Markets are euphoric on expectations of the Prime Minister, Narendra Modi working wonders for the Indian economy. Sensex and Nifty are trading at record highs, the Rupee is trading at eleven months highs and even bonds that were sceptical on deficit and inflation have rallied with ten year benchmark bond yields at five month lows.
It is difficult not to get carried away on euphoria. In euphoric markets, gains could be high in a very short period of time. A look at weekly gainers shows many stocks with 50% gains week on week. Companies declaring very average fourth quarter results but beating downbeat market expectations are rallying 10% to 20% on results. For example SBI, that showed a marginal dip in bad loans quarter on quarter and made higher provisions for bad loans that brought down profits, rallied 10% on results!
To some extent, stocks are under owned by the market that has seen a six year bear run and the rush to buy stocks is feeding into sharp gains. However in this frenzy, opportunists in the form of promoters and speculators try and make quick money at the cost of unsuspecting investors. Investments based on euphoria usually leads to losses.
It is important to stay calm and not carried away by unrealistic expectations. How do you do this? List out all the issues plaguing the economy and individual stocks. Once you do this, realism will hit hard. What are the issues plaguing the economy and individual stocks?
On the economy front, the biggest issue facing Modi is the lack of funds for spending on creating capacity including infrastructure. The government is servicing three times more debt than what it was servicing in 2008 and interest costs form almost 80% of government borrowing for a fiscal year.
Tax revenues have been below budget targets for the last two years. Given that GDP growth is at decade low levels of below 5% and growth is expected at around 5.5% for this fiscal year, there is not going to be a major jump in tax revenues. Tax reforms will take at least one to two years to implement and until that happens, the tax to GDP ratio will not trend up from levels of around 10%, which has been the norm for the last ten years.
So where will the government find money to spend? Increasing fiscal deficit and borrowing from the bond market will spike up bond yields, leading to higher interest costs that again leads to more borrowings. Rising government bond yields will hit INR as FIIs sell debt. Pressure on INR will force RBI to keep policy tight and interest rates will stay high in the economy.
High interest rates have impacted both investments and consumer spending with industrial production for last fiscal showing negative growth and consumer durables showing negative growth.
The banking system is ridden with bad loans with most public sector banks showing rising bad loans year on year. SBI fourth quarter results (read the result update here) reveal the bad loan problem of banks. High interest rates and a weakening economy will further exacerbate the bad loan issues.
Corporates, especially in the construction and infrastructure sector are carrying heavy debts and this is reflecting on the bad loans of banks. Highly leveraged corporates will continue to struggle to service debt and this will reflect on the performance of the stocks.
The Modi government has a lot of work to do to fix the economy and the government requires time. Markets front running unrealistic performance expectations can only lead to sharp falls if results do not match expectations in the short term, and this is most likely case.
Invest by all means as there is positive sentiments but be realistic on your investments and give it time to perform.