<b> Devangshu Datta</b>: Markets hate uncertainty

And, there are far too many as we head into the new year

The Nifty was traded at 7,963 on January 1, 2016. And, it will close out the year at more or less the same levels. This is depressing, since the index hit a peak of 8,968 in early September. In fact, market action through 2016 was unusual. The year started with a downtrend, and ended with a downtrend, with one bullish period in between.
 
The market hit a 52-week low of 6,825 on the Budget day. It bounced on the news that Mr Jaitley intended to hold the fiscal deficit to 3.5% of gross domestic product (GDP). From then till September, there was a positive response to every item of good news. Both foreign institutional investors (FIIs) and domestic institutions bought through this phase. The Reserve Bank of India (RBI) also cut rates as inflation eased. Crude oil prices stayed down, ensuring a low trade deficit even though exports fell. A good monsoon boosted rural sentiment. The economy was growing faster than most, though GDP growth did not translate into earnings growth. The Brexit shock was handled easily in June, even though it hit multiple Indian businesses. In September, the market peaked. Rationality returned with the damp squib of telecom spectrum auctions. In October, investors sold in disappointment since earnings had failed to pick up in the second quarter (Q2). Bank NPAs (non-performing assets) remained high and even a rate cut from the new RBI committee and governor did not rekindle bullishness.

 
The demonetisation drive led to a crash. It coincided with the shock of the US Presidential election. A third blow was dealt by the Federal Reserve raising dollar  policy rates in mid-December. That last has triggered capital flight out of every emerging market. There are many possible policy triggers through 2017.
 

Donald Trump’s policy prescriptions are, as yet, unknown but it is feared that his administration could cut access to the US markets. Servicing US demand has kept the global economy ticking over. Europe is mired in problems, Japan is in stasis. China grew at the slowest pace in 25 years in 2016 and struggling to cope with an incipient bond market crisis.

 
India’s exports have lost ground steadily through the past 18 months. There were minor signs of revival before Trump won but those might be fading. Crude oil is also expected to rise higher and the rupee is under pressure, as the dollar appreciates. A weak rupee and rising crude oil could be two themes. Demonetisation has hit demand across multiple domestic sectors. It’s impossible to know how long a rebound will take. It’s all very well to talk about cash-less or less-cash but the infrastructure is not there to translate speech into rural and semi-urban penetration. Privation and cashlessness, coupled to income-tax raids, have damaged sentiment and retarded demand.

 
There are some hopes of an accommodative Budget. But, there are also hints of new taxes targeting capital markets, and of taxes targeting high bank withdrawals. Demonetisation has also put goods and services tax (GST) implementation under a cloud, due to opposition from regional parties. The April 2017 deadline is likely to be missed. GST must be implemented by September 2017 or else a workaround found to avoid a constitutional crisis. The Bharatiya Janata Party’s leverage will depend to some extent on the results of Assembly elections.
 
Where do investors seek returns in this uncertain scenario? The market is trading at 21PE, while logging negative, or very low earnings growth. Note that earnings in the second half of 2017-18 will, however, look excellent due to base effects caused by the trough of H2, 2016-17.

 
Investors should give weight to strong balance sheets rather than fast P&L growth, since businesses with high reserves and low debt on the balance sheet are more likely to emerge in good shape. Sectors with high-cash components, like real estate, construction, jewellery and agro-industries, are more likely to see long-term suffering.
 
Markets hate uncertainties and there are far too many of those as we head into 2017. So, there should be a further downtrend. One hope is a drastic, wide, deep correction that pulls valuations down across the board. That would make many bargains available through 2017. An investor who bought systematically into an index fund would not do badly in the long term. Banks and telecom would be of particular interest. Public sector banks are close to crisis point, and that could force the government to structure some kind of bailout. Telecom must also gain, since any ‘less-cash’ system must be built on top of (currently non-existent or low-quality) telecom networks, which must, therefore, receive investments.