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Worse slowdown yet to hit markets

Published on Fri, Oct 10, 2008 at 16:22 | Source : CNBC-TV18

Updated at Fri, Oct 10, 2008 at 20:06

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Markets are witnessing fresh bouts of selling and have plunged further on the back of weak IIP numbers. Benchmark indices are under extreme selling pressure, due to heavy sell off seen across the globe. Meanwhile, the news of RBI move to cut CRR by 150 bps with effect from tomorrow has given some cushion to markets and frontline indices have seen mild recovery from lows of the day.

Amid the 'industrial recession' as named by the Prime-Minister economic advisory council member, Udayan said there is a pronounced slowdown which will only deepen with the passage of time given how things are unfolding globally. That's what the stock market has been pricing in over the last few weeks. So it should come as no surprise, that the bad news is now coming out because that is exactly how it happens, stocks fall first, then bad news follows.

Here is a verbatim transcript of Udayan's comments on CNBC-TV18. Also watch the accompanying video.

On 'industrial recession':

People have been in denial all along and this is typically how things work out. In previous cycles too, this is exactly the sequence things follow - first the stock markets fall, then the CEOs, economists and the government tell you that 'nothing is wrong and things will be fine' Not just the Prime Minister's economic council, but recently you had the finance ministry you that we are still on target for 8% this year and 9% next year. That's the level of denial that we see in this country. So far, not significant segments of the CEO population have come and told that things are bad. But this is not a number for the figment of somebody's imagination, this is a data point, the kind of capital goods and manufacturing data point that you are witnessing today. Just juxtapose that with all the voices that you have been hearing every time an IIP number comes out. We have comments like 'Everything is fine, our order books are healthy and there is no evident sign of a slowdown', So obviously these signs are coming from some other planet because we are not facing any kind of slowdown at all, this is just a classic denial. Finally the CEOs will come around in the next couple of quarters, to tell you that things have changed and they changed while they were in denial mode, they didn't change day before yesterday. So what we will follow right now is that the estimates of GDP growth will get crunched down further and the bigger problems will come for the next year which is FY10 when GDP and manufacturing growth assumptions will fall off quite significantly. But now when you do a lot of channel checks with companies on the ground, particularly many of those SMEs, a lot of stress is visible which we are not hearing directly out in the open or in the media -- which is companies freezing employment, laying off employees, raising bench sizes, resorting to production cuts and stalling purchases of capital goods in a significant way. All of this is symptomatic of the kind of slowdown which is unleashing. So as some people have been saying for the last few weeks that 'our house is very much in order, India is a great story', it might be a better story in a relative sense but that is not to say that India is in a very good economic and corporate situation at this point. Far from it, we heard the IBA chief telling that they are not lending in any major manner and all that they want to do is hold on to liquidity at this point and companies which bankers are hearing directly from them are beginning to cut down production. So there is a pronounced slowdown which will only deepen with the passage of time given how things are unfolding globally and that's pretty much what the stock market in its wisdom has been pricing in over the last few weeks. So it should come as no surprise, that the bad news is now coming out because that is exactly how it happens, stocks fall first, the band news follows.

On GDP (Gross Domestic Product):

The industrial sector is not in shape and the point is that we are looking at current figures and that's the dangerous bit, it's pretty much like the Infosys example. This quarter numbers were great but the market is still hammering the stock down because it worries about the future. At this stage you are already looking at these kinds of 1%-1.5% IIP (Index of Industrial Production) numbers. Now the question is not whether in the next couple of quarters because the first half of the year was not too bad and which is already behind us, the average number turns out to be 7% and more. I do not think that should cause any jubilation.

To me the bigger worry is even if you somehow stretch through the next couple of months and arrive at more than 7% or even if it closer to 7.5% by the end of this fiscal, should we all be rejoicing or should we now start worrying about What lies ahead given the way and the pace at which things are worsening globally and locally?? What lies ahead after March 2009? What kind of numbers could we then be seeing? We have come out of four years of very heady stock markets and heady economic growth. Therefore the pace at which opinion tends to worsen is also a little sticky because we are spoiled with seeing extremely good numbers at the macroeconomic level and at a micro stock market and a corporate level. So people will always be slow adjusting their views downwards. People are people, whether it's the Finance Minister or stock analyst or the head of the Prime Minister's Economic Council; people are the same.

So in the stock market when you come out of a fantastic trajectory of earnings for 15-16 quarters then the downgrades always tends to be extremely slow and the stock market always leads, where stock prices fall first and the downgrades follow later. I think that exact sequence will follow this time as well and what we are leading up is that things worsening progressively from quarters and us landing into fairly bad soup in the FY10.

So the bigger question what should be asked economically is not whether we can get away with 7% growth this year but whether we are staring at sub-6% growth in FY10 and that is a data point and a fact then one should be prepared to ask and challenge squarely because we don't want to be in a pretty scenario with denial saying, "we cannot mention 6% its absolute sacrilege." That probably you are staring at next year.

What if we lend up in FY10 at a 5.7% or 5.8% growth? How would that sit after looking at 9.5% GDP growth in the matter of just about 18%. Would you then celebrate and take joy at the fact that you are still growing at 5.8% or 6% or would you say, "It was 9.5% and we have already got skittle down to sub-6%. That is a real threat and things have to improve materially on the ground for us to be not presented or faced with their reality in about 6-9 months from now. "

Q:Even about this year, are we being a trifle optimistic in expecting even 7%? The stock markets have discounted and will discount more but this is just an August number, that is another more than half the year left to go and it is 1%; the economist was talking about industrial recession so probably we are going to see contracting numbers. Even this 7% and whatever EPS growth we were looking for the Sensex it was shot of 1,000 after the corrections but should we scale that down considerably and therefore look at a very different GDP number, IIP number and Sensex EPS forecast for FY09 itself?

The stock market in its wisdom has been doing it. That is what is getting priced in, the way stock prices have been falling for the last few months, that is clearly the market's apprehension. 7% is not in the bag, 13-15% earnings growth is not in the bag by a long stretch because when things start worsening, they worsen far more rapidly than one can ever envisage.

This is not to suggest that there is only gloom and doom on the horizon and we are harbingers and messengers of gloom and doom. This is exactly how things have played out in the past. The things go up for a while and then hang around for a few quarters before it starts decelerating due to the impetus of the past and as momentum takes a while to turn down quite so decisively. But now that the momentum on the way down probably has started and the worse the numbers look, the worse sentiment will get and that itself will unleash. It will become like a vicious cycle as we have seen in the past. So you maybe 7% is not in the bag, maybe we see sub-7% numbers in fiscal year 2009, which sets the platform for a much lower GDP growth and economic growth in 2010.

On Earnings:

Earnings is a different matter altogether. While GDP growth will fall, I think the pace at which earnings might fall could be even more dramatic than GDP growth, because there is lot of elements to GDP other than just pure corporate earnings or manufacturing sector. So you could probably see a lot more deterioration in the corporate earnings profile over the next few quarters if things continue like this. So at the micro level the damage might be far more.

Two months back the assumption was that we are not growing that fast any more, so last year we were thinking about 20% growth so sadly we will have to get resigned to 15% growth, but 15% is in the bag, do not question that. Now I have heard a couple of people talk about 10% growth. What if at the end of the next couple of quarters, we go back and say there is no growth or corporate earnings for a large number of companies is absolutely flat? Has the stock market price that in fully or a completely flat earnings growth profile?

You can imagine that a large number of sectors like real estate, autos and metals are probably going to show you negative growth. By the end of this year,many commodities, real estate, autos perhaps many other sectors, which are dependent on commodities, natural resources could all report negative growth. So what is so sacrosanct about the overall index earnings not becoming flat? In that case, you are talking about earnings recession as well. So then does 10-11 times look so cheap?

The only point one is making is this is not an environment where you need to be complacent about. Do not assume things for given that this economic growth, this earnings growth is in the bag and that is my metric with which I construct valuation and stock price levels. Things are not very fluid; they could turn out easily far worse which the stock market has tried to price in. I think a lot of pricing has happened.

The one thing is that yes things are bad but the stock market is also at 10,000 now. The stock market is no longer at 14,000, so a lot of it has been priced in maybe a bit more needs to be priced in and I am sure that the market will do it at its chosen pace.