Indian markets : With waning momentum, theme to shift from Growth to Value.
Markets love to stitch a story. When the year began in 2016, it offered more than the required recipe for stitching a consumption story. It all started with pay commission bounty. Budget took it from there and built on it with huge boost to rural spending. Monsoon moved next to spruce up the spice with its windfall gains on rainfall. But, for any story to steamroll into spellbinding saga, it needs the final bollywood-style splurge in the form of mega budget. This final push came in the form of EM carry trade i.e. gush of dollar flows into Emerging markets in search of better yield, that became a formidable up-tide. What followed was a stupendous surge in consumption stocks in the next six months that eventually elevated the valuation of some sectors to unsustainable levels. Some of the shadow banks shining at 8+ times the book was one such scary outcome of this saga. But in the end, the fiction fizzled out on the lethal combo of Trumponomics and Demonetization. De-mon derailed the over-heated consumption theme while Trump Tantrum triggered the much expected reversal of EM carry trade. Both miraculously coincided (on the same date of Nov’8th to be precise) to bring the perfect storm to Indian stocks.
As the new year dawns, bruised markets are set for a makeover, if we may call so. When there is no story to stitch, as being the case now, markets find refuge in Value. With de-mon damage set to linger longer, it is easy to guess that the consumption will be the first casualty. Story is set to repeat on FII flows, except that it is in reverse this time. Outflows from EM will magnify the consumption crack as how the inflows glorified it during the up-tide. Going forward, the theme that is likely to dominate the early part of 2017 (at least) will be “Growth to de-rate and Value to re-rate” as someone succinctly put. In other words, when momentum moderates, Value comes to the rescue. This trend will gain more traction on the likely divergence between FIIs action and domestic flows. While FIIs rush to the exit doors, domestic flows will gather steam on the expected shift in savings from physical to financial assets on Govt’s crusade against black money. More so, with the weakening outlook for both property prices (on prospects of stronger benami act) and for gold. This divergence between FIIs and domestic funds will gravitate the markets to bottom-up stock picking (value theme) given the tendency of local funds to dabble in broader markets (small and mid-caps) in contrast to FIIs who fancy the larger cousins.
That said, it is not all gloom and doom for momentum theme. The later part of 2017 may have a surprise in store. The churn from growth to value is based on the premise that EMs will see continued outflows on stronger US prospects i.e. faster Fed rate hikes and surging dollar index. While this may be the case in the early part of 2017, one may not be so sure about this on the later part. As we move more into 2017, more realistic view may emerge on growth prospects for US which might temper the rally in dollar and consequently one would see more objective flows for EMs. On the domestic front, with base-effect kicking in the second half, supported by GST gaining traction, growth and consumption themes may revisit in the IInd half of 2017 with vengeance. It is going to be an interesting year to watch out for!
But for long-term investors, the question is not about Growth or Value. Can it be both i.e. Value embedded with Growth. As someone wise once said, long-term returns in stocks are function of two critical factors i.e. buying price and earnings growth. First one represents Value and the second one stands for Growth. Long-term portfolio returns are delivered by the synthesis of Value and Growth. Deep downturns in the markets provide stellar opportunities for such synthesis to steamroll. In this context, current market weakness is a wonderful opportunity to create value from delayed (not denied) growth!!
If historic data is anything to go by, FII sell-offs have always been a boon for long-term investors. Below chart brilliantly captures this phenomenon. The succeeding years of FII sell-offs, have always delivered huge returns to investors (pls note “always”). Going by this, when the year ends in 2017, investors who have capitalized on the current fall induced by FIIs will have more than ample reasons to cheer.
This is not to say everything is rosy. The damage the de-mon has inflicted will take a while to heal. But, markets mired in its manic mood set by FII sell-off, have chosen to ignore the medium and long-term prospects of changing financial landscape driven by demonetization. Markets seem to be under-estimating the dramatic multiplier effect of shift from informal to formal economy. When markets price-in only the short-term risks, not the medium to long-term prospects, which usually happens during aggressive sell-off by FIIs, subsequent years have always been hugely positive. Needless to say, current period is one more such opportunity for long-term investors.
Wish readers a very Happy and Prosperous New Year!