A fractured mandate is not priced in yet. Besides, without a revival in earnings, Indian equities still remain vulnerable to the waxing and waning of global liquidity flows
The stock market in India on Tuesday jumped in late trade, after a nine-day long losing streak. Do not let this bounce confuse you. The uneasiness in India’s financial markets remains intact. As we head into the 7th and last phase of Lok Sabha election on May 19 and the results are announced from May 23, stock markets lack the 2014-type assurance when it comes to the outcome.
Irrespective of who forms the government, markets may have everything to lose from here on, at least in the short-term. Even if a BJP-led coalition seems to be the base case and may actually be better with checks and balances with greater accountability, it may lead to a sell-off as it’s already priced in, says Vijay Krishna Kumar, Director & Head – Liquid Alternatives, IDFC AMC. Much worse would be a fractured mandate followed by lengthy bargaining on coalition government formation by either party. Markets appear to be unprepared for this tail risk, says Kumar, an early pioneer in India Long / Short investing with a total investment experience of over 18 years.
Although the latest sell-off has de-risked the potential of a post-election outcome shock, earnings and downgrades continue to challenge unsustainable valuations. Volatility has begun to spike and we believe this will continue through till May 23 when results are announced, says Kumar.
He argues that if indeed the bull narrative has been built around the single party BJP returning to power is positive for growth and the markets, IDFC AMC finds little evidence of the former (over the previous Congress-led coalition’s two term tenure) in the last five years. “Were this narrative to have indeed driven the March rally, it’s worth pointing out that the BJP’s single-party majority win in the last general elections was almost unprecedented. No single party had won a majority in the prior 30 years,” he says.
To this probabilistic outcome, add on anti-incumbency, demonetisation on the rural economy (recall the 2004 precedent of a shock loss to the opposition Congress in the background of similar rural stress), and markets appear to be underpricing the risk of an adverse outcome, remarked Kumar, who has generated annualized gross INR returns of over 20.5%+ over his career, with very low correlation to Indian equity markets..
While a BJP-led coalition seems the base case and may actually be better for checks and balances with greater accountability, it may lead to a sell-off as it’s already priced in, says the IDFC AMC expert. “Much worse would be a fractured mandate followed by lengthy bargaining on coalition government formation by either party. Markets appear to be unprepared for this tail risk,” Kumar says.
India VIX may continue to spike until the May 23. Striking a contra tone, Kumar asks what if the bull narrative has not been built on the ruling party returning to power? He reasons that India ‘catch-up’ flows were largely responsible for driving the rally in March. “This is our base case. That beyond a potential volatility event, centralised politics has little impact on a complex country such as India in the midst of greater decentralisation of fiscal power to the states, and where far greater forces are at play. Here, the macro, corporate earnings, and global factors do not augur well either. Without a revival in earnings, Indian equities remain vulnerable to the waxing and waning of global liquidity flows,” says Kumar, indicating caution.
While overseas credit spreads have been benign, spreads back home have continued to tighten following last year’s IL&FS default. And the impact of this is starting to percolate across India’s NBFC (shadow banking) sector as funding from money markets and mutual funds dries up and asset growth stalls. “Markets are yet to wake up to this reality and price in the extent of the slowdown even as the consumption story has begun to unravel. India’s consensus earnings estimates look especially infantile this year,” says the IDFC AMC manager.
Kumar has proof. He says the Q4-FY’19 earnings season has gotten off to a disastrous start. “According to the Mint and Capitaline, excluding one-time exceptionals and Financials and Oil Services companies that follow a different revenue model, aggregate net profit growth for 124 listed firms that reported earnings so far fell 8.4% YoY, a 13 quarter low; while net sales slowed to just 11.3%, a 5 quarter low. Key bellwethers led by Consumer Cyclicals and Non-Cyclicals, Tech and Financials have warned,” he said.
The consumer slowdown is especially ominous, spreading from cyclicals (autos) to non-cyclicals (staples). Volume growth in bellwether staples such as Hindustan Lever has moderated from double digits to high single digits. Sky high (safety trade) valuations in staples appear especially vulnerable. “A broad-based slowdown appears to be taking root in India’s consumption led economy. One that we cautioned about ever since the NBFC crisis added to the rural slowdown last year. While these results are early, and the transmission of the RBI’s latest rate cuts and rural election spend need monitoring, headline index valuations trading at a 50% premium to EM peers appear untenable,” he signs off.
Subscribe & keep learning!