The current year, CY2018, has been an interesting year for the Indian stock market. The headline numbers do not do full justice to the actual events in the markets. Though the large cap index – Nifty, is up 3% for the year, the real story lies in the mid and small caps space. The Nifty Midcap index is down 17% and the Nifty Small cap index is down 32% for the year. This has resulted in several investors and funds trailing the Nifty. Some of the stocks that saw the sharpest fall were the ones where questions were raised about their accounting and corporate governance practices.
The negative sentiment in the markets was triggered by multiple adverse factors – sharp rise in the prices of Oil, associated weakness in the rupee, increasing bond yields in India and expectations of higher inflation. To a large extent, all these factors are interrelated. Brent crude started the year at $ 67 per barrel, reached a peak of $ 86 in early October and is currently down to under $ 60. The sharp rise and fall in Crude Oil in a short period has largely been attributed to geo-political factors rather than significant change in demand supply. Given the state of global economy, there does not seem to be any material threat of oil prices spiraling up significantly, the way they did in 2008-2011 period unless there is continued escalation in global political situation. India being a large importer of oil, did get affected, resulting in a rapid weakness in the INR. From about 63 INR/USD at the beginning of the year, it fell to 74 in October and currently trades around 70. Similarly, the 10 year G-Sec rates increased rapidly from 7.3% at the beginning of the year to 8.2% in early October and has corrected to about 7.6% now.
The sharp moves in Oil, INR and the Bond yields created material concerns around the government’s ability to hold up to the fiscal deficit targets and potentially slowing down the economic recovery. Some of the defaults, and the potential stress in credit profiles in the bond markets, were also linked to these moves. Fund flow to NBFCs were also affected as the market became risk averse and started to take note of potential risks of funding profile and Asset Liability mismatch of some aggressive NBFCs. Though not widespread, these factors could indirectly affect businesses and consumption. As per early news flows, the festive season demand seems to have been affected. We will have to wait for a few more weeks to understand the full extent of impact. Markets were expensive earlier this year, especially so in the mid and small caps. Expensive markets tends to correct sharply when faced with material negative news and valuation tends to revert back to normalcy in such periods.
On the positive side, some of these threats have diminished. Since early October, Oil, INR and interest rates – have moved favorably. FPIs (Foreign Portfolio Investors), who were selling aggressively till October have also turned positive. Domestic mutual fund inflows, which had slowed down seem to be gathering momentum again. The broader market correction has led to several pockets of exaggerated valuations turning in favor of the long term investors. Despite the correction, we are not yet seeing cheap valuation across the board like what one would see at the bottom of bear markets. We do see some pockets of attractive valuations and are using incremental capital to invest in these companies. The negative economic factors are not completely behind us. There is an added uncertainty due to the upcoming general elections. Despite these factors, we find comfort in the earnings of good companies which are gaining momentum. We are comfortable buying and holding these excellent businesses at sensible prices. As long as these companies keep growing, time is your friend.