Short Call: South Indian Bank, Lupin, is the worst of banking crisis behind

Foreign funds have been net buyers in the last couple of trading sessions, though it is early to say if this signals a change in outlook

“It's not earnings changes that cause stock price changes, but earnings changes that come as a surprise.” ~ Howard Marks

The sense of fatigue in the market persists. Valuations in quite a few pockets now look reasonable, if not attractive, but investors are waiting for cues from the fourth quarter earnings season. Brokers are telling clients to start bottom fishing in small cap stocks, now that the BSE Smallcap Index is back to where it was in August 2021 and Nifty Smallcap 100 is back to where it was in March 2018.  Foreign funds have been net buyers in the last couple of trading sessions, though it is early to say if this signals a change in outlook. The panic in global markets has subsided, and the popular view that the banking crisis is as good a closed chapter.

South Indian Bank shares are in a bear grip over Managing Director and CEO Murali Ramakrishnan’s impending departure. The stock had trebled between June and December last year, going from a low of Rs 7.25 to a high of Rs 21.80. Credited for turning around the bank’s performance since taking over in September 2020, Ramakrishnan had set a target of 13 percent Return on Equity and 1 percent Return on Assets by 2025. There is now uncertainty over those goals. Equirus Capital has downgraded the stock following the development.

“We see the non-extension of his tenure as negative for SIB, with the potential of adversely impacting the turnaround and recovery efforts at the bank. With the expected change in this top position at the bank, we cut our target multiple to 0.6x (from 0.75x earlier) Price to Book,” the firm said in a note to clients.

If clearly defined processes are in place, Ramakrishnan’s successor may be able to take things forward smoothly. But the change comes at a time when the operating environment for the industry in general is getting tougher. Even if the long term story has steam left, investors are likely to wait it out for a few quarters.

Another turnaround story that could take a knock after the US FDA issued a form 483 with 10 observations for its Pithampur plant. This comes barely 4 months after the regulator had made eight observations for its Mandideep plant. The stock had shrugged off the previous US FDA red flags, and gone on to hit a 52-week high of 799 in December. Analysts are still waiting for details on the latest observations, but there could be a knee jerk reaction to the development. “Expect analyst concerns to remain high,” broking firm Nomura said its report. The stock has made a strong comeback from the lows of June as the restructuring exercise is beginning to yield results. But the news flow of late has been negative. In January, the company  recalled over 16,000 bottles of generic tuberculosis drug in the US market, and last month it recalled 5,720 tubes of a skin medicine over quality issues.

Has the banking crises In the US and Europe been resolved fully? At least equity markets seem to think so, as do depositors. But it would be worth keeping in mind a line in George Charles Seldon’s 1912 best seller Psychology of the Stock Market: “Some events cannot be discounted, even by the supposed omniscience of the great banking interests.” A summary of the book can be read here:

Deposits at small banks fell $119 billion to $5.46 trillion in the week ended March 15, more than twice the previous record drop as a percent of overall deposits since March 2007. During the same period, deposits at large U.S. banks rose $67 billion. The pace of deposit outflows from small banks to big banks may have slowed over the last few days, but things look bleak for small banks. If deposits shrink, they can’t make loans, which soon will result in a credit crunch for small businesses

Wall Street columnist Greg Ip has warned of a new template for financial crises- a banking crisis in slow motion.

“Unless federal insurance is extended to all deposits, small and medium-size banks could be in for a prolonged period of pressure on their deposits, which could in turn force them to be acquired, or limit their lending. It won’t be a crisis in the usual sense of the word. But the end result may be the same.”

The Federal Reserve’s use of the “Bank Term Funding Programme” to staunch in the banking crisis may have calmed depositors and investors for now, but it does not fix the problem, warns The Economist newspaper. Under this facility, banks can borrow from the Fed at the full face value of the collateral (bonds), even if the market value is much lower.

“The programme could change the understanding of collateral that has built up over the past 150 years. This would mean that financial institutions benefit when interest rates fall and their bonds rise in value; and when rates rise and the bonds slump in value, the Fed comes to the rescue. To remove the risk of sudden collapses, and make the financial system safer, policymakers may in the long run have done just the opposite.”

Here are some of the market voices who feel equities could be in for a rough ride shortly because of the problems brewing in the banking system.

"If you go back to every previous financial crisis, they usually start with a small place or an out-of-the-way place. The 2008 crisis started in 2007 with some small banks, and the next thing you know, we had Lehman Brothers. That's the way these things always work. So this is not over yet.”

Jim Rogers in an interview to my colleague N Mahalaxmi

“Those are massive losses under the surface. Our 21 leading systemic risk indicators are pointing at the highest probability of a crash or a sharp drawdown in the next 60 days. What happens is, as a shock comes in, credit markets start to price in the risk but equities don't — they focus on things like AI or things like the dot-com revolution in the '90s.”

Larry McDonald, author of Bear Traps Report newsletter

“Given the events of the past few weeks, we think (earnings) guidance is looking more and more unrealistic, and (US) equity markets are at greater risk of pricing in much lower estimates ahead of any hard data changes.”

Michael Wilson, Strategist, Morgan Stanley.