing a new bull market from formulating. There are several emerging markets that have already made new highs and some reforms or other policy push can be positive for the markets. Foreign Investors have been continuous buyers into the Indian markets this year driven by the longer term growth prospects of the country as well as the fact that India has inflation and thus pricing power. While globally the concern today is deflation and as such economies that have a reasonable growth with prospects of moderation in inflation in the longer run should keep on getting global flows. The potential to get FDI flows also is very high; however it is constrained by policy inertia as well as capital controls.

The major reason for broader markets underperformance continues to be high interest rates that are taking a toll more on the relatively smaller corporates as well as the fact that domestic money flow into the markets continues to be negative. Normally smaller companies are invested into by domestic investors initially and at later stages of a bull market the global investors come in.

There seems to be a consensus in the markets building up that the month of September will be tough for the markets and there could be a significant sell off. As a result we have seen investors become wary lately. Normally consensus does not work so let’s see.

Bernanke and Draghi

The month of September will also be very important for the markets due to two reasons. The first being the fact that the Europeans will be coming back from vacation and the Euro Crisis will again be in focus. The actions of the ECB will need careful monitoring. Incase they are able to bring about a mechanism to control the yields on Italian and Spanish bonds we could see global markets including India rally significantly. Ben Bernanke delivered in line with my expectations and contrary to what some people believed. It is very clear that although the QE’s till date have been helpful in preventing a collapse of economic growth and prevented a depression as well as a deeper financial crisis the FED is clearly worried about the long term impact of more QEs. With operation twist the maturity profile of FED’s holding has gone up substantially therefore putting the balance sheet at risk if yields rise sharply. More money printing would have only contributed to commodity speculation rather than helping economic growth revival.

From the domestic perspective the data point of importance will be the inflation figures for August which should see a decent moderation from last month. This could set the tone for monetary easing and set the tone for a significant market rally. The global markets are in a situation today where the global Market Capitalization/GDP is at around 100% and for India it is at 75%. At the peak of the last bull market this had gone up to 160% levels.The reason for this is that we have seen profit compression in India due to higher input costs and interest rates whereas in countries like the US the profit margins are at all time highs due to lower inflation and extremely low interest rates. In my view profits margins have now bottomed for Indian companies and will show a rebound over the next 2-3 years and as such result in a market rerating.

The end of the month also saw the Shome panel deliver its report on GAAR as well as other aspects of taxing capital gains and capital flows. The recommendations are extremely progressive and if implemented fully would lead to an increase in capital flows into the country and also reduce tax litigation substantially. By removing artificial taxation different ions it could boost the domestic Fund Management industry substantially. Today lots of Fund Managers handling offshore Indiamoney sit in places like Singaporeand Hong Kong. Implementation of these recommendations could make management of funds independent of the place in which the fund manager sits, which should have been the scenario in any case. This could actually, over a period of time make India a Fund Management Hub. Let’s hope the government implements these suggestions which are positive both for the stock markets and the economy.

Some Interesting Statistics

The last five to six years show some very interesting statistics. In 4 out of the last 5 years the month of August has been pretty subdued (at least on headlines) for the markets and the amazing part is that the markets have given a return of exactly 0.6% in these 4 years. The only exception was the year 2011 when the markets fell by 8.8% August. In all these years the month of September has been extremely dynamic except for the year 2011 when September was subdued.  The only year when the markets actually sold off in the month of September during this phase was in the year 2008 when September was the Lehman month. The table below illustrates this phenomenon. 



The last week of August also saw the markets correct with a substantial reduction in the Put/Call ratio in the derivative markets thus reflecting negative trader sentiments. This shows that the month has started with more short positions than longs. So could we have a repetition of 2007,2009,2010 this year ? Only time will tell. 

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