The credibility of Indian macroeconomic data is low. The collection is inefficient and, sometimes, the methodology is also flawed. The IIP Index of Industrial Production is dubious —elements are often not updated for months, causing absurd variations. When the revised IIP is released, the differences with provisional numbers are huge.
However, we are obliged to work with what's available. So, October saw a year-on-year contraction. The worst hit sector indices were manufacturing and mining. In use-based terms, capital goods saw a 59 per cent fall. The last time the IIP went into negative territory, it stayed there for seven months (December 2008-June 2009) on point-to-point basis.
De-seasonalising and massaging data to compare the new IIP series with the old is not easy. Nor are point-to-point comparisons the most rigorous means of trend diagnosis. However, allowing for all fudge factors, the trend appears directionally correct. The IIP has a fairly good correlation with reported GDP growth, though the latter also has a large error factor. GDP projections had been scaled down before the latest IIP data release.
The downtrend gels with everything else we know about the state of the economy. Key consumer numbers such as vehicle sales and housing loans are negative and flat, respectively. Corporate earnings are not growing enough to beat inflation.
It's dangerous to draw exact analogies from previous cycles. But note that when the IIP dived in the last financial crisis, it stayed negative for more than two quarters. The stock market laid low in the first four months of that period and then started a recovery.
This time around, most economists project that IIP could stay weak through the second half of 2011-12, and weakness could continue into the first quarter of 2012-13. The government doesn't have ammunition for counter-cyclical measures and shows no signs of political will, unlike in 2008.
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The stock market anticipates the real economy, since it reflects consensus expectations about the future. The market has trended down since November 2010 and lost 20 per cent. It is reasonably logical to assume the stock prices will trend down for somewhat longer.
Most long-term investors are uncomfortable about shorting, which is an obvious method of exploiting the above. But, it is also possible to buy methodically, staggering purchases to average down costs. Besides this, consider two possible derivative positions.
One is hedges of stock portfolios via far-from -money long puts in, say, a February 4,500p or a March 4,000p.
Another possible trade is long USDINR positions, which will benefit if the rupee continues to fall. Both positions have been recommended before. They're running in profits. Both could be even more profitable before the IIP weakness runs its course.
The author is a technical and equity analyst