Nifty and Sensex traded weak throughout the day as positive manufacturing data from US has strengthened case for tapering
As suggested last week, the stock market is in the process of giving up some of the recent gains. The weakness has surfaced as the US reported strong factory activity, which raised expectations that the Federal Reserve could taper sooner than later. The markets opened Tuesday lower, rebounded into the green during the morning session for a while before falling back into the red where it stayed for the rest of the session. The fall was cushioned by metals, commodities and realty which were buoyed after yesterday’s positive PMI data.
The BSE Sensex opened down at 20,857, hit an intra-day high of 20,927 and then trended down to an intra-day low of 20,817 before closing at 20,854 (down 43 points or -0.21%). Similarly, Nifty opened down at 6,204 briefly rebounded to hit an intra-day high of 6,225 then trended down to hit an intra-day low of 6,191 before closing at 6,201 (down 16 points, or -0.26%).
Most of the NSE indices fell today. Only a few such as metals, commodities, realty, energy and media have finished in the green. Media and realty finished strong moving up 1.08% and 1.17% respectively.
Of the 50 stocks on the Nifty, 22 advanced and 28 declined, indicating weakness. The top gainers were GAIL (3.06%); BHEL (2.76%); DLF (2.59%); Jindal Steel (2.54%) and NMDC (2.31%). The top losers were IndusInd Bank (-1.82%); Kotak Bank (-1.63%); Dr Reddy (-1.42%); HCL Tech (-1.32%); L&T (-1.27%).
According to Reuters, Indian silver imports jumped 40% to 338 tonnes in October from 241 tonnes in September, as per GFMS, driven by demand during the festivals and weddings season that starts from October and tapers off by early May. The price of silver in COMEX stood at $19/ounce. UBS has cuts its silver forecast to $20.50 for 2014, from $25.
Ratings agency CRISIL stated that Indian fiscal deficit is expected to come in at 5.2% of GDP for FY14, which it also expects CAD to inch up higher in Q3-Q4 FY14 to 3.1% of the GDP in FY14. CAD has reduced sharply due to lower trade deficit numbers.
Asian markets were mixed too, spooked by tapering talks. However, Tokyo’s Nikkei finished up 0.61% because the Japanese Yen weakened to 140/Eu for the first time since October 2008. It has weakened both against the dollar and Euro, making exports look good.
All European markets were trending down, too. France’s CAC-40 is down nearly 1.50% at time of writing this piece, while FTSE is down 0.80%.
US markets dipped on Monday despite good manufacturing data. The Institute for Supply Management (ISM) said its index of national factory activity rose to 57.3 in November—its best showing since April 2011—from 56.4 the prior month. This week will see a slew of important data namely: ADP private payrolls and ISM non-manufacturing numbers on Wednesday, GDP on Thursday and finally nonfarm-payrolls report caps on Friday. US stock futures were trending down in early trade.
In their latest note, Morgan Stanley has revised upwards their Indian economy growth estimates for 2013, 2014 as well as 2015. At the same time, it is cautiously optimistic about Indian economy prospects
Morgan Stanley believes that the Indian economy will be able to achieve 6% growth by 2015 from the current stagflation-type economic environment. It has revised and raised its Indian economy growth expectations for this year end as well as 2014, to 4.7% and 5.1% (India’s GDP grew at 4.8% as per data released on 29th November.) The note said, “We are lifting our 2013 and 2014 GDP growth estimates to 4.7% and 5.1%, respectively, from 4.4% and 4.6%.” It has revised its updates based on the following factors: delay in QE taper, improving the external funding environment; short-term policy fixes in the form of aggressive control on gold imports and FX swap-related dollar flows; better than expected export growth; and better than expected farm output.
The bullish and bearish scenarios
Morgan Stanley has plotted three outcomes for the Indian economy: bullish scenario, base scenario and bearish scenario. In the bullish scenario, it believes India will grow at 6% by 2014, while in the bearish scenario it believes that the Indian economy will grow at 4.2% by 2014. The below chart depicts their expectations.
What India must do to overcome challenges?
When it comes to forecasting, Morgan Stanley is cautiously optimistic and believes that 2014 would be the year of “adjustment” for the Indian economy, or the year at which the Indian economy will recover, provided certain challenges are overcome, and will also hinge on the outcome of the 2014 Indian elections. According to Morgan Stanley India must do three things:
However, to achieve all these collectively require the government as well as regulators like Reserve Bank of India (RBI) to initiate several policy actions and reforms, particularly increasing Indian household savings.
The note said, “The government sector will need to continue to be on a path of fiscal consolidation, ensure that rural wage growth do not spike up, and boost growth via policy reforms that will help to improve investment. These measures will help to improve productivity growth and moderate inflation pressures. At the same time, the central bank will also need to manage real rates in a way that incentivises households (savers) to increase their allocation towards financial saving (deposits) and away from gold. As deposit growth is lifted, liquidity for the banking sector (as measured by loan-deposit ratio) will also improve simultaneously, which can then be transmitted towards lower interest rates for the corporate sector.”
High inflation hurting, savers flocking to riskier assets: gold and real estate
High inflation has eaten retail investors savings, thus discouraging households from keeping money in bank fixed deposits and savings account (aka cash), and instead are moving to more risky instruments such as gold and properties. The note states, “High CPI inflation has kept real interest rates negative since the credit crisis, encouraging households to reduce financial savings and increase allocation to gold and real estate.” This has put a dent to the CAR. However, Morgan Stanley also expects inflation to moderate a bit. It says, “In our base case, we expect CPI inflation to finally decelerate to 7% in a sustained manner by December 2014 after five years of average inflation of 10%.”
Morgan Stanley states that one of the most important things the government must do is to encourage household savings. The note states, “Adjustment of the fiscal deficit and resultant deceleration in CPI inflation is critical to allow for increase in public saving and increase in household financial saving (deposits).”
RBI desperate measures to reduce CAR
In order to beef up household savings and prevent further deterioration in CAR, the government imposed controls on gold imports and increased dollar inflows via FX swaps (and thereby restricting rupee downfall. Morgan Stanley says, “These two near-term policy fixes will improve India’s balance of payments position by a combined US$50-55bn, thereby reducing the external pressures in the near term,” and “alleviate upward pressure on short rates.”
Banks in trouble
Since household savings is low, banks have had to rely on other sources to augment its deposit base. Moreover, banks are to blame as well. Their reckless lending has led to impairment of loans. The double-whammy of poor deposit growth and high credit growth has put further stress on bank balance sheets. As per Morgan Stanley, public sector banks impairment of loans stood at 10%. Public sector banks will have to slow down and lend less or else be recapitalised to stimulate growth without a slowdown. The note said, “We believe that as public sector banks provision fully for the underlying non-performing loans, their ability and willingness to lend for new investment will be constrained unless the government takes up a quick recap of their balance sheets.”
Moneylife had predicted this mess last year itself, in July, that this would snowball to a major issue. You can read the Cover Story here. With the banking system in trouble, Morgan Stanley expects capex, which depends on credit, to slow down and remain constrained within the next 12 months.
Exports the key to growth turnaround
Apart from controlling inflation, exports will be a key to bridging the CAR divide and GDO growth. Because domestic demand will be restrained viz low spending, low savings and such, the external sector becomes a catalyst. Morgan Stanley says, “The key factor that will influence the growth outlook in the near term will be external demand.” They also say, “We expect services exports to follow the trajectory of goods exports, showing recovery in the next six months. In this context we expect external demand to provide support to slight recovery in overall growth over the next three quarters.”
However, in order for this to happen, Morgan Stanley believes that the government must do two things to improve productivity:
Morgan Stanley has also listed six key drivers that will determine where the markets will be headed along with their views
Morgan Stanley expects Sensex to hit 25,600 as the best case scenario and 17,000 as the worst-case scenario. Morgan Stanley is bullish on information technology and bearish on banks.”
However, for two reasons forecasting Sensex was a difficult call to make. Firstly, the Indian elections next year is approaching and it is difficult to predict the outcome. The second is there is uncertainty on the policy front, whether government will do anything at all to get things moving. According to Morgan Stanley, “the market could gyrate around election outcomes and, obviously, we cannot forecast the election result with any confidence. What we can do however, is lay down the framework and likely drivers for equity share prices. All is not lost for investors since we still think there is money to be made in picking stocks across styles and sectors.” It has identified six factors that will determine the stocks to buy.
Indian elections: Morgan Stanley feels that this time the election will be different that ones in the past, particularly, because two of the largest parties, the Indian National Congress (INC) and the Bharatiya Janata Party (BJP) do not have a deep impact. However, Morgan Stanley believes says that the BJP-led NDA is gaining at the national level. The rise of regional parties has made it difficult for a single party mandate. Public expenditure tends to rise prior to elections. Congress has passed the Food Security Bill and subsidies.
Macro stability: India suffers from twin problems of fiscal and current account deficits. It needs to address these. This has been a recurring theme for a while. However, if the twin deficits decline than equities will prevail. Similarly, if oil prices fall, equities will do well. If yield curve is flat, then growth outlook remains tepid.
Growth: Morgan Stanley expects a long drawn out recovery even though there are some positive signs of “bottoming out”. Here, there are some conflicting signals, some positive, some negative.
Morgan Stanley makes the following observations that Indian retail investors need to watch out for in their stock market call:
Liquidity: At the moment, Morgan Stanley is bearish on the liquidity front. It feels that liquidity scenario is tightening as the US economy improves, and therefore, is in “negative delta” territory. Refer to the two graphs below made by Morgan Stanley using their proprietary indicators.
The first one shows the relationship between Indian economy and the US economy, in terms of “delta”. For Indian equities to do well America must underperform. The second graph shows that the liquidity indicator has rebounded from bullish territory. Morgan Stanley says, “The indicator has fallen from its July 2012 high of 5.3% to 3.5% – below 4% which signals maximum bullishness for (Indian) equities but above 2% – a level which tells us that equities do not have global liquidity support.”
Market sentiment: Morgan Stanley believes that stock market sentiment at the moment is neutral, neither positive to warrant a buy nor negative to warrant a sell. The report says, “In the current macro earnings and valuation construct, we prefer depressed (stock market) sentiment as a threshold to buy (Indian) equities. The biggest problem for equities is that tail risks are not in play.” However, it realises that volatility has risen and this is not good for investing in general.
Stock market valuations: Morgan Stanley says that the Indian stock markets appear “attractive” on the basis of price-book (PB) as well as price-earning (PE) ratio, but cites it is not “cheap”. However, it feels that yields are an important indicator at the moment and more crucial than PB or PE ratios. The note says, “When the gap is rising, the market does not worry about earnings or book. Indeed, when real rates are rising relative to GDP growth, earnings growth is likely to be tepid. In such an environment, the Indian stock market worries about how equities trade relative to bonds. This is logical because the earnings outlook is uncertain and therefore relative yields matter.”
According to Morgan Stanley, “our economist is forecasting weak industrial growth in the coming months and history tells us this warrants a rising real equity yield (i.e., inflation or share prices or both need to fall).”