Markets welcomed 2018 with a big bang with indices soaring new heights. Just when bulls were feeling invincible, a series of events unfolded that threw spanner in the works. Law of gravity says, ‘what goes up has to come down’. This holds true even for the stock markets. The one way up rally had to stop at some point and in our opinion, this correction was long overdue.
The moot question here is whether it is a trend reversal in the stock markets or a mere course correction?
We firmly believe that underlying bullish trend is intact and the events that are unfolding point towards a healthy correction. What remains uncertain however is the timeframe over which it may persist. Hence, as always, we would once again urge our clients to use these corrections to consolidate their position in the recommended portfolio stocks and not try and time the markets waiting for the next up move.
In India there are a number of factors that are weighing on the markets. A) Domestic liquidity, which had shot up post demonetization, is now normalizing, B) Markets adjusting to the introduction of Long-Term Capital Gains Tax (LTCG) in the Union Budget, C) Absorbing the shock of recent LoU scams reported by some of the leading PSBs and D) Hardening of long-term bond yields indicating expectation of rise in base interest rates going forward. Generally, it has been observed that bond and equity markets share an inverse relation i.e. when bond yields rise equity markets in India correct and vice versa.
In our opinion, liquidity and introduction of LTCG are likely to have a temporary overhang as markets adjust to the new normal. However, what is important here is to determine whether the factors leading to rise in bond yields are more long term in nature or not.
We believe current situation is more a reflection of risk-aversion mechanism rather than the fear of a deep-rooted recession. Revenue shortfall and expectation of fiscal slippage along with sustained high growth in the GDP has translated in inflationary pressures to surface leading to hardening of bond yields. As long as underlying growth in the economy is intact, we do not find a major cause of worry as RBI has sufficient headroom left to manage inflationary pressures.
Hence, overall bull market is still intact and the current correction, however severe, is an opportunity to enter good growth stories with significant margin-of-safety. Factors we believe are working in favour of Indian share market and that would help it stabilize soon are as follows: -
- GDP growth likely to pick up going forward and India is expected to emerge as the third largest economy in the next 10 years.
- Credit growth in the economy has been very encouraging. In 9MFY18 period, aggregate advances growth reported by the banking stocks under our coverage is Rs. 10.7 trillion, a YoY growth of 22%
- In Q3FY18, earnings growth for companies under our coverage universe has been fairly broad based with consumption sector leading the pack. Even the infrastructure space is showing good traction supported by increased Governmental spend on infrastructure.
- Rising trend of financialization of household savings that is increasingly finding its way in equity market.
Aiding all these factors is also the Government’s efforts to systematically clean up the Indian banking system by putting in place a stricter framework for stress recognition and resolution of bad loans in a time-bound manner. Under the new rules, insolvency proceedings would have to be initiated for loans above Rs. 20 billion if resolution plan is not implemented within 180 days of the default. Having addressed a bulk of the stress through the initial NCLT lists, timing of this move indicates that the Government is confident that there is only limited stress remaining in the system. Besides, it is well prepared to handle the impact as the bulk of Rs.2.1 trillion offered under the recapitalization scheme is likely to get utilized towards cleanup of the remaining stress. Overall, we believe that this is a well thought through and concerted effort by the government to clean up the NPA mess in the banking system involving, timely recognition of stress, faster resolution of bad loans and putting in place deterrents for the defaulters, while ensuring that PSBs remain well-capitalized to carry on with their credit growth.
Long term demand triggers are in place to ensure sustained growth in economy. This, coupled with Government’s efforts to strengthen the credit systems in India is only expected to augur well for a sustained bull run in Indian stock market going forward. Hence, we strongly recommend our clients to take advantage of these market corrections by investing in fundamentally sound growth stocks.