Markets touch record highs: Will the rally last? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Markets touch record highs: Will the rally last? 

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In this issue:
» Rising stressed assets for PSU Banks
» Slowdown takes a toll on small companies
» How will Ukraine crisis impact global stock markets
» Tough times ahead for state power utilities
» ...and more!

The week gone by has been quite eventful for Indian economy and stock markets. While the economic fundamentals still remain shaky, statistics suggest that Indian economy is taking the first steps in its efforts for a turn around. Current account deficit (CAD) that indicates the excess of imports over exports, one of the basic indicators of state of the economy, has fallen to its 8 year low. With this, the Rupee has strengthened against the dollar. The global confidence in Indian economy seems to have been revived. All this has come at a time when the economic data in the US - and other parts of the world - has not been very encouraging. As such, foreign institutional investors (FIIs) are returning to Indian markets, thus taking benchmark indices to new highs. So far, so good. But one key question does remain. Is the trend in CAD and the ensuing rally in stock markets going to last? An even more important question is whether the CAD accurately reflects current state of India's external balance.

Here are some interesting points one must know before getting carried away by the recent trends. The contraction in CAD has been a result of lower imports on account of economic slowdown , curb on gold imports and dollar swap schemes by Reserve Bank of India in the past. It is estimated that lower gold imports itself led to a 26% decline in the total value of imports in 2013. What is surprising is that in the same period, the demand of gold was up 13% (as per the estimates of World Gold Council). Needless to say, this was mainly catered through the unofficial channels. If one adjusts for the same, the CAD would have been higher by 0.5% of the GDP. On the top of that, any demand revival post elections may lead to surge in imports, making CAD difficult to sustain at current levels. External factors like depreciation in Yuan, thereby making Indian exports less competitive, can also reverse the recent decline in CAD. What more, there is increasing pressure on the Finance Minister to lower the import curbs placed on gold as well. In short, the factors that led to fall in CAD are unlikely to continue.

The key problem with India's external account is that a huge CAD is financed by uncertain capital inflows. For a sustained improvement in CAD, there is a need to address economic issues and constraints, such as reducing dependence on oil imports. Until then, the Rupee's recovery, FIIs interest in Indian stock markets and stock market rally lie on a very shaky ground. Hence, investors are better off not undertaking a significant revision in their future earnings projections for companies. We are nowhere out of the woods yet and hence, emphasis on companies with strong pricing power as well as strong balance sheets should continue.

Do you think that the shrinking current account deficit and ensuing stock market rally are sustainable? Share your views in the in the Equitymaster Club. Or post your comments below.

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01:50  Chart of the day
The problem of rising stressed assets in the PSU banking space has been a cause of worry of late. Stressed assets basically constitute gross non-performing assets and restructured advances. As of December 2013, stressed asset ratio of PSU banks averaged at about 12.6% of gross advances. This means that out of every Rs 100 lent roughly on an average Rs 12.6 was either restructured or classified bad.

Of the key public sector banks, Central Bank of India leads the list of banks where stressed ratio is higher than the industry average. It is followed by UCO Bank and United Bank of India. Rising stressed assets in the banking system especially in the PSU space raises questions over their lending practices. While the increase in ratio could be partly due to slowdown concerns, one cannot rule out lapses by PSU banks when it comes to assessing the credit quality of the borrower. The United Bank saga is a case in point. In order to improve the asset quality, PSU banks will have to tighten their lending criteria. Also, the current issue of rising troubled loans is because quite a few PSUs have high exposure to sectors which are affected by slowdown like infrastructure and real estate. Hence, sectoral caps should be reviewed. If not, the gap between asset quality of PSU and private banks will widen further.

Public sector banks facing a rise in stressed asset portfolio

Just as the economic slowdown is taking its toll on big corporates, small and medium sized enterprises are facing the heat as well. Indeed, for some of the smaller companies the impact of the slowdown has been so adverse that they have been forced to apply for sick status. This is so that they can protect themselves from creditors in case there is liquidation. This is something that is reflected in the statistics as well. As reported in Mint, 2013 saw the highest number of companies registering with the Board for Industrial and Financial Reconstruction (BIFR) for "sick" status since 2006. A total of 92 companies registered with BIFR in 2013, compared to 118 in 2006. These companies include both listed and unlisted entities. Many of these small companies are suppliers to their bigger counterparts. So when the big companies delay in making payments, the working capital requirements of these smaller firms increase piling on the pressure on them. Moreover, smaller companies also face hurdles in terms of securing funding from banks or when it comes to debt restructuring. Thus, unless the economy picks up, we may see more of these instances in the coming months as well.

For global strategists who were obsessed with either the US taper or a potential slowdown in China, a new front has opened up. And it answers to the name of Ukraine. The situation may look well under control there. Especially after Russia backing away from a full-fledged confrontation and diplomats across the world springing into action.

However, the fact remains that Ukraine can turn violent on the slightest provocation. This could then send the global markets into a tailspin. CNBC highlights that the size of the Ukrainian economy could well be not large enough. But it does have the potential to send prices of few key commodities like corn and wheat rising. Besides, the reverberations are also likely to be felt across Russia and impact its economic growth. However, do such events matter over the long term? We don't think so. The world has seen crises far worse than Ukraine. But the stock markets haven't stopped creating new highs every decade or two. Ukraine would be no different. There could of course be short term knee jerk reactions. But such situations should be looked upon as an opportunity to pick up fundamentally strong stocks at attractive valuations we believe.

Power utilities have as it is missed being part of Sensex rally. Shortage of fuel supply, lack of reforms, poor health of SEBs and the latest confusion over power tariffs have together kept investors away. In fact, the latest CERC guideline on power tariff calculation came in as a huge shock to state owned power utilities like NTPC and NHPC. Power regulator, CERC's final guidelines have been in favour of plant load factor (capacity utilization) for tariff fixation. CERC has shifted the incentive structure to plant load factor from plant availability factor for period FY14-FY19. A report by S&P, quoted by Economic Times, states that revised regulatory tariff structure is likely to weaken the operating performances of National Thermal Power Corporation (NTPC), National Hydroelectric Power Corp. (NHPC Ltd) and Power Grid. We believe that while the guidelines could be a temporary negative for the PSU power producers, focus on efficiency could be a long term positive.

The UPA government regime has been full of populist policies that include subsidies and freebies to the millions of poor Indians. But do the benefits really reach the deserving beneficiaries? The answer to this is not very encouraging. Most schemes are mired with massive leakages, corruption rackets and operational inefficiencies. The real problem is the involvement of layers and layers of commission-seeking middlemen. Is there a better and more efficient solution to ensure that the benefits reach the poor population without leakages? Yes, there is. By harnessing technology, government programmes can possibly bypass all middlemen and directly reach the beneficiaries. This is already happening successfully in some pockets of the country. The Direct Benefit Transfer (DBT) programme uses electronic system to transfer benefits. In doing so, it makes payment delivery more efficient, decreases leakages and enables more convenient access. With well-designed electronic transfer systems, India's poor population can benefit immensely and this in turn can result in huge savings for the economy.

In the meanwhile Indian stock markets have extended their gains and are trading at day's high. At the time of writing, the benchmark BSE Sensex was up by 361 points (1.68%). Realty and Banking stocks were the biggest gainers. Most of the Asian stock markets were trading lower led by Hong Kong and Japan. The European markets opened on a negative note.

04:50  Today's investing mantra
"You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets."- Peter Lynch
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4 Responses to "Markets touch record highs: Will the rally last?"


Mar 8, 2014

Good explanation but Market do not act on only data , market act on some compulsion also.



Mar 7, 2014

thank u very interesting i could gather vast economic information in just 5 minutes. I hope i will get it daily.


virendra bapna

Mar 7, 2014



Goutam Ghosh

Mar 7, 2014

It is really very helpful suggestion .

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