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When bulls laid bear

Author: Debasis Mohapatra & A. Saye Sekhar/Saturday, March 17, 2018/Categories: Cover Feature

When bulls laid bear

Euphoria to mourning is a short trip. And stock market is the place where one finds credence to this sentence quite often. In the run-up to the budget, the 30-share sensitive index, BSE Sensex, was roaring high with the benchmark hovering at a record level of 36,300.

This bullish overtone was also driving the 50-share index, Nifty, to an all-time high. A near consensus on corporate earnings recovery was taking the equity market to a higher trajectory each day. Except occasional noise on impending correction, everyone was enjoying the mindless bull run, which was riding on expensive valuation.

But, the party was short-lived as the applecart was upset after the announcement of Union Budget on February 1. On the budget day itself, market indices witnessed high degree of volatility, which amplified with each passing day. The Sensex crashed 840 points or 2.3% on the next day of the budget, making it the second sharpest fall by points post-budgetary announcements. The reintroduction of Long Term Capital Gains Tax (LTCG) was attributed as the main factor behind such sharp downturn.

LTCG tax & global cues

After a gap of 12 years, LTCG tax will now be imposed from the next financial year. Finance Minister Arun Jaitley has reintroduced the tax which was scrapped by former finance minister P Chidambaram in 2004-05. The budget proposals say that investors will now have to pay 10% tax on profit exceeding Rs 1 lakh made from the sale of shares or equity mutual fund schemes with a holding period of over one year. Some analysts are of the opinion that this was the major reason behind such sharp correction.

However, another school of thought doesn’t subscribe to this view. “We think that the market had already priced in long-term capital gains tax,” said Morgan Stanley in a recent report. They are also of the view that grandfathering clause has reduced the impact of LTCG tax to a large extent. According to budgetary provisions, capital gains made until January 31, 2018 will be entirely exempt from LTCG tax net.

A global comparison also puts the impact of this step in right perspective. For example, while Singapore and Hon Kong don’t impose capital gains on equities, other emerging markets like China, Brazil and South Africa have such tax provisions. In fact, China imposes 25% tax on capital gains from equities. So, the impact of LTCG couldn’t be termed as the sole factor behind the market crash.

Rather, there is a global angle to the whole story. Tightening job market coupled with faster wage growth in the United States has fuelled fears of rising inflation, going ahead. Markets worldwide are also increasingly worried about the withdrawal of monetary stimulus by central banks. Especially, faster rise of interest rates by US Federal Reserve seems imminent in the near future. All these global factors have riled the equity markets worldwide and India is no exception. In the first week of February, Wall Street’s three major indices logged their biggest weekly losses in two years with Dow Jones Industrial Average posting its sharpest one day fall since 2008 global financial crisis. “If the entire world index has gone down by 3.4%, naturally it would have ripple effect on Indian stock market also,” Finance Secretary Hasmukh Adhia had said.

Apart from these factors, deteriorating macros of Indian economy has also played a role in the recent market crash. In this year’s budget, the glide path for fiscal deficit was deferred to facilitate higher capital expenditure. The initial target of 3.2% for 2017-18 was revised to 3.5% for this financial year. Similarly, rising crude oil prices are likely to inflate the current account deficit (CAD) figures this fiscal and India is likely to end up with close to 1.5% of CAD in FY18, according to a Nomura report. Meanwhile, RBI’s hawkish tone on inflation indicates that monetary easing cycle is over and hike in interest rate is pretty much a possibility going ahead.      

PNB scam:

While equity market was coming to terms with the newly-imposed LTCG tax apart from a host of global factors, a stock exchange filing by public sector lender Punjab National Bank took the financial sector by storm. The PNB in the filing informed shareholders that it had stumbled upon a mammoth Rs 11,200 crore fraud involving Nirav Modi and his associate companies. The import financing instrument- Letter of Undertaking - was grossly misused in connivance with some of its officials.  

Notably, an LoU is a bank guarantee which allows its customer to raise money from another Indian bank's foreign branch in the form of a short-term credit. It helps the customer to make payment to its offshore suppliers in foreign currency.

In the PNB fraud case, the public sector lender had issued LoU to companies owned by Nirav Modi and Mehul Choksi for payment to their overseas supplier. These overseas suppliers discounted these instruments with banks abroad to receive payments. When post maturity of these instruments, Modi and Choksi couldn’t pay back, the PNB rolled over these Letter of Credits (LCs). This happened with many LCs which were extended by the PNB to create an overall liability more than Rs 11,200 crore.

This piece of news has further dampened the market sentiments with banking index facing severe selling pressure. Till the last week of February, stocks of public sector banks were down by 20-60% from its earlier peak. Immediately after the news of fraud broke out, share price of the PNB was shaved off 22% in the first two days. It had lost Rs 11,000 crore of market cap in the first 5 days after its filing at the stock exchange. Similarly, market cap of Indian banks had plummeted by around Rs 70,000 crore during this period.

The PNB fraud case has wide-ranging implications. Firstly, it weakened the expectations of a full-fledged economic recovery which market participants were betting on after improvement in corporate earnings. It has also dashed the hopes of any meaningful recovery in credit growth. After reeling under huge bad loan burden, Indian government has announced a massive fund infusion plan of Rs 2.11 lakh crore in public sector banks. This has rekindled hopes of restarting a healthy credit growth cycle by cleaning up the balance sheets of public sector banks. However, the PNB scam has put a question mark on the efficacy of the fund infusion plan as such off-balance sheet exposure has the potential of nullifying its impact.

Not surprisingly, market is not amused with market participants exiting most public sector banking counters in droves. Even, a host of credit rating agencies has put PNB’s credit rating under watch.

Way forward:

To predict and forecast the future market movement is very difficult. Most pundits and experts regularly get it wrong. So, let’s not dwell on the subject. Rather, our focus is on the factors that can drive the market in the short-run.

Most important factor from which market will take cue is the way PNB scam pans out in the near future and the response of the government in defusing the issue. As the buzz created around bank recapitalization has been faded due to the mega fraud case, market participants will look at future capital infusion plans of the government in public sector banks.

Moreover, resolution of big bad loan accounts such as Bhushan Steel, Essar Steel and other 10 accounts referred by the RBI in the first phase to Insolvency Board will give fair level of indication about the banking sector recovery going ahead. Industry watchers will also evaluate the sustainability of corporate earnings recovery in coming quarters. Meaningful recovery in demand growth will be the key to drive equity indices.

Gold loses glitter, realty shaky

The retail investors invariably keep an eye on the decisions of the government. For instance, the government is contemplating bringing about a piece of legislation to launch a crackdown on Ponzi schemes. The Government would soon introduce the Banning of Unregulated Deposit Schemes Bill in the Parliament.

Once passed, it would surely block the real estate developers from luring customers by offering fixed returns until possession of the property.

What’s more, several deposit-seeking bodies, be it corporates or other entities, including jewellery stores which tailor-make attractive schemes to draw customers, will all be brought under the ambit of the new law that would legally refrain them from making such offers. The law would make registration of the entities mandatory with a designated authority to ensure flawless enforcement of regulation.

The government, which is incorporating stringent punitive measures in the law like imprisonment up to seven years, strongly contends that these so-called offers are indeed intertwined with ‘unregulated deposits’.

We have seen jewelers offering to pay the first instalment and asking the buyers to pay the rest on an ornament or the total purchase in 11 instalments. The fine print with an asterisk would entrap the customer.

Similarly, many a real estate companies are openly offering return in the form of over 12 per cent of assured interest until the property was handed over to the customer concerned. Some others are offering huge discounts after a minimum period of depositing regular EMIs (equated monthly instalments).

These drew the State’s attention, for the companies would use such money for bulk purchases and execution.  

How would it be possible if it is not a deposit. If it is called a deposit the same cannot be done outside the law. This calls for regulating the same.

When the new law would make investments in gold and realty sectors regulated, equity markets would continue to remain attractive to the investors.

Michale Moe’s 10 commandments

Apart from domestic factors, global events relating to crude oil pricing, interest rate decisions of US Federal Reserve and other geopolitical happenings will be the key factors do move the needle northwards or southwards.

Michale Moe’s “Finding the Next Starbucks”, published in 2007, still holds good when it comes to how to find the hot stocks and invest. The 10 commandments proposed in the book are considered still the thumb rules for investments in equity markets. Being right on fundamentals of the target companies and picking the fastest-growing companies; being proactive instead of reactive and attain the ability to predict; being rigorous and intuitive; making decisions based on current facts and honestly admit when one wnet wrong; believing and working on the four Ps (people, product, potential and predictability); finding three important reasons to pick a stock and the likes are the keys to successful investment.

Investing in stock markets going by the domestic trends without taking cognizance of the global cues would be a big mistake. Investors, especially the retail investors, can’t always blame domestic factors for the blood bath in the bourses. If they heavily bank on the local trends, they will have to blame themselves when the bulls are laid ‘bear’.

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Debasis Mohapatra & A. Saye Sekhar

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