MAKING SENSE OF THE NOISE AROUND US

Over the last few days we have seen a selloff in the stock markets and from initially blaming it on the North Korean crisis the narrative has slowly shifted to “Poor Economic Growth”, mostly by people who now see there being a divergence between the performance of the Indian markets and the rest of the Emerging Market basket. It’s more a post facto analysis as 10 days back the economy did not seem to be a concern. We need to now evaluate how things stand taking into account all aspects around us.

GEOPOLITICAL CONCERNS- At the end of last month I had clearly pointed out the North Korean Crisis to be something to be concerned about as the leaders on both sides are unpredictable in the nature of their responses. The rhetoric peaked out at the time of the UN General Assembly and now seems to be getting toned down. Factually it’s a 0 or 1 kind of event which is tough to call. However the reality is that the US will not lead the situation to a stage where there is an actual military conflict unless they are harmed directly as South Korea, especially Seoul is so near to the NK border that Kim Jong Un can cause serious damage before he is eventually contained. The ridiculous part is that most people talk of NK crisis triggering a world war. That absolute nonsense. World Wars happen between two equal or equivalent blocs not one small rouge nation against the rest of the world. To that the argument is that Russia and China are with NK. However that’s not factually proven as they have voted in favour of Security Council resolutions against NK. I would say this crisis will most likely be contained. It’s just that Donald Trump has to give Kim Jong Un an exit out of the situation which will not put him down in front of the people of NK.

 

THE ECONOMY- The economy has been hit by three speed breakers over the last one year. Irregular monsoons last year and poor agricultural incomes, Demonetization and GST implementation delays. These have slowed down the economic growth from what it should ideally have been and each impact has been incremental and sequential one after the other. However these are past events. Now I see poor economic growth being blamed for the market correction. I don’t buy the argument. Markets are forward looking and not backward looking. 2018 will see a significant traction in economic growth driven by

  • Improved Rural Incomes- Higher agricultural production does not mean better incomes. Higher agricultural prices do as in the case of all commodities. Last year was poor for agricultural income as prices were down substantially. This year we see that scenario being better as MSP’s are being implemented in a better way, farm loan waivers have happened and other non MSP Agri prices are also higher. This combined with greater focus of the government on rural credit delivery we will see that part of the economy come back sharply. This economy was also hit by Demonetization and that base impact has also gone out now. Late rains, especially in deficient regions have boosted water storage in reservoirs and hold positive for the Winter plantation season.
  • Faster Implementation of Infrastructure Projects- There is significant traction in the implementation of infrastructure projects and next year this will pick up steam as per my interactions with various construction companies. Affordable housing, electricity schemes and railways investments are also picking up along with Urban Renewal Projects. This will be a good driver of economic growth next year.
  • GST Stabilization and Efficiency gains- Before GST was implemented most “Experts” were of the view that it will boost economic growth significantly. Just due to some glitches people have turned negative. Factually it is not a one quarter project it is a big change which has been done for years and decades. Its positive impact will start getting seen from 2018 and we will see efficiency gains kick in. Benefits to the formal sector will be much greater and drive earnings of listed corporations starting sometime in this financial year and going on to the next few years.
  • Corporate Tax Rate reductions- The Finance Minister had indicated reduction of Corporate Tax rate to 25% over a period of time. This process should start gaining steam from next year and average tax rates could be cut by 2% thus boosting Net Profit Growth.
  • A general bounce from depressed levels- GST implementation led to reduction in the inventory of the trade channel, this will start building up. Lower base across categories will lead to a higher apparent growth in general in the year 2018. For example the impact of Demonetization was seen on growth for 4-5 months and that base will set the tone for higher growth numbers going forward. Similarly the destocking of April-June quarter of this year will see proper stocking plus higher real growth next year.

The global context also needs to be understood properly. Fed Fears come back every few months as half informed “Experts” focus on that to declare the end of the Bull Market. This is as far away from reality as possible. Rate normalization is happening as economic growth is stabilizing and they believe that it can be self sustaining. As such normalization is the best way to go. Normalization will be negative bonds and positive equities as risk assets will get greater allocations as visibility of growth improves. Similarly the scare that when FED will hike rates all foreign investors will dump Emerging Market shares is far from reality. Actually as investors become more comfortable on the growth outlook Emerging Market allocations will actually increase. Key is to see when we should be worried. Well that is when FED Funds rates comes to a level that it becomes restrictive for economic growth. That should be in the region of 3% which is far away at this stage. That will happen only when there are signs of overheating of the economy along with a significant pickup in inflation.

IN CONCLUSION

In conclusion I believe that corrective moves will happen in the markets which are part of any bull market. People who are left out will should “It’s the End” every time this happens. This is actually good as scepticism is the best thing for Bull Markets. As someone has said

Are you holding cash because you are negative on the markets or are you negative because you are holding cash?

Unbridled speculation in zero fundamental stocks, euphoric rises etc are part of bull markets which get corrected periodically. That process is happening now. It’s time to accumulate high earnings and growth visibility stocks which are trading at attractive valuations. Many good stocks fall 10-30% in such Bull Market corrections focus on them and not speculative stocks with no fundamental basis.

Markets will be much higher by the end of 2018 and that should be the focus of Long Term Investors.

One thought on “MAKING SENSE OF THE NOISE AROUND US

  1. A decline in stocks is not a surprising event ,it’s a recurring event -as normal as frigid air in Minnesota .If you live in a cold climate ,you expect freezing temperatures ,so when your outdoor thermometer drops below zero ,you don’t think of this as the beginning of the next Ice age. You put on your parka, throw salt on the walk, and remind yourself that by summertime it will be warm outside. A successful stock picker has the same relationship with a drop in the market as a Minnesotan has with freezing weather . You know it’s coming, and you are ready to ride it out, and when your favourite stocks go down with the rest ,you jump at the chance to buy more. -Peter Lynch

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