Are we entering a bear market?Being a bull in a bear frenzy is as strange as being a bear in bull territory. A bullish investor always sees the glass-full. A bearish investor smacks his lips at every opportunity to drive down stocks. With Indian markets correcting by 15%, the bear market debate is back in the reckoning. Many renowned bears have come back from hibernation, while bulls are struggling to counter the negative forces, which are helped by a weak rupee, rising oil prices and uncertainty about 2019 Lok Sabha polls. Let us find out whether the bear arguments have any merit and then you as an informed RupeeIQ reader can decide.

Bear market definition

There is a commonly accepted definition of a bear market world over. That definition says that if the markets fall by more than 20% then we have entered a bear market. Looking at last one month may make you believe we are half-way there. If we undergo another 5% correction, then bears will announce the start of a bear market.

Pundits have already started declaring that we are entering the grip of a bear market or at least a quasi bear market. Markets veteran and founder of First Global, Shankar Sharma, in an interview to CNBC, said that most of the investors have seen 30-40% dip in their portfolio even though the index have corrected only 13% or so (markets have corrected more after this interview).

Rohit Srivastava, Fund Manager and technical expert, Sharekhan, said in an interview to CNBC today: “We are in a bear market in medium term. Several key levels have been broken.” According to him, another indication of market top was the inter market divergences – where mid and small cap markets were making lower highs when the index was moving up. These kinds of divergences happen at a turning point, Srivastava said, adding “if you are in a bear market, it doesn’t spare even good stocks”.

There are many reasons why market fall got accentuated. First, the IL&FS default showed the fragility of institutions. Two, the government going back on oil price deregulation hit the OMC stock sentiment. Three, the use of LIC as an ATM for rescuing banks and financial institutions. Four, the Congress suddenly being projected to win 2 out 3 major states going for polls. Five, the weak performance of the equity market has started making many investors edgy. They are not yet pushing the sell or redeem button, but they are worried nevertheless. Six, there is a sense of despondency creeping into markets even though economic indicators do not show any bad signal.

Global growth and trade war

Global growth cues are not good. If global growth slows, India cannot be an exception simply because India still has strong linkages with global economy and has a big export basket. The International Monetary Fund has downgraded its outlook for global growth on Tuesday, with new projections talking about 3.7 per cent in 2018 and 2019, down from the 3.9 per cent estimate the group made in July. Most major markets, including the U.S. and the euro area were downgraded.

The U.S.-China trade war and a slowing of emerging markets such as Brazil and Turkey were to blame for the first downward revision since July 2016. The trade war threat is real. US and China have been embroiled in slapping an escalating series of retaliatory tariffs against each other over the last few months. About 50% of Chinese imports to the US have an extra 10% duty, while China has, so far, taken revenge with tariffs on US goods worth about $110 billion. India has got sucked into trade war scene.

First reason to get sucked in is India’s Iran crude ties. Reports emerged that India would buy a total of 9 million barrels of oil from Iran in November, suggesting that India will continue to purchase Iranian crude even after the U.S. sanctions on Tehran return. India is Iran’s second-largest single oil customer and was expected to cut back on Iranian oil purchases. But, that hasn’t happened as cheap Iranian oil is suitable for Indian refineries.

Second reason is India’s Russia defence trades. President Donald Trump on Wednesday said that Delhi will soon find about his decision on punitive sanctions after India signed a $5 billion deal to buy S-400 air defence system from Moscow.

Rupee rush

There is the worry about the rupee. The government seems comfortable with a weak rupee. The RBI in its latest monetary policy meeting also did not see US dollar at 73 versus the rupee as a fit case to take lots of intervention action. With the Brent oil price now trading close to USD 85 per barrel, there is more pressure on INR and interest rates. If the US sanctions on Iran push up oil prices more, rupee can go further down (it is already at 74.2 levels).

Recent macro challenges like oil price rise, rupee depreciation, liquidity crunch are having a negative impact on discretionary consumption. Since India is a net importing country thanks to its huge needs for oil that it does not produce, the government fiscal situation is under watch. If rupee does past 75 level, it can well be pandemonium, to put it mildly. This is because the effect of a weak rupee on fuel prices and high fuel inflation can cause a lot of problems.

Earnings mirage

At the start of each earnings season, investors wait with bated breath for the elusive recovery. But there have been some quick fireworks. That’s it. There is no 5-10 minute long dhamaka in earnings that investors in Indian stocks were long expecting. When PSU banks performed badly, private sector banks did well. When PSU banks recovered, private sector banks and NBFCs started show weak signals.

The high base of last year due to GST implementation and delayed festive season this year are likely to have some impact on the overall revenue growth of consumption-oriented sectors. In the upcoming season, growth in earnings will largely be supported by companies in oil & gas due to higher crude prices resulting in higher realisation. But this remains a weak point, as rising oil prices will force the government to take action. IT stocks will also do well but that’s partly because of a weak rupee. Subdued performance can be expected from the auto & banking space. FIIs have pulled out about Rs 18,000 crore in YTDCY18 of which 80% has happened in the last 15 days. Clearly, foreigners are not exactly waiting for Indian earnings recovery anymore!

Rising interest rates

The RBI may not have hiked the interest rate in the latest policy meeting. But, it has now ruled out rate cuts. This means the interest rate cycle is truly on its way up. If interest rates rise, that can never be good for equity markets.

With rising interest rates in India, cyclical sectors with weaker balance sheets would face challenges. Why? Because there will be an increase in financing cost. Rising rates will also make equities less attractive because a typical investor would think he or she would get more money risk-free than exposing it to some risk. Of course, inflation would be high but Indian investors do not look at real rates of return, which adjust inflation. They are much more focused on absolute numbers.

An upward move in interest rates and a downward revision in earnings across sectors will post the adverse movement in macro parameters. Valuations for Nifty has already corrected 12-14% in September. However, relative to peers and relative to own historical standards it still remains expensive. Expensive markets always have doubts. These doubts are amplified with more negative events, and this is where risk aversion, something bears are keenly looking forward to, can set the centerstage for a bear market.

Author
Rahul Sharma

Rahul Sharma is a contributing writer with RupeeIQ. He can be contacted on contact@rupeeiq.com