We are now at the fag end of the results season for the third quarter. Most results have been in line with expectations except for the Banking sector where a Raghuram Rajan propelled cleansing left most PSU banks and some Private sector banks reeling under massive stress which was always there but the public could not see it. This purge over the long run is healthy for the banking sector as well as the markets and the Indian Economy. Different fears got built up as the markets fell and the key is to see what lies ahead.
The Union Budget- The Budget is under the limelight this time mainly due to two factors. Firstly the need to drive the economy towards a sustainably higher growth path and secondly maintain Fiscal discipline which is important to maintain macroeconomic stability. Of the camps that believe in relaxation of the deficit targets and those who say we should not relax I am at this point of time in the second camp. Given the stimulus that is going to come out of the pay commission recommendation implementation as well as a generally low inflation environment it makes sense for the government to stick to the 3.5% target for next year. This will have several self fulfilling implications. As the fear of crowding out reduces we will see market interest rates come down. As RBI becomes comfortable with this aspect they will also cut rates. As such a virtuous cycle will start. The push on Infrastructure spending is showing some signs of pushing growth further and if we get a normal monsoon then growth might become self sustaining. So in brief, push Capital Expenditure while reining in Fiscal Deficit is the key.
The two big fears- Two fears prevailed in the markets since early 2016. First was Yuan devaluation which was shouted everywhere. As we stand today Yuan is down just 0.5% for this year and the rupee is actually down 3.5%. Net net we are more competitive than we were at the beginning of the year. The second was crude price crash. Even crude has stabilized now although it is likely to be in a prolonged sideways move for several months or years now as has been the case with Gold after it crashed and stabilized. So the two big fears are not playing out any longer and fear mongers need to generate new ones now. As per my view the crude price fall is unambiguously positive for India.
Where the economy going- The Indian economy is has been bouncing off the bottoms for the last 18-24 months. The systematic destruction of the economy under the previous regime combined with poor global recovery has not been helpful. Commodity companies have taken the worst of battering due to continuously falling prices and these companies are the biggest concern factors among the NPA’s of Indian banks. Infrastructure companies will eventually come back as the economy recovers; however global commodity price related companies will be of concern for some time to come. However as I write now it seems as if the commodity cycle could have bottomed out. This does not mean that there is going to be any sharp recovery. However some recovery will play out in 2016 and will be incrementally positive. Indian economic growth is likely to be driven by revival in consumption expenditure with low inflation and pay commission implementation and government’s infrastructure push in the near term. Subsequent support could come from normal monsoons (which look likely as per initial predictions) and some capital expenditure cycle revival. Overall the economy should strengthen continuously over the next three years.
ECB and FED action- The ECB meets in early March, just after the budget and is expected to ease monetary policy further. The action of the US FED is uncertain at this point of time; however market expectations of a hike in rates have gone down substantially. Post budget over the 10 day period these events will be closely watched. At this stage it does not seem that they will contribute towards any additional negative sentiment.
Fear is at peak- Negative sentiments peaked out last week when I called the bottom of the markets on Friday, 12thFebruary. Latest BAML study indicates that cash levels in funds are highest in the last 15 years and this is after record redemptions since the beginning of 2015. On top of that we saw most analysts shouting 6000 or 5000 on the Nifty last week which also indicated a peak of pessimism. Markets will recover for sure but the key is the pace of recovery.
Reforms could actually play out this year- Many pending reform measures could actually play out this year. The Bankruptcy code and GST will be watched closely. Current expectations are for GST to come through and be implemented from April 2017. This should happen even with all the delays. The Real Estate Regulation Bill should also be passed now after all the delays. The government is pushing all the reforms possible with executive action. Legislative reforms should follow this year.
Nearly Rs 30000 Cr worth of Road Projects and Rs 20000 Cr worth of Railway projects have been cleared in the last 15 days itself. Several state governments are also pushing a number of projects across various segments. There is still a lot to be done, however the push should gain steam over the next few months.
MARKET OUTLOOK
The short term market move since the beginning of January took me by surprise due to the ferocity of the fall. However there were several contributors which included a global fear factor, Indian banking sector woes as well as the over frenzied activity in the Mid and Small cap segment of the market which needed to correct and has happened now. Most if not all negatives are in the price now and the positives are totally absent. The same time last year was that to be bearish, which I was. Now is the time to be bullish, which I am. The only spanner in the works will be if the harebrained idea of someone to implement Long Term Capital gains tax on equities is implemented. No Finance Minister in his senses should do that when the markets and economy are poised at the cusp of a recovery, however frankly no one knows how the Bureaucracy works. There is huge value in the markets for sure but the question is whether we should let the event of the Budget pass first. I would think so. No harm buying 5% higher than seeing some GAAR kind of harebrained idea like higher taxes being implemented when the economy & markets are in no stage to absorb it.
The absence of any disruptive & crazy idea in the Budget would create an ideal platform for a 20-30% upmove over the next 12 month.