It has been an uneventful month for the Stock Markets after the strong rally seen over the last few months. The August was like most Augusts’ that tend to be boring. The boredom got released a bit yesterday as the FED talked of potential rate hikes “AGAIN”. It’s a good thing to bring some fear into the markets to set them up for the stronger run that lies ahead.
The key developments for the markets this month from a local Indian perspective was the passage of the GST Bill, a strong move in the progress of the monsoons which has led to record crop plantations as well as the appointment of the new RBI governor Mr. Urjit Patel, “The Owl”. There were no major events as far as global markets go and data continues to indicate uneven recovery in progress.
As we come to the end of August we again have a phase where FED fears have come to the fore again. This is good from the perspective of the upward progress of the markets as the rally in any case has been marked by huge scepticism. Every small dip leads to comments like “Valuations are high, markets have moved up too much” etc. Every rise is accompanied by sentences like “It’s a liquidity driven rally, upside is limited etc”. Normally market tops never happen with such a psychology at play.
Given the pay commission payouts, improved liquidity as well as the possibility of a good rural economy revival due to the monsoons we should see a strong revival in the demand for Consumer Durables to start with followed by a stronger recovery in consumer non durables. Infrastructure projects award process especially in roads, select metro projects, irrigation etc have been strong however the capital goods sector revival is still not seen in the horizon at this stage. Although we have seen some announcements of capital expenditure into new plants by corporate it is not across the board.
Sufficient capacity availability, sustained low raw material costs as well as reduced interest rates and higher agricultural production is likely to keep consumer inflation in check for the foreseeable future. Government revenues have also been strong driven by improved tax collections and greater compliance. Government spending has also helped keep growth going at the current rate of 7.5% per annum.
Continuous money printing by central banks which has driven bond yields lower and lower has seen much greater fund flow into bonds than equities where equities have seen outflows over the last many months on a global basis. Domestic funds flow into equities has been stronger both via the Mutual Funds, Direct and Insurance route. In my view the next few years will see bigger flows into equities as the US FED moves towards normalization of interest rates which will lead to greater flows into equities as the overall liquidity will remain strong as most central banks sustain their expanded balance sheets and some like ECB and BOJ expand the balance sheet further. The only risk would be if the interest rate hike cycle is very rapid which does not seem likely at this stage. A shallow rate hike cycle which allows bonds to adjust slowly will be positive for risky assets especially if accompanied by some positive economic data.
Meanwhile the eternal wait for the collapse of the Chinese economy continues. It is unlikely to happen any time soon as growth stabilizes, economy rebalances and interest rates remain low. The one reason why the Indian PSU Banking system also did not collapse is because domestic depositors via the extremely low savings rate subsidizes the banking system and helps them generate high Net Interest Income. The Chinese regulate interest rates even more and this will help Chinese Banks repair their health over the long run. Brazil’s rating was downgraded to Junk by Moody’s on the 24th of February 2016, since then the Brazilian Real is up 19% against the USD and the Brazilian Markets are up 40% i.e. a USD return of over 65% since the downgrade. The one FED hike which will happen sometime this year is also likely to be the same. Risky Assets will do well after that.
CONCLUSION AND MARKET OUTLOOK
Too many people ask me about market valuations and NIFTY P/E ratio. The reason for the high P/E and its correlation to 2008 peak needs to be properly analyzed. The reason for the optically high P/E at this time is because of the high P/E of growth companies like Asian Paints, HUL, Pharma stocks, private sector banks etc and not the cyclical stocks. In 2007-08 the cyclical stocks contributed to the high P/E levels. Moreover it is my belief that at a time when inflation is not a concern, economy is just starting to recovery and the earnings recovery cycle is around the corner this is not the time to do static P/E based investing.
Indian Markets present huge opportunities on the consumption, rural as well as investment themes today. There is lot of money to be made over the next three years. This is the first leg of the bull market which is marked by scepticism, this will be followed by belief and then Euphoria, however that seems a long way off at this stage. Invest well and hold tight.