It’s been some time since I wrote on the markets and the main reason was to let the event of the US Presidential Elections get over. However on the same day we also got hit by Demonetization as announced by PM Modi which has its own implications on the short as well as long term. The earnings season is also on, which has been pretty decent as compared to expectation. Overall markets look well placed to ride out the events.
Donald Trump’s potential victory as US President has been used by many mainstream economists as well as commentators to build up a doomsday scenario. However the actual impact post his election today might be dramatically different. I have not been negative on Trump simply because of the fact that as a businessman and a successful one at that his understanding of economics would be much better. On top of that we also have a situation today that the US Congress and Senate are both controlled by Republicans. This will actually help push Trump’s growth agenda. Most western economics have been relying on the lifeline of monetary stimulus without much of policy action to drive longer term growth in the economy. The tax cuts, infrastructure investments and focus on manufacturing proposed by Trump should be positive for the US Economy. It will also be inflationary long term and as such could mean a sharper increase in interest rates than what is being currently budgeted. However that is a moving picture which we will analyse later.
The negatives come out of his protectionist rhetoric during the election campaign. This has been taken very negatively by many. Although we will monitor this going forward, however given many binding agreements under WTO and the fact that Republicans are more about a free economy than Democrats the actual action might be much more muted. From an Indian perspective the impact at all could be felt by the IT Industry if there is some action on Visas etc. However, on the other hand if growth actually picks up due to growth friendly measures it could mean more business.
My guess is that we will see better growth and as a follow through better equity markets under Trump over the next 1-2 years.
The other big event that hit us last night was Demonetization. Overall I am very bullish on the move. Many people argue that Demonetization in the past has been again followed by a surge in black money generation under future Congress regimes. However I believe that things are much different today given the prevalence of technology, monitoring and the growth of cashless transactions. This demonetization is going to be very different from the past. The surge in black money, especially during the 10 years of the UPA regime was huge and the terror funding concerns due to counterfeit currency is for real. On top of that the number of taxpayers in India continues to be very low despite the kind of growth that the economy has seen.
With GST likely to become a reality over the next six months, a combination of this move of demonetization and introduction of new currency notes will lead to a huge increase in the formal economy and be a death knell for the black economy. The entire cycle of the parallel economy and the loopholes that fed the parallel economy will now come to an end. This move will lead to several things
- Will slow down the economy in the short run- As cash crunch hits the system given the fact that India is still largely a cash economy given the huge rural population it will impact consumption, transactions, investments etc essentially the entire cycle in the rural economy. Many short term traders and shopkeepers etc will also see disruption in their business. The onus here is on the RBI i.e. the speed at which they can bring in new 500 and 2000 notes into the system
- Tax revenues/Bank Deposits will increase – Tax revenues of the government will increase as most people come into the formal income net. The potential is huge given that hardly a few percentage point of Indians pay taxes. This can potentially lead to much lower marginal tax rates for honest taxpayers (like us) over the next few years. Bank Deposits are likely to see a huge jump up in the near term which will moderate over the next few months as people again withdraw money and get cash in hand however a significant amount will be sticky. This will improve system liquidity and lead to lower interest rates going forward. As lot of black money gets sucked out i.e. becomes junk it will also reduce inflationary pressures in the economy.
- Growth will be higher in the long run- This move will lead to higher growth in the long term as interest rates will be lower than base case, government tax revenues will be higher and there could be higher investment in infrastructure. A combination of GST and Demonetization will boost economic growth by 1-2% per annum over the long run after the initial blip this quarter.
- Real Estate Sector- Price of real estate in India will remain here or lower for at least 10 years into the futures. Prices will moderate however rentals might move up as more people prefer to rent.
Now coming to the results season. The results season has been positive and outperformed analyst expectations by nearly 5%. The current quarter due to demonetization will see some impact on demand for durables and non durables. There might be some impact on the execution of projects etc as payment to labourers, contractors etc might get impacted in the short run. However the current quarter blip should be short term in nature if RBI pumps in the new currency fast enough. The positives related to lower interest rates, Pay Commission payouts, better farm incomes etc still remain. Overall growth outlook looks positive beyond the current quarter and growth should pick up steam and accelerate over the next 1-2 years.
After the Brexit and Trump bogey the next bogey to be faced by the markets will be FED Hike fears. Investors need to look beyond this. FED is hiking due to improvement in employment and the economy and is positive for equities. The FED funds rate even after this hike will be just 0.62% on an average. We will be concerned only after the rate crosses 2.5% which is a few years away.
At a 7900-8000 level of the markets they would correct 50% of the move which started after the February panic bottom. I believe that these levels will hold in the markets. In today’s panic reaction we saw the Nifty move to 8000 levels before bouncing back substantially. We could see a retest plus minus 1 percentage point going forward. After February this is going to be the opportunity to build up a strong portfolio again. There is no need to be fearful today. Everyone is fearful this will be the time to buy for long term gains.