Will 2018 Have a Happy Ending for Indian Investors? - The 5 Minute WrapUp by Equitymaster
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Will 2018 Have a Happy Ending for Indian Investors?

Dec 3, 2018

Ankit Shah, Research analyst

The year 2018 has been a roller coaster for the Indian stock markets.

January started on a promising note, riding high on the optimism of 2017.

But come February and the bull run began to develop some cracks with rising yields on US government bonds, reintroduction of long-term capital gains tax, and other macro factors.

From its January high to its March low, the Sensex shed 10%. But the correction in the small and mid-cap space was much deeper following reclassification of mutual funds and additional surveillance measures by the market regulator.

I'd found out in early April that the average correction witnessed by BSE 500 index companies from their respective 52-week highs had been 24%.

And while the Sensex resumed its ascent in April, the broader markets remained subdued.

Then in May we witnessed a shocker in the form of rapidly rising crude oil prices as Brent crude oil prices shot above US$ 80 a barrel. Low crude oil prices had been the greatest boon to the Modi government until then. And now, rising oil prices threatened to jeopardize the economic recovery that seemed to be underway in the Indian economy following the twin shocks of demonetization and GST.

Mounting crude oil prices hurt India's balance of payments, resulting in a steep decline in the value of the Indian rupee against the US dollar. It also caused India's forex reserves to decline.

After rising rapidly to alarming levels in May, crude oil prices were in correction mode from June to August. This led to a strong rally of the Sensex through July and August. In fact, the Sensex went on to hit a life-time high towards the end of August.

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But here was the dichotomy. Not only was the rest of the market still in correction mode, even the Sensex rally was driven by just a handful of its constituents.

So, it would have been misleading if you'd tried to gauge the direction of the overall markets looking at the Sensex alone.

September saw crude oil prices again flirt with US$ 80 per barrel mark, posing a risk to import-dependent countries like India. The Indian rupee continued its downward descent. Foreign investors continued dumping Indian equity and debt instruments. The Sensex couldn't hold its ground against this onslaught and slid into correction mode.

October was the worst month for the Indian stock markets in 2018. For a major part of the month, crude oil prices held above the US$ 80 per barrel mark. The USD-INR exchange rate plunged to over Rs 74 per US dollar.

October was witnessed one of the worst foreign investor exodus from the Indian stock market (more on it in today's Chart of the Day). From it lifetime high in August to its October low, the Sensex had shed 14%. But the bloodbath in the rest of the market was much, much worse following the NBFC crisis and a sell-off in the global markets.

In an editorial I'd penned early October, I'd compiled the stock price data of 2,733 listed companies on the BSE. I wanted to know how much each stock had fallen from its respective 52-week high. I found out that 688 stocks (25% of the active stock universe) had crashed 61% or more from their respective 52-week highs.

And on average, Indian stocks had corrected 46% from their 52-week highs.

These were my concluding remarks at the time:

  • While the recent market crash and the macro uncertainty is a big cause of worry for investors, it must be recalled that Indian stocks were driven to unsustainably expensive valuations on the back of a flood of domestic liquidity.

    The ongoing market crash has brought down stock valuations to more reasonable levels. This may be a good time to scoop up great long-term investing opportunities.

    Of course, this doesn't mean that stocks couldn't crash further if things get worse.

    The correction could last longer.

    But looking at the history of equity returns, I can tell you that this would be just a passing correction phase.

    Despite all the volatility and periodic crashes, equities are still one of the most rewarding and safe asset classes over the long run.

November witnessed a recovery in Indian equities. After months of heavy selling, the foreign investors turned net buyers.

Now, the question is: What will December bring us? Are the Indian stock markets out of the woods? Or was the November recovery just a temporary breather before the downslide resumes?

Which factors are currently in favour of the Indian stock markets?

  • Oil price crash - One of the biggest relief for the Indian markets has been the steep crash in crude oil prices.
  • Rupee appreciation - The crash in crude oil prices has helped stabilize the Indian rupee with the USD-INR exchange rate coming below the Rs 70 mark for the first time since August 2018.
  • Dovish commentary by US Fed - Global market participants closely monitor US monetary policy. One of the key risk factors to the global stock market rally has been rising US interest rates. What has changed recently?

    Last week, Federal Reserve Chairman Jerome Powell said that rates were "just below" the level that would be neutral for the economy. The comment indicated a shift from his earlier remarks that rates were a "long way" from the bank's aimed neutral level. So, while the Fed is expected to carry out the rate hike in December, the recent commentary has given a thumbs-up to the markets.

But there are some concerns too...

  • GDP slowed down in July-September quarter - India's economy slowed to 7.1% in the recent July-September quarter from 8.2% in the previous quarter. This was due to a sharp drop in manufacturing, agriculture and mining activities. If growth doesn't pick up in the coming quarters, then it may impact corporate earnings, posing a downside risk to stock prices.
  • Fiscal deficit may be a challenge - GST collection in November dropped to Rs 97,637 crore, lower than Rs 1 lakh crore collected in October. There is a fair chance that the government may miss GST collections for the fiscal year. Amid the volatility in the markets, the government is also struggling to meet its disinvestment target for the fiscal. The government is taking various steps through buybacks by some PSUs, and purchase of government stake in certain entities by other PSUs. But whether it will manage to achieve the full year disinvestment target of Rs 80,000 crore remains to be seen.
  • Political uncertainty to remain a risk factor - The twin shocks of demonetization and GST severely impacted the informal economy, which is also the biggest employer in the country. With unemployment rates increasing and the ongoing agrarian crisis in several parts of the country, the government is hard pressed to initiate populist measures in the run up to the 2019 general elections.

The RBI Monetary Policy Committee is expected to announce its policy rates and an assessment of the economy in a couple of days. I'll publish an update on the state of the economy in my premium newsletter Insider.

All in all, be prepared for a bumpy ride ahead. My approach right now is to be selective about the stock picks, and not follow a blanket approach.

Chart of the Day

In the past, I've written about the structural change in investor behaviour in the Indian stock markets - the phenomenal rise of the Indian investor.

For a very long time, foreign investors were the dominant forces in the Indian markets. Their influence on the market movements used to be so significant that many market participants would closely follow FII flows.

But that has changed over the last two years. There's been a flood of domestic liquidity pouring into the Indian stock markets.

The domestic liquidity has been one of the key reasons that kept the market relatively buoyant despite the exodus of foreign investors.

Today's chart shows the monthly trend in foreign investor flows since the start of the current financial year.

Are Foreign Investors Heading Back to the Indian Stock Markets?

Here are some key takeaways:

  • As you can see, foreign investors have been net sellers of Indian equities in six out of the last eight months.
  • On two occasions, foreign investors were net sellers for three consecutive months.
  • The month of October witnessed one of the worst monthly outflows from the Indian markets.
  • While there was net buying in July, November has been the only month that has witnessed sizeable foreign investor inflows.
  • For the financial year so far, foreign investors are still net sellers of more than Rs 500 billion worth of Indian equities. That's higher than the foreign investor outflow witnessed during the global financial crisis of 2008-09.

So, while the net FII inflows in November are a positive sign, whether the inflow will continue is contingent on several domestic and global macro factors.

Happy Investing,

Ankit Shah
Ankit Shah (Research Analyst)
Editor, Equitymaster Insider

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