Patanga - don't get burnt by the "bull market" - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
Patanga - don't get burnt by the "bull market" A  A  A
19 MAY 2014

The exit polls - barring the astoundingly accurate one from Chanakya - were wrong: they did not predict the intensity of the disgust against the Congress and, by default, the willingness to try the alternative.

The BJP - led by the relentless campaign of its Prime Ministerial candidate, Narendra Modi - wiped out the Congress. The Congress, with 43 seats, did not muster the 10% of the 543 seats needed to be recognized as the official Opposition Party in the Lok Sabha: a new low for their lack of relevance in India's future.

This is the first time, since 1984, that a single party has won a majority in the Lok Sabha. The Rajiv Gandhi win of 400 seats was on the back of the sympathy wave due to the assassination of Indira Gandhi, this win of 283 seats by the BJP (and 337 seats including its allies), was due to the anger of being ruled by an impotent and arrogant Congress.
Narendra Modi's credentials as the Chief Minister of Gujarat for 12 years was brilliantly packaged by his media team and led to this historic win.

The market roars then whimpers?
Scientists have said that, when the sun dies out a few billion years from now, the world will not end with a bang - but with a whimper, in a sure but gradual destruction.

Is the Indian stock market in a whimpering stage where the spectacular recent rally fizzles out slowly?
Or is this is a pause before the next Bull Run?

Given that the stock market was reaching new peaks in recent weeks on the assumption of the BJP and its allies winning a small majority, should the market not have surged higher on Friday, May 16th in reaction to the poll results which showed the annihilation of the Congress and the surge of the saffron flag in the Hindu heartland?

If you expect your child to get a 70% pass grade (we do live in times of inflation, and 70% means little these days, just as a Rs 100 note means nothing!) and, as you scroll down your child's report card and the results show 80%, 90% and 95% will your joy increase, or decrease?

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The markets surged by over 1,000 points in the opening minutes. The S&P BSE 30 Index breached the 25,000 level and then - by the end of the day - the Index surrendered 80% of its gain to close at 24,122 which was a gain of a stingy +0.9%. The prodigal Messiah gets a great report card and the supporters celebrate with a +0.9% gain?


Was the market in a "buy on the rumour, sell on the news" frame of mind?

Was the market ecstatic that the victory was beyond expectations but there was now a reality of policy making that needed to be announced and there were doubts creeping in? After a rally from the 17,500 lows of August 2013 the 43% surge in the Index did deserve a rest - but does the winner rest before or after a celebration? But any victory is followed by a popping of champagne bottles, a new sense of lightness of being - and then the winner gets to rest. But here there was no "pop" after the clear majority.

Was the market troubled by the weakness in the Eurozone economy and the decline in the US markets? Were global factors hurting the local news?

This Bull Run is still based on "bull"
Since the win of Narendra Modi and the BJP, many market watchers and stock brokers have "upped" their estimates for the Index to the 28,000 levels by December 2014 - a gain of 10% from here.

All these estimates are based on a mix of expectations and assumptions - and some of these may be too optimistic.

A sustained bull market needs:

  1. The reality of better earnings, and
  2. A tsunami of money flows.
Earnings of companies as a group are typically driven by 4 macro variables:
  1. Rate of growth in GDP,
  2. Rate of inflation
  3. Rate of interest rates, and
  4. The fx rate of the INR
None of these support a case for a great near-term earnings story.

GDP can get a boost from investment in projects. The investment cycle can be turbo-charged if the BJP government announces concessions for the business houses, many of which reportedly backed the Modi campaign with supposedly large amounts of money. Given that the business groups will be telephoning Mr. Modi and his cabinet colleagues to remind them of who paid for the helicopter trips, the buses, and the maidans - this boost for business investment is very likely. In addition to the investment by private groups, the public sector companies may also be pressurized to invest - just as they were during the recent stewardship of outgoing Finance Minister Chidambaram.

Chart 1: Can the Modi wave energise the economy?
Source: IMF projections, Equitymaster Chart Of The Day

However, capacity increases and higher investment may not result in profits - there is already excess capacity in many sectors and it will need a leap in demand to wipe out this excess capacity and return pricing power and profits to companies. So, a higher investment will lead to higher GDP but not necessarily to higher profits. We already saw the outcome of a similar cycle in the 2005 to 2008 period: Indian companies invested heavily and GDP surged - but profits have not surged since then. In fact, the cost of financing the expansions has led to subdues profits and more debt in the balance sheets of many companies.

To buy this higher output of goods, Indian consumers need to start earning more. They can have higher earnings from a larger salary - or by seeing their cost of living decrease. If inflation declines, the Indian consumer will have more money in their pockets to spend on the products manufactured by Indian industry. Food, rents, medical costs, and education costs (or property mortgages) probably account for over 70% of the consumption basket of a typical Indian household.

Food inflation can decline if the level of production increases or if there is less wastage in the supply chain. That cannot be done overnight. Or of the BJP chases the trading community - one of its backbone voters - to sell products at wafer thin margins. Or of the BJP leans heavily on the real estate firms (and the banks that have loaned money to them) and forces them to drop property prices by some 20% or so to clear unsold inventory of existing apartments and commercial spaces.

Is that likely to happen?
The conflict within the BJP policy making will be to now address the expectations of the 200 million people who voted for it v/s the expected returns of the thousands of business men who will be waiting for their reward. The BJP, in my view, will do what the Congress has been doing: subsidies for the poor and favours for the rich. The question is what will be the efficiency of the subsidies and the degree of the favours? Time will tell how the BJP deals with this reality.

With inflation unlikely to decline, interest rates will stay high. The BJP's media campaign may have convinced voters to have faith in a BJP government's ability to wave magic wands and shoot silver bullets to cure India of the inept rule of the Congress.
But media slogans will not sway the Reserve Bank of India. Thankfully.

The RBI fought the very public pressures from Finance Minister Chidambaram and the lobby of complaining industrialists to reduce interest rates and sour growth: that was a potential recipe for higher inflation and a crumbling economy. The RBI will now have a saffron flag being waved in their face. I hope they will continue to allow data and economic analysis to decide what they do next. In my opinion, the only difference between India and a basket-case banana republic (like North Korea or the United States, though -admittedly - the US is a far more fun place to visit and Narendra Modi will now get his visa! ☺) is the existence of a RBI that has had to bear all the responsibilities of the irresponsible actions of past governments (most of them Congress, of course).

The Indian Rupee, in recent time, has been one of the best currencies in the world - when measured from its weakest point. From its low of INR 68 to the US Dollar in August 2013, it has seen a 15% increase to INR 58 levels.
But, the INR has been a consistent loser over the decades. It has lost some 5% per year from INR 8 per US Dollar in 1980 (when the first reforms were put in place for NRIs doing business with India) to INR 58 today. As long as inflation stays higher than that of the developed world (currently inflation in India is 3x that of the global numbers), the INR will stay fundamentally weak. Gold will remain a great protection against this long term weakness of the INR.

And the global issues have not disappeared. The stunning recovery of Wall Street bonuses, arrogance, and power should remind us not to write off the potential return of The Cream Team of the Congress. The continued misery of millions in the developed world who have not seen any increase in their incomes or job security suggest a two-tiered economic recovery mostly described as the gap between "Wall Street and Main Street". With debt remaining high at personal and government levels and pensions for the retiring populations still a problem, there are risks.

Add to this the annual worry over the monsoon and food output in India (and globally), geopolitical problems in Russia, China, and the Middle East and Africa - sprinkle in the impact of all these on energy prices - and there is enough to suggest that something can go wrong.

Don't be the Patanga, be sensible, be balanced!
Can the Index surge to 28,000 by December 2014?
It can: based on pure money flows, if people ignore the facts.
Or it can if a lot of things go right on the inflation and growth front and the "facts" indeed support a higher level of long term earnings.
But it may be better to invest carefully; maybe reduce your allocation to equities, or reduce the amount of money in your SIPs for a few months...stay invested but not fully invested. Again, on a very long term view of years - buying stocks is a great idea. But invest with that long term view and not because some talking head on TV said "the markets will zoom".

And while you mull over this: please hear the brilliant song from Patanga, which was sponsored by Quantum Mutual Fund and the National Streets for the Performing Arts.

Beware the chamak, chamak of the business news channels and their "experts". There are already enough noises screaming that Indians are "under-owned" in equity and that individuals need to buy more shares.
We agree with that statement - but warn you that the people making the statement are out to steal your wallet.
Ask them how they got rich? Ask them if they ever gave you advice knowing that it was bad advice but they gave it to you knowing they would earn money from the transaction?

Every analyst makes errors of judgment, which is part of our work. But the bad ones write doctored opinions to get you to act in a particular way. And the industry is full of these doctors of numbers!

And what I see on the horizon so far is less of the mitti and more of the lapat kapat ka chhaunka.

Let the gaanv ki mitti of earnings and fundamentals always guide you in the world of investing where thieves are standing in line to pick your wallets. Enjoy the message of Patanga!.

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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.

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7 Responses to "Patanga - don't get burnt by the "bull market""


Sep 8, 2014

Friends, the very reason of reading this article was my skepticism in the overwhelmed market and the trap being laid for some gullible retail investors.
I think being cautios and value investing will help. let me know more to stay solid in a bull mkt when it bursts.


Yash kalra

May 28, 2014

Very informative & honest.

Like (1)

Sambaran Mitra

May 20, 2014

The stock market's measured reaction after the actual result is really surprising. (I am not complaining though). I was expecting at least one upper-circuit-break.

Like (1)


May 19, 2014

very nice article...

Like (2)

prabhu dayal sahu

May 19, 2014

Dear Ajit ji,
The article Patanga- is really an eye opener.It gives the common investor like me a correct picture of the current state of Indian economy and that of the future probabilities which otherwise would have been impossible to get given the spate of TV channels luring the investors into trap.Hats off to your sincere service to the investor community.

Like (1)

devendra dass kochar

May 19, 2014

You may be the devils advocate,but you at least put the honest truth on the table, only the bones without flesh. A group of readers may not digest what you put forth but eventually the truth as put forth by you shall prevail.
Congratulations & keep stroking the minds of slumbering millions who are wishing to listen to you.

Like (1)

devendra dass kochar

May 19, 2014

You may be the devils advocate,but you at least put the honest truth on the table, only the bones without flesh. A group of readers may not digest what you put forth but eventually the truth as put forth by you shall prevail.
Congratulations & keep stroking the minds of slumbering millions who are wishing to listen to you.

Like (1)
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