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Brokerages to cut EPS forecast; more policy action likely
Published on Fri, Jun 20, 2008 at 13:16 , Updated at Fri, Jun 20, 2008 at 15:17
Source : CNBC-TV18
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Inflation for the week-ended June 7 is at 11.05% versus 8.75%. A CNBC-TV18 poll saw inflation for the week-ended June 7 at 9.93%. Inflation for week-ended April 12 has been revised to 7.95%, it had earlier been estimated at 7.33% earlier.
Political fallout: If this had happened two years back, the market would not have been so worried. But the elbowroom for policy errors is so huge that the market is worried. Elections are probably six-months away and the government is already panicking. It will have to lean on every instrument available, even if it knows that it cannot solve the problem; it has to be seen as trying to do something. Otherwise, it is staring at electoral defeat because of 11% inflation, which we haven’t seen for so many years now. The steel companies are talking about raising prices in August. Obviously, the government would not let them do that. This might percolate down to so many sectors and spoil global sentiment towards India some more. We are not the only country facing high inflation. China has a big inflation problem right now and the government there is extremely worried. They raised fuel prices by 17%. So, the policy responses from different countries are different. As there are so many political undertones right now for India, our policy responses are actual recipes for disaster from an equity market point of view.
Impact on markets: From a market point of view, there could be so many different policy mistakes, which the government will probably end up making over the next three-four months, if inflation remains at these elevated levels. I don’t hold to it but in December, every analyst said that come March, interest rates would start coming down in India. In March, they said they may not come down. Now, they are saying it may be only 25-bps points on the way up. We are all getting surprised with the magnitude of inflation problem. I would not be surprised if the interest rate situation also moves at a pace, which is much faster than we are predicting at this point in time. Brokerages may start wearing down EPS targets, may be by 4-5% from the current consensus. This may not start this current quarter because the current quarter still may have a reasonable amount of earnings growth. But the market will probably look ahead and see beyond the current quarter. Looking forward, the apprehension will be that earnings growth will slowdown and go to between 10-13% for this current year. The PE point is also important because stock prices are a combination of both. I don’t think the market’s possibility of correction from here is only contingent on an earnings slowdown. With the environment that one is in now, interest rates going up and inflation at double-digits, there is scope for PE derating as well for the market. All of this is coming at a bad time where the market is already flirting with very important support levels. It is merely a percent away from what has been the long-standing support over the last one and half years. So, people would be apprehensive of the number that came in today.
On oil: With respect to the oil situation, it is easy for politicians or analysts to say that inflation is 11% in India just because of crude. We are talking about 11% inflation in India with crude at probably USD 80 per barrel. Let us not fool ourselves that the inflation at 11% is a product of a full pass down of USD 130 per barrel crude which is a global problem affecting all countries. In our country, the kind of a pass down we have had is to the extent of USD 80 per barrel and at that pass through you are talking about 11% inflation. So, I am not in complete sync with that argument that our inflation problem is just crude because we have just passed down so little of it. There is a lot of other inflation problems. The worse-case scenario is what happens if one had got the inevitable pass down to a larger extent? What kind of inflation are we staring at then?
On tax structure: That is the problem which is making a lot of global investors extremely nervous. The inflation number, interest rate and market’s reaction is fine. Why do you think India is getting punished more than some of its neighboring markets? Inflation is not an India-specific problem, it is a global problem. It is the unique nature of how we are trying to deal with it. Having completely messed up our macro situation over the last one-year with bad policy-making, it is a difficult situation, not just for us but also for almost every country in the world today. Look at how oil pricing has been dealt with and what a big hole we have drilled into our fiscal situation. We are making distortions in several sectors with attempted price controls, which never work. There is pressure building up on RBI to bail the government out on the inflation front. On June 20, Moody’s said they are not reviewing India’s rating. But the day is not far when one of these rating agencies sit up and say that it needs to be looked at once again because there is just too big a mess on the macro economic balance sheet. The situation is quite bad and policy making has not had a very small role to play in it.
We have been hurt by circumstances, but we have not made it very easy for us either with policy making in the last one-year because of political expediency. You have got 160 advances to a 1,000 declines and the midcap index is down 4%. I can think of at least 50 top-traded midcap stocks, which are down between 5-7% now. So, the index may be masking what is going on and the kind of damage happening outside. The overall bank index is down more than 2.5%. So, things are bad and one can see how sharply some of these sectors are selling off. But these are technical levels and around these levels there will be short covering. One day’s bounce will happen but things are not getting better for the equity market, the headwinds are increasing. Whether the level of 4,400 holds out for the day is a matter for traders to obsess about. The bigger problem is when will the equity market get out of the woods? Nothing is improving for the better. Oil is not cooling down and inflation just got to 11%. Now, the stock markets will learn to live with much higher interest rates, which is not good for the stock market per se. The headwinds are tremendous and are only mounting. The best hope for the equity market is that, it will get over in 4-5 months when we can put a bottom in place and look forward to 2009 as the year of rebuilding for equities and for corporate India. When things continue to get worse, you cannot put a bottom in place. That is the problem for the market. So, it is not so important whether 4,400 holds out for the day or not. The bigger problem is that we are faced with an environment which is extremely not conducive for stock markets and for corporate India. The CEOs are usually the last people to admit that there is a problem because they have to put up a face. This rise in interest rates is not just an earnings problem. India Inc was just starting a good capex cycle. If interest rates continue to move up and global capital continues to be as scarce as it has been for the last six-months, what happens to capacity addition in the economy? You are trying to cool an inflation problem, yet you have a high interest rate and a low capital availability situation which is a big hindrance for new capacity and capex. The question is whether it is a problem which could filter down to the economy in 1-2 years down the line, making it an even stickier problem than small earnings revisions downwards for the next 2-3 quarters. It is very difficult to sound optimistic at this kind of a situation because there are many things, which could actually go wrong.
On FII outflows: FIIs have already started exiting. We have lost about USD 6 billion already. So, you have a sense of what is going on and how FIIs are positioning themselves. They know that there are structural macro problems in India. The environment for equity outperformance in India is probably not very strong. Near-term investors have taken away money from India. These include hedge and absolute return funds. The bigger question is what happens to the long-term FIIs who do not get swayed by small 15-20% moves in the market and have taken a bigger bet on India. They are probably still in the market. They feel this is a temporary cyclical adjustment phase, which will get over may be in a year’s time. In 2008, I don’t think many of them are expecting too much by way of returns. They believe that from 2009 onwards you would probably see returns coming from India, once the adjustment are in place. On growth rates: Have FIIs taken a view that growth will slow down to something close to 7% for the next 2-3 years? It could be 7.5%, 6.5%, or 7%. What they and the market will then do is to de-rate the P/E multiples. An economy that is growing at 9.5% might get a 16-17 P/E multiple. The economy is now growing at 7%, it may do so over the next couple of years. Then, the P/E multiple might move southwards and settle closer to 13. In which case, we are talking about a significant de-rating that might happen over 7-8 quarters and that too from long-term investors in this market. It may or may not happen. But that is the question which will be asked. What should investors do now? In this kind of situation, the mistake that a lot of people make is to take an ostrich kind of view. They feel everything will pass and get better, and in four months the bull market will resume. That is never a clever thing to do in a stock market. One has to be realistic; one cannot be a blinker. Investors have to ask those hard questions because it is ones’ money at work. They need to ask whether things can get better and how soon. What will be the triggers that will make it better? The answers to those are not very easy to find in the next 3-4 months. So, one can close their eyes and say it doesn’t matter what inflation is doing or what interest rates are going up to. We are in a long-term great growth secular story, which may well be the case. At least enough has happened over the last four months with the environment and that theory has to be put to question. One cannot assume to get a 7-9% growth. I don’t think that is given. You have got to question it. If the answer to that is yes, we will still be okay at the end of the next six months, and will come back to between 7.5-9% growth in 2009-10, then this is a great buying opportunity. If the answer to that is I don’t know, then you have got to wait. The market needs to do far more work out here. I am not in that camp that closes my eyes and says it is a great bull market, long-term secular story, and nothing can go wrong, because the numbers are suggesting that things are not looking great right now.
On crude and global inflation: Crude coming down to around USD 90 per barrel is certainly a possibility and can happen. But we cannot say that with conviction right now. I don’t know whether it is a likely probability that crude will cool down to USD 80 because China has raised prices by 17%. I do not see a huge demand destruction happening in India. The situation is not academic. We are in a real problem. We can only hope that crude cools down, China and India consume less, there is demand destruction and crude does not go to USD 175, which is our nightmare scenario. We cannot say that with conviction. Crude seems to be in a very strong bull market of its own. When things are bad, we have got to say so and accept it. People are in a denial mode and are not choosing to do so at this point. There are huge risks to growth and to the equity environment foreseeable over the next many months. That is something that the stock market is trying to price-in today. Therefore, every prudent investor who worries about his financial health has to take those risks on board. We need to understand the risks about investing in things that can go terribly wrong over the next three months, as indeed they have over the last six months. It does not look like the markets are going to come around and settle down over the next 3-4 months. |
By Udayan Mukherjee, CNBC-TV18
Messages on Market Outlook - Short Term
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