A statistical correlation that we have noted in the past is that whenever the government securities yields have fallen below 7%, the returns from stock markets in the next year has been double digit. Right now ten year benchmark Gsec yields are close to 6.4%, the past fifteen years history makes us believe that this is a no fail formula, stocks will rally. It may take longer then we expect but rally it should.
Table 1. Ten year sec yield, GDP growth and Sensex returns.
While we do not really like to look behind to predict the future, the way we see the current environment is that it is highly conducive for equity. Th reasons are as follows a) Global equities are rallying on expectations of fiscal pump priming post Trump victory and that is negating Fed rate hikes. Business confidence is increasing in the US on expectations of better investment climate. b) Demonetisation will give one time revenues to the government and it will show high spending next year leading to a sharp rise in GDP growth.
Keep Calm, stand in the ATM line and go long on Equity
“It was the age of wisdom, it was the age of foolishness, it was the epoch of belief, and it was the epoch of incredulity”..
This seems like the perfect quote from the Charles Dickens classic, A tale of two cities to symbolise India as is now..
The country has been attempting to get past 8th November 2016 audacious announcement of demonetisation of 86% of the currency in circulation by Prime Minister Narendra Modi.
Your beliefs of how the demonetisation exercise is going to play out depends on which side of fence you are on, either what an unmitigated disaster or what a brilliant success it eventually will turn out to be.
A Critic or a fan, accept it or not,this is a fait accompli.. an event which is done and cannot possibly be undone.. so non-believers of demonetisation have to stop whining, readjust and realign their financial lives and move on..
The critics of the move believe that this exercise will not achieve any of its objectives of stemming black money and will paralyse the economy which was just getting back on its feet. It may be really hard to get the growth momentum of the country back on track.
The believers think that the demonetisation will clean up the stock of black money and the additional measures like the new voluntary disclosure scheme will encourage wrong doers to come clean. The tax net will widen, government may give infrastructure a boost.The exercise will leap frog India into the digital age to realise India’s super power potential.
Last week India’s reticent RBI Governor along with the MPC stated that the effect of demonetisation will be transient and cannot be fully assessed right now. The MPC decided to pause the easing cycle and did not reduce short term rates.
The consensus view of the market was that at least a 25 bps reduction in rates was warranted and many participants now believe that the RBI has erred on the side of overcaution.
Nonetheless, it was heartening to note that in RBI’s immediate assessment the global factors of the imminent possibility of the Federal Reserve raising interest rates and rise in oil price were a bigger threat than the possibility of a deflationary effect the demand destruction which may be brought about by the demonetisation.
Be that as it may, the next two quarterly results will make it amply clear on how much damage the demonetisation demon has inflicted and how quick the turnaround is going to be.
The Governor may oblige with interest rates reduction and other measures to boost the economy if the GDP prints seems slackening. One can only hope that later next year should we need to support the economy, the global scene is conducive to cut rates . Right now it seems that the US Fed is set to make a series of rate hikes. It will be hard for the Reserve Bank to take an opposing easing action against the Fed’s hardening stance but that’s a bridge we need to cross when we get there.
Global equity markets have been enthused by Donald’s Trumps victory to the White house as he is seen as business friendly. How global fund managers will view emerging markets and in that India is anybody’s guess and an unpredictable. The FII flow into India is a variable which therefore is better kept at arm’s length in deciding the direction of the market.
One thing is certain that India’s growth momentum of 7% plus was one of the highest in the world and demonetisation can stall it for two quarters or more at worst and may just be a transitory one quarter phase at best.
Sure there may be some sectors of the unorganised sector which may never recover from this demonetisation blow and some organised sectors like luxury goods and gambling and gold jewellery which may suffer a huge negative impact for more than a couple of quarters.
On the other hand there may beneficiaries or insulated business from the demonetisation exercise. It may do as well to pick these stocks in your portfolio. If you have missed getting into the bandwagon,the correction in the market may have given an opportunity to buy into these stocks which may have run up earlier.
So all in all we think that the implementation of demonetisation leave a lot to be desired. The ATM queues are annoying to say the least and banks still are short of notes for withdrawal.One just hopes that GST goes through as promised and the reform agenda is not compromised.
As long there is at least a three year view when buying into equity we recommend buying stocks on dips. If the stock picking is intelligent you should be home and dry with great returns despite the intermittent volatility in markets.