‘Ignore the noise’; the market cycle will bottom before the economic cycle

Image result for ‘Ignore the noise’; the market cycle will bottom before the economic cycleJuly was a tough month for the Indian stock market. The Nifty shed about 6 percent during the month, making it the worst July in 17 years for the benchmark index.

The pain was worse in broader markets as BSE Midcap and Smallcap indices fell 8.52 percent and 11.16 percent, respectively, during the month. The carnage in July also extended to the global markets as Dow Jones moved in the red despite a rate cut and dovish outlook from the US Federal Reserve.

Pessimism is hitting peak levels in the market and the economic situation is also benign. However, history has always taught us one thing that the market cycle will bottom before the economic cycle.

Despite global and domestic headwinds, we expect the market to make a bottom far before the shape of the economy improves because that is the nature of market cycles.

Markets are always ahead of the curve and as investors, we need to follow the signs the market is giving.  All is not lost and this is the time investors must cut out the noise and maintain their poise.

The trilemma of flows, negative corporate commentary and policy issues impacting markets. It’s a three-pronged problem, the FPI sell-off is what has hit markets first.

Foreign portfolio investors (FPIs) have sold stocks worth $2.5 billion. The taxation surcharge is what is being pointed out by most plaudits, but on closer examination, we realize that from pure taxation point of view, the additional surcharge should amount to something in the range of Rs 400 crore, which is a pretty insignificant amount for FPIs who have hundreds of billions of dollars under management.

In reality, it is a sentiment issue, and the sentiments have been worsened by the weak commentary given by most companies post the Q1FY19 results.

Most sectors have missed earnings estimates, baring few cement companies and select banks. Auto and consumption stocks continue to take a hit.

The market is estimating 24 percent EPS growth for the Nifty, about 70 percent of which is expected to be contributed by banks. However, the poor numbers reported by select banks, such as Yes Bank, RBL and DCB bank, has spooked the market.

Furthermore, baring cement production growth, most high-frequency indicators like auto numbers, PV sales, IIP growth, are also not encouraging.

A possible way out of this mess is if the government intervenes and cuts rates further, those rate cuts should also result in a meaningful transmission.

We already saw some small shreds of evidence of this when the State Bank of India cut FD rates. Moreover, the liquidity surplus in the banking system is nearly Rs 2 lakh crore which should also help accelerate the transmission.

The 10-Year yield is around 6-6.5 percent, while corporates are borrowing at 4 percent higher. Going forward, the corporate bond spreads have to come down.

The RBI has definitely induced liquidity into the system but it is stuck in the interbank levels, when it transitions to the corporate levels we will see some relief.

Secondly, there are talks that the government will consider giving some relief to the SEBI listed FPIs from the super-rich levy. If that goes through the sentiments will change.

The Nifty50 is finally reflecting the current economic reality.

The Nifty was still trading near all-time highs in spite of the broad-based sell-off and slowdown seen in the economy, but now some market leaders such as HDFC twins, Bajaj twins, Reliance Industries, Larsen & Toubro, and other HRITHIK stocks have also started falling.

This has created a dual impact where mid and smallcaps were anyway in a downtrend and now the large Nifty stocks have started showing weakness dragging down the headline Nifty.

Sentimentally there is no respite as all indices are in the red. The Nifty50 is so polarized that if we construct a #Nifty 40 index i.e. stripped of the top 10 cos and kept the balance 40, the Index would actually be at 9,000 levels.

The Nifty is currently trading at 11,000. Since January 2018, the top 10 market cap companies have rallied 21.4 percent whereas the remaining 40 are down 14.6 percent.

Now, the fear in the market is that the Top 10 will also join the remaining 40, so convergence will be on the downside.


Before the slump, the market was looking overvalued despite a weak economic situation. Now, the market valuation is starting to look in line with the economy.

If the fall gets arrested, the valuations would reach a level where it aligns with the economic reality and that may enable some investors to take contrarian bet on the market.

The market cycle will bottom before the economic cycle!

The collective wisdom of Mr Market is stronger than all us investors. Eventually, the market will start discounting the future and look beyond the noises of the present.

We have been falling for the past 18 months because negative news has been running amok, but markets have a mind of their own and seldom move in tandem with the economy.

Bottoming out of valuations will be the key, after a point the market will stop looking at the next couple of quarters and will start taking the next few years into account.

In hindsight, if we step back and widen our lens, we will find that there are many well run and growing businesses in our market that are available at single-digit valuations. Mr Market will take cognizance of this and when it happens the market will bottom out and turn.

Excesses on either side are unsustainable, markets have definitely outrun themselves and just like how the excessive bull run of 2017 was not sustainable on the upside, this particular sell-off will not be sustainable on the downside for long and market will have to mean revert.

How low do we go from here!

The Nifty is reaching long term Moving Average support. If one uses a 100-period moving average to track the long term trend of the Nifty, then it is clear that the market is heading down into support.

On the attached chart we can see that the 100 EMA has provided support so many times in the past that it is difficult to ignore its influence on the trends. Barring two occasions (2008 and 2011), the index never really lost this support on a sustained basis. There were marginal penetrations in 2013 and 2016 but those were reversed very swiftly.


Investment implications

The problems are partly sentimental and partly due to policy issues. However, we expect that the market will bottom out in the next 2 months, even though the economy continues to slow down.

There are many fantastic companies out there that have given meaningful corrections and are only part of temporary slowdown.

At Plus Delta Portfolios, we are using this opportunity to identify winners in this pullback. We will be buying the market once the dust settles.

We are constantly analyzing the trends and where we see earnings growth coming in the Q1FY20 results coupled with some traces of momentum in the stock we will be ready to enter.

This is an excellent opportunity for investors to build a portfolio form a 3-5 year perspective as the margin of safety is very high since we are nearing the bottom.