Where do you see the pain?
Nifty is not reflecting the pain and the pain is more in the broader markets. There is some logic to the pain also. We started off 2016 and 2017 with a big boom in mid and smallcaps. Prices went up through the roof a lot of it was much beyond fundamentals. So some correction was obviously needed and it also coincided with some tough calls which the economy had to take from the longer-term perspective, changing the way the business is being done.
It also coincided with issues within the banking and NBFC segment and access to credit became very tough. All these are known facts. When all these things happen towards the end, the sentiment just goes for a toss. Over the last couple of months, we have been seeing that the sentiment is going completely towards other sides. During 2016 and 2017, sentiments had run much ahead of fundamentals. We are now coming to a stage where fundamentals are running much below the fair markets. The earnings season has not been great. It is helping the bear view makers or even the doomsayers.
Buffett says stock prices are slaves of earnings. But now we are in an earnings bear market. We start each passing year with a high number and by the end of the year, we cut it down drastically. This year is no different. How does one understand that equity markets will come back when earnings are likely to contract further?
You are right. Markets are all about earnings, earnings and earnings. For the last two-three years, all of us, including me, have been propagating that the next six months are going to be tough but then the earnings will recover and that has not happened.
Frankly, this quarter there were expectations largely because the corporate banks were looking like turning around. So banks like Axis, ICICI even State Bank have reported a turnaround in their earnings and hopefully as we move forward, that would happen but some of the other larger companies like the telecom side or even on the auto side has seen a big sort of headwind and that has to some extent damaged the earnings trajectory.
Having said that, one interesting aspect of the quarter’s earnings June quarter earnings is that a)though small, we still have positive earnings growth. b)On the gross profit margin, across segments we are seeing quite a bit of stability which is very unlike the slowdown which we saw in 2001 and 2003. So, the balance sheets of the company are more or less very good. You remove the companies which are facing stress and who are going to go down under because of excessive borrowings and mishaps, but by and large, in the broader markets, a lot of companies have the debt equity ratio much below what we have seen.
In the last two-three years, they have maintained the good prospects of reducing the debt levels and the gross profit margins. Our expectation is that once the top line grows, demand starts coming back which hopefully has not happened as yet, but the profit growth can be significantly higher than the top line growth and in a couple of places, there can be a tailwind in terms of profitability because of lower interest rates and lower costs of fuel as well as raw materials. So we remain quite optimistic.
What you are saying is that the current environment does not look like 2008. That was scary environment but it certainly smells of 2013.
In terms of the large cap and midcaps, it is exactly a mirror of 2013. In 2013, again Nifty was flattish but mid and smallcap indices fell 20% to 30% and between August and October 2013, the country seemed completely lost. We were heading to election which was supposed to be very uncertain. The rupee overnight depreciated 15% odd. The foreign exchange reserves were very precarious. Government had to have SBI issue dollar bonds to replenish those foreign exchanges and stocks had fallen completely out of whack because earnings were not there.
The only difference this time vis-à-vis 2013 is that the mid and smallcaps are still not as cheap as they were in 2013-14. They are quite cheap but in 2013-14, they were very cheap and the next three years we saw the smallcap and the midcap indices go up three-four times. This time we do not see them going up three-four times but we definitely look at prices now and there is decent money to be made.
But if you compare the scenario, it is similar in terms of markets but in terms of the economy, we are much stronger now than we were in 2013 and 2014. So currency is very stable. In fact, the rupee is at the same level as it was in 2013 which was 69. Foreign exchange reserves are at $430-440 billion which is in the all-time high and oil is at $57-58 and looking very weak.
On top of it, we have a very strong government with significant majority in the lower house and hopefully a majority soon in the upper house. Politically we are very stable. In geopolitical term also, we are pretty okay. All we need is the economy kicking back in terms of growth rate and corporate profit to follow.
Do you think the markets and economy will get worse before it gets better? Right now, it is bad. Will it get awful before it gets better or are we nearing the fundamental bottom and the end of the price decline?
Let us just divide it into two – the economy and then the markets. As far as the economy is concerned, we are getting to the bottom. Maybe in the next one or two months, numbers might not look that great because this is a low sort of growth period. Monsoons have been pretty widespread and aggressive. There have been some states where there have been floods and normally the activity during this period slows down.
It is only post monsoon, when the festive season starts — mid September-October — that you will start to see the economy kick start. The other thing is the budget this time was in July, unlike in January and typically it takes six weeks after the budget for the ministries to start focussing on their allocation and therefore the spending.
All the government spending on infrastructure should now start post monsoon which will again be a big kicker as far as the economy is concerned.
Also, liquidity has come back into the system. The banks’ balance with RBI is at three-four year high at almost Rs 2 lakh crore. It has not been transmitted because there is this fear but once that fear goes away and the interest rate fall gets transmitted, that will cause a kicker as far as the economy is concerned.
On the other hand, the markets are now looking at bottoming out. Maybe the next two-three months will be a great time to start.
Both for largecap and midcaps?
Rather stocks which have fallen. Even in largecaps, you have a very different kind of market where one segment has not fallen and which is holding the market. I would say get stock specific irrespective of the market cap but obviously, the smallcaps and the midcaps have fallen the most because there is more fear there and they have fallen more.
I would say that stocks would start to react much faster and in advance. I will just give an example – people all talk about motor car sales. For the last four months, Maruti reports 25-30% degrowth in terms of car sales and therefore the prices have also fallen by almost 40%.
Imagine one month, when the spreadsheet will completely change from 105,000 cars a month to 120,000-125,000 cars a month. All it needs is one or two months where the sale number starts to come in. I would say that stocks might precede the economic recovery. All we need is two-three-four good news in a couple of segments and the sentiment will change completely.