Factors for a bull market are looking a little thin, says Shankar Sharma

'A narrow list of stocks was trying to convey an impression of a bull market, but in reality, it was a market of deception', says Shankar Sharma

It has been a rollercoaster ride for the markets in the past few sessions. SHANKAR SHARMA, vice-chairman and joint managing director at First Global, shares his views on the recent developments and his sector preferences in this backdrop with Puneet Wadhwa. Edited excerpts: 

What is your  view on the markets?

I had been noticing from June / July and getting concerned about the markets’ internals, as they were being driven by a handful of stocks in the Nifty50 index. Stocks in the broader indices, including some scrips in the Nifty50 had turned into the reverse direction. So, a narrow list of stocks was trying to convey an impression of a bull market, but in reality it was a market of deception. The crash seen recently was fairly predictable then and I am not surprised how the markets have played out. The only thing is that I was expecting the market to crash in November, while it crashed about two months before.

Do you advocate a 'bull' or a 'bear' case for the Indian markets over the next 6 - 12 months?

Fundamentally, Indian markets have suddenly fallen off a cliff. The other markets were performing average, but India has suddenly dived from what appeared to be a bull market into almost a bear market territory – all in a matter of a month. On a fundamental basis, the economy seems to be doing okay. There have been no major negatives on corporate earnings as well. 

One needs to think through the lens of the markets as to why the market is behaving the way it is. The first reason, I believe, is the current imbroglio around the non-bank finance companies (NBFCs). That said, if the markets are in a ‘good mood’, then such events are brushed aside. Defaults, though not of similar magnitude, have happened earlier as well. It totally depends on the mood of the market whether the problem gets blown up or there is only a short-term / knee-jerk reaction. 

The markets are attaching a lot of importance to the problems at IL&FS. If they were truly in a bullish phase, they would have shrugged off this issue after a short-term reaction. If oil prices head towards $100 per barrel, one doesn’t need to be a genius to figure out where the markets will be. Factors for a bull-market in India are looking a little thin.

So, what’s the real reason in your view?

The main problem for the sharp correction from the high is not the IL&FS problem, which we believe is just a catalyst. Drilling deeper and we find the real reason. The reason for a fall from the peak levels is that the goldilocks situation which existed in the last three – four years is fast evaporating and the market is seeing this very clearly now. 

Oil has been a major factor and I have always believed that oil prices pose a significant risk for India. I have been bullish on oil for the past two years – since the price was in the low $30s/barrel.  In this backdrop, a lot changes for the Indian economy. Another factor is the political environment / uncertainty. The general elections are less than a year away. The state elections will give an indication of what lies ahead. Putting all this together, the markets now believe that there are a lot of dark clouds ahead. In a bull phase, the markets look for a reason to rise and in a bear market, they look for a reason to fall – and the IL&FS development just gave them a reason to correct.

Have the markets punished bank and NBFC stocks more severely than what was deserved?

Markets have figured out that interest rates are a problem, policy making could be a problem going ahead and oil prices are rising. It is the larger macro picture which is a worry for the markets that led to a crash. Problem with IL&FS and NBFCs is just one factor that triggered a crash. Calendar year 2019 (CY19) will be a very troublesome year for the markets on all fronts – whether it is elections or crude oil prices.

When the markets want to turn around, there are only two areas that get punished. They can be punished together or separately. Every bull market has a few heroes and the top performing sectors. The 1999 – 2000 bull-market was a technology-led bull market, whereas 2007 was a ‘credit boom’. This time again the markets have been driven higher by financials. Banks and NBFCs have been standout sectors in the last one year and have a good weightage in the frontline benchmarks. When the markets turn or want to turn, it will punish the sectors that have performed the best. Secondly, it will punish the sector that is most leveraged – which is banks and NBFCs in the recent market conditions. So, the markets will punish these two sectors when it wants to become bearish.

Should one stay away from banks and NBFC stocks in the light of recent developments?

I do not like businesses that need to borrow $15 for every dollar of equity in order to deliver a reasonable return on equity (RoE). These businesses thrill for some time, but they kill most of the time. There is no point in entering markets to get thrilled and then get killed. Look at the history – financials have been the cause of every major bear market.

Do you see a pick-up in domestic (mutual funds) and foreign flows over the next 6 - 12 months?

The main problem is the mutual funds’ flow and is a real worry for the markets. Foreign institutional investors (FIIs) have been selling over the past few months. Indian markets have been supported by domestic flows. With rising interest rates (some banks now offer around 8 per cent interest rate on fixed deposits), the case for equity investment becomes extremely shaky. Though I don’t think the flows will become negative, the fall in the quantum of monthly flows now is a cause for concern. 

During the 1990s, FDs used to yield around 8 – 12 per cent. In this backdrop, the markets remained mostly flat for nearly a decade as investors got a relatively risk-free return. The only sector that did well was the technology sector. The likes of Infosys and Wipro did well as they did not have much leverage / borrowing on their books. Any industrial company – Tata Motors, Larsen & Toubro – did not do well at the bourses. Indian investors were not inclined to invest in equities as an asset class when they got a relatively attractive risk-free return from FDs.

How are you viewing the macro-economic data? Are the markets prepared for a possibility of a slippage in fiscal and current account deficits?

A lot of people counted India among the ‘Fragile five’ back in 2013. However, the fact of the matter is that there were two huge global crises back then. First, the global financial crisis (GFC) that started in 2008. Indian economy, even then, managed to grow at a heathy rate without a stimulus. Secondly, the tapering of quantitative easing (QE) was announced in 2013 that sent currencies of all emerging markets into a tailspin. The easy money era was likely to end. India was then confronted with the problem of a rise in twin deficits – the current account and the fiscal deficit. 

This time around however, there is no major global macro crisis. The world is actually in a reasonably good shape, while India is suddenly looking a very fragile. That’s what is bothering me. My view on oil is that it will be north of $100 per barrel going ahead. Given the export growth where it is, the twin deficits can hit the 7 – 8 per cent mark without a global macro crisis. Problems are fairly India-centric right now. No matter what anybody says, the markets are slowly realising this, and the rise in oil prices are making Indian economy more fragile. 

The disturbing thing about Indian economy is that structural imbalances have not improved in even 25 years. High interest rates, vulnerability to oil, rains, large trade deficit and then there is hardly any export edge. That apart, there is over-reliance on portfolio flows. All these have come home to roost together. 

Your sector preferences at this stage?

I continue to believe that the small-caps remain the best place to be in the markets to make money. In the end phases of the irrational market fall seen recently, one needs to look past these irrationalities and go back to the basics to assess whether the how businesses / companies are faring. If they remain on a good fundamental footing, they remain screaming buys without any doubt. In a quasi-bear market, investors need to be circumspect. While the opportunities are abundant in a bear market, investors need to be more cautious on what they are buying.

How are you viewing the entire debt resolution / NCLT process given that nothing significant has materialised yet? Has the confidence in the debt resolution process been shaken?

This is an evolving regulation but it is an excellent one. It was conceived by the previous government and is being executed by the present one. We need to give it time to settle down.

What is a bigger threat to the Indian equity story over the next one year – earnings not picking up or a hung Parliament in the next general elections?

I do not think a coalition government is any threat at all. Our best years of economic growth have been under coalition governments. In fact, I would say that coalition governments are good because they have checks and balances.

That said, oil is very big worry for India. Our policymakers should not have spent the gains of oil, but should have put it in a fund and salted it away for a rainy day. The rainy day is here now. And we have spent all those gains thinking they were permanent gains.