Return of the Lemmings
I have been awaiting a correction in the Indian stock market for some time now. After defying gravity for a little more than three years, stocks there gave up more than 7% on Thursday and another 4% on Friday. Mass suicide amongst Lemmings might be a myth, but no major stock market can drop like this without a significant proportion of its participants suffering Lemingitis, aka the desire for mass-exodus.
As you might expect, the crash is front page news in India, where the media is trying to explain the crash to a medley of reasons: among others, these included the Indian government's notification on how investors and traders are distinguished for tax purposes and the recent rate hike by the US Fed.
The first thing that strikes me about this crash is the timing: exactly two years ago, the market experienced its worst fall ever in percentage terms. I am certain that painful memories from that crash added to the selling this time in a self-fulfilling prophecy. People will do well to bear in mind what has happened since then: the Business Standard (a leading Indian financial daily) reports that over 220 stocks are up 10 times, or 1000%, since the previous crash. While the trigger for the previous crash was the unexpected victory of the left-of-center Congress coalition, the precursor to this crash was increased risk aversion amongst investors the world over. With oil pushing 75$ per barrel, Copper prices up 4 times in 6 months, the Fed rate moving above 5% even as inflation creeps up in the US, Indian Treasury returns quite a bit above the average for the past few years, something had to give. The government tax notification provided the immediate trigger, and the momentum in the downside forced many in the Options market to cut their losses and add to the selling.
So, what's next?
While the last crash seemed like a fantastic buying opportunity to me, this one doesn't. Here are a few reasons:
I could be wrong, of course, which is one reason I don't plan on selling my Indian holdings on a net basis. The other reason is that I have been getting increasingly defensive over the past 6 months, concentrating on, you guessed it, stocks with economic goodwill.
Like I have been doing over the past year or two, I plan to wait and watch till there is less cheer and more despair before putting any new money in. Meanwhile, my allocation to Indian equities will drop by inaction (it's now down to 38% from 55% in 2004). The only specific move I am considering at this point is selling Tisco, but I am going to ruminate on that some more.
As you might expect, the crash is front page news in India, where the media is trying to explain the crash to a medley of reasons: among others, these included the Indian government's notification on how investors and traders are distinguished for tax purposes and the recent rate hike by the US Fed.
The first thing that strikes me about this crash is the timing: exactly two years ago, the market experienced its worst fall ever in percentage terms. I am certain that painful memories from that crash added to the selling this time in a self-fulfilling prophecy. People will do well to bear in mind what has happened since then: the Business Standard (a leading Indian financial daily) reports that over 220 stocks are up 10 times, or 1000%, since the previous crash. While the trigger for the previous crash was the unexpected victory of the left-of-center Congress coalition, the precursor to this crash was increased risk aversion amongst investors the world over. With oil pushing 75$ per barrel, Copper prices up 4 times in 6 months, the Fed rate moving above 5% even as inflation creeps up in the US, Indian Treasury returns quite a bit above the average for the past few years, something had to give. The government tax notification provided the immediate trigger, and the momentum in the downside forced many in the Options market to cut their losses and add to the selling.
So, what's next?
While the last crash seemed like a fantastic buying opportunity to me, this one doesn't. Here are a few reasons:
- The flight to Economic-Goodwill: The last crash was totally indiscriminate, stocks fell in large percentage points across the board, irrespective of their economic goodwill. For e.g, HDFC Bank (NYSE:HDB), Asian Paints, Infosys Technologies, all stocks that I consider having strong economic goodwill, fell 15% or more the last time around. This week, these stocks have been more resilient: they are down 4%, 7.3% and 7% respectively. Compare that with the ~10.3% fall in the BSE 30 Sensitive and the Crisil Midcap 500 Index and a ~20% dive in Tisco and Reliance Industries, two leading beneficiaries of the commodities and oil boom. This was no indiscriminate sell-off, there was a flight to quality that is typical of the late stage of a bull run.
- Stocks are more expensive than they appear: The newspapers report that the market is now trading at about 19 times trailing 12 month earnings, which translates to a rate of return of 5.3%+, where the + signifies the upside from future earnings growth. The risk-free rate of return is at about 7.6%, and my math suggests that the market is now implying a rate of earnings growth of about 6%. Prima facie, that is cheap for an emerging market like India. However, we have to bear in mind that corporate earnings for the past couple of years have been swollen with profits from the commodity and cyclical boom. If steel prices fall 20% from today's levels, Tisco's profits drop by 40%. As more oil refining capacity comes on stream the world over, I am guessing refining margins will drop by 20% or more over the next three years, taking a big chunk of Reliance's profits with them. From what I recall from languid afternoons in 2004 studying Tata Motor's annual reports, India has never seen six straight years of growth in sales of Commercial Vehicles. A cyclical economic slowdown should be around the corner in India, and CV/Cement and Heavy Engineering stocks should be running into a headwind. In summary, it is not obvious that corporate profits will grow at 6% p.a. over the next two-three years.
I could be wrong, of course, which is one reason I don't plan on selling my Indian holdings on a net basis. The other reason is that I have been getting increasingly defensive over the past 6 months, concentrating on, you guessed it, stocks with economic goodwill.
Like I have been doing over the past year or two, I plan to wait and watch till there is less cheer and more despair before putting any new money in. Meanwhile, my allocation to Indian equities will drop by inaction (it's now down to 38% from 55% in 2004). The only specific move I am considering at this point is selling Tisco, but I am going to ruminate on that some more.
posted by Sirish at 12:07 PM
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