Moneycontrol
Sep 14, 2017 07:06 PM IST | Source: Moneycontrol.com

Poor macro data and Nifty @10k – should you care?

It may be early to ring alarm bells, but macro indicators are far from comforting. Unless things improve meaningfully in the second of this fiscal, equities will struggle to climb higher, no matter how strong the inflows into mutual funds.

The stock market has climbed every wall of worry in recent times as investors appear to be sold on the “India growth story”. But where is the growth, one may wonder, looking at the latest set of disappointing macro readings close on the heels of the disastrous first quarter GDP figure. Weak industrial output for July and a jump in August consumer as well as wholesale inflation have revived debate on whether the economy is staring at stagflation.

It may be early to ring alarm bells, but macro indicators are far from comforting. Unless things improve meaningfully in the second of this fiscal, equities will struggle to climb higher, no matter how strong the inflows into mutual funds.

The undesirable combo – rising prices and falling growth

CPI Inflation (Consumer Price Inflation) accelerated to 3.36 percent in August from 2.6 percent in July led by higher food prices. Core inflation, a key matrix tracked by the RBI, also inched up to 4.5 percent from 3.9 percent in the previous month. The base effect coupled with the full impact of Pay Commission’s house rent allowance revision would keep inflation firm in the foreseeable future. That leaves little room for the RBI to cut rates.

Rainfall has been deficient to the tune of 6 percent overall, but the bad news is that it has been hugely deficient in foodgrain producing states of UP, MP, Haryana and Punjab. This might stoke food inflation in the coming months, while normal rains should support softer prices of oilseeds and cash crops.

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The GDP print for Q1 FY17 wasn’t the only worrying signal and should not be dismissed as an aberration. The industrial production data, despite its inconsistency, points to a trend that was borne out by the GDP estimates as well. The weak IIP print for July at 1.2 percent compared to -0.2 percent in the previous month indicates that the economy is yet to shake off the fall-out of GST. Manufacturing continues to stagnate and saw a sequential decline in July.

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While disaggregate data points like auto sales, airlines traffic growth, uptick in power tariff etc. keep getting disproportionate attention from market participants, broad indicators clearly point to weakness.

Myriad indicators but broadly the same conclusion

Bank credit growth has fallen to 6.3 percent compared to 9.2 percent in the year-ago period. Some feel that should be not be a cause for worry because firms may be borrowing money from other sources. Nevertheless, bank credit growth still remains a barometer of economic well-being. As our analysis suggests, 70 percent of the incremental credit is generated by private-sector banks catering to retail and higher rated corporates. The avenues for financing risk has completely dried up and is unlikely to revive unless banking sector’s asset quality mess is sorted.

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The investment cycle shows no signs of upturn as evident from the fall in capex to GDP ratio. While government spending has gathered pace in pockets like roads, railways etc., private sector is not investing enough.

With a million Indians reaching the employment age every month, flagship projects like “Skill India”, “Make in India” etc. need to start showing results. The only remaining engine of growth, namely consumption, can only power the economy so much. The services sector will not be able to create enough jobs, since tectonic shifts are taking place in sectors like information technology, an important contributor to India’s consumption engine so far.

Weakness evident in corporate earnings

The slowdown is evident in corporate earnings which markets have decided to ignore as part of it has been attributed to the lingering impact of demonetisation and the rest to GST-led adjustment pangs.

Nifty companies reported high single-digit aggregate sales growth in the June quarter, but margins have contracted sharply leading to a decline in profitability. There has to be a dramatic improvement in the coming quarters if the double-digit profit growth estimates for FY18 have to be achieved.

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For India Inc., the aggregate number of the large universe of all listed companies is equally disappointing. Like Nifty companies, the topline growth has been in high single-digits. But margin contraction resulted in profits declining by double-digits.

All credit goes to sticky domestic liquidity

Empirical evidence suggests that market returns are a function of earnings growth and liquidity. For India, the good news on the liquidity front is that volatile global capital flows have been replaced by stable mutual fund flows.

Monthly Inflow into Mutual Fund SIP

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But for how long?

The bull camp is hopeful that benign inflation, strong currency, political stability and sticky mutual fund flows should keep the stock market party going. The bear camp is pointing to the sick banking sector, poor job market, weak earnings and steep valuation as reasons why the rally is unsustainable. So far, bulls are winning hands down.

Should macro challenges persist and earnings growth fail to pick up, the “hope rally” driven largely by domestic money will be vulnerable to a sudden reversal. As the saying goes, in the long run, markets are slaves of earnings. While stable liquidity is a good cushion, the big upside will depend on earnings growth. With a decent correlation between earnings and growth indicators, poor growth cannot be wished away.

For more research articles, visit our Moneycontrol Research Page.
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