Rising markets, falling economy: Which indicator will reverse first?
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Rising markets, falling economy: Which indicator will reverse first?

A few stocks, popularly known as Hrithik stocks contribute most of the index gains.
20 Jan, 2020, 13:44 IST | Mumbai, India
Rising markets, falling economy: Which indicator will reverse first?

The opening lines of A Tale of Two Cities is most apt to summarize the state of the Indian stock market and the economy: The stock market that trades at highs is having the best of times whereas the faltering economic growth is facing the worst of times. It is the epoch of belief that Indian economy will hit the $5 trillion GDP mark and how it will get there is the epoch of incredulity. It is also the season of hope that worst is behind us and season of darkness, especially on various fronts like employment. And so on.

During my recent travels and meetings with different types of investors and corporates of all sizes, the common question was: ?Why is the market going up when the economy is struggling?? And in spite of Sensex ruling above the 40,000 mark and Nifty above 12,000, no one seems to be happy. In the past, such psychological levels have been celebrated by releasing balloons from top of stock exchanges and TV anchors coming out in their creative best to celebrate such milestones. The current low happiness quotient is because of corresponding low participation in the wealth effect.

A few stocks, popularly known as Hrithik (HFDC, RIL, ICICI Bank, TCS, HDFC Bank, Infosys, Kotak Bank) stocks in WhatsApp groups, contribute most of the index gains. These stocks do not form the bulk of portfolios of most investors. The Nifty Smallcap was down 9.5% last year and Nifty Midcap index 4.3%. If you remove Hrithik stocks from index calculations, then you are left with an index, which is much lower and truly reflecting the current state of the economy.

The market is rising because of robust FII flows post corporate tax cuts announced in end September. In nearly four months since the tax cut, FII net inflows to India equities have been about $8 billion. Most of the inflows have gone into the usual suspects, and that explains why Nifty levels are where they are.

Domestic flows have also been healthy. Amfi has been reporting a steady collection of about $1 billion in equity SIPs every month. This reflects the maturity of retail investors and points to the fact that mutual funds have now become a preferred investment vehicle for retail investors.

Global economy is slowing down and central banks are adopting dovish policy stances. There is an increased hope of a permanent trade pact between the US and China. As a result, global markets are rising and the risk-on trade is back.

India has also been a beneficiary. Nifty broadly delivered 12% gain last year. Developed markets have performed significantly better; S&P500 rose 29% and European markets around 23%. Emerging markets have been a mixed bag: Russia is up 29%, Brazil 32%, Turkey 25% and China 55%, whereas Mexico and Philippines are up 5% each. Many of these stocks have outperformed India on local currency terms.

Second quarter earnings were not a disaster. But Nifty trades at a premium to other emerging markets on a 12-month forward basis, with falling RoE, which has become a cause of concern.

The pain in the economy has its origins in September 2018 when IL&FS defaulted. In last 12 months, the Indian financial system has withstood multiple arrows: - IL&FS, DHFL and ADAG defaults, debt problems in Zee Group, corporate governance issues in CG Power and Coffee Day and so on. All this has had a cascading impact on domestic liquidity flows. We are in a situation where systemic domestic liquidity is high, but transmission is low.

In spite of the rate cuts, credit flow and rate transmission have not been happening. RBI?s focus must shift from rate cuts to rate transmission and making credit available to different parts of the economy.

Some observers are hoping that private sector capex will help recover the economy. In my view, private sector capex revival is at least 24 months away. A large bank has shut down its project finance department, and that reflects the appetite or lack of it for corporate lending. All banks are focusing on retail. Fresh capex proposals are far and few in between. The Essar judgment was probably the best thing to happen in the sphere of project financing or corporate lending.

This is a watershed moment and we will look back and say that 2019 was the year when corporate lending in India changed for the better.

The government clearly needs to do some heavy lifting and spend. Fiscal deficit, which is tracked by most economists in developed nations, should not become a deterrent in a developing country like India where growth is a bigger problem than inflation and deficit.

Consumption remains the other engine. This can be triggered by the implementation of Direct Tax Code and rate cuts to make more money available in hands of the common man. We are passing through the last phase of pain that began with demonetisation, followed by GST implementation and then the IL&FS defaults. We believe economic indicators will start looking up over the next two quarters. This cannot happen by merely hoping. The need of the hour is spending on infrastructure and changes in personal taxes. To fund this, India needs big ticket privatisation. PSU divestment is a low-hanging fruit. Pluck it before the global liquidity tap dries up. Structural changes are required to put India back on track to aim for the $5 trillion economy goal.

The stock market may change directions many times over the next six months. The Indian economy will also hopefully change its direction for the better. All eyes will now be on Budget 2020.