Markets tend to anticipate events in the real economy. The lead-lag factors vary. Markets also tend to overreact to events because participants are prone to panic and euphoria at different times. When some unanticipated event occurs, the reactions can tend to the extreme.
The last major bottom in the Indian stock markets came on December 20, 2011, when the Nifty dropped to 4531. We may hazard a guess that this was in anticipation of bad news in the near future. If that was so, poor results in Q4, 2012 were, to a certain extent, discounted.
However, the gross domestic output, or GDP, estimates for January-March 2012 have just been released. The numbers are quite a bit worse than the market anticipated. Consensus projections were 6.1 per cent GDP growth, whereas the Q4 estimates are 5.3 per cent.
This is the lowest quarterly growth on record since January-March 2003, when the economy trudged along at 3.6 per cent. The annual growth for 2011-12 is estimated at 6.5 per cent, which is also a multi-year low. The January-March 2012 period is also the seventh quarter in sequence when the growth rate has slowed.
|Current (June 1)||Value
14 days ago
|Index dividend yield||1.69||1.64||0.05|
|Index book value||2.84||2.86||-0.02|
|USD-INR (RBI ref rate)||55.9175||54.3875||-2.81|
|FII net buys/sales(May 18-31)*||-1397.8||-460 (May 1-17)|
|DII net buys/sales (May 18-30)*||233.5||167.6 (May 17)|
|* Rs crore|
Prior to the Q4 estimates being released, several institutions had already estimated that growth in FY 2012-13 would miss the Budget estimates of 7.5 per cent GDP growth by a wide margin. Those estimates have now seen further downgrades. The reviewed projections place India’s GDP growth at somewhere between 5.7 per cent and 6.4 per cent in 2012-13. The unexpected nine-year low in GDP growth gels with corporate earnings records in Q4. Corporate projections for 2012-13 also back up pessimistic GDP projections for this fiscal.
Given that the numbers for the last quarter are worse than anticipated, and that the projections for the next four quarters have also got worse, there is a strong case for believing that the stock market could also react downwards. Actually, there is a case for believing that the markets could react downwards by even more than the projections warrant.
This is owing to the phenomenon of feedback loops that mega-speculator George Soros calls “reflexivity”. Soros borrowed the term and the concept from the philosopher, Karl Popper. It applies to all situations with strong feedback loops.
For example, assume a financial trend is established. The strength of the trend will be reinforced as more traders identify the trend and jump on the bandwagon. Their expectations will become self-fulfilling and the trend will often last longer than it “should”. When feedback loops occur, they ensure that financial trends move well beyond fair-value (in either direction).
There’s strong empirical evidence for reflexivity, both in general, and in Indian financial history. If reflexivity continues to hold, there is every chance that the Indian stock market is going to hit new lows before it bottoms out.
So, will the nine-year low in GDP growth rates lead to nine-year lows in Nifty and Sensex values? Let’s hope not! However, the chance of the 4500-4550 support level being broken is good. The domestic economic trends all suggest there will be some more pain to endure before the Indian economy bottoms out.
None of the current trends in the global economy offer much in the way of hopes of a quick recovery. Europe remains on the edge of a massive crisis. Even if the Greek situation is more or less discounted (and it’s not), Spain could go into a tailspin and Spain is a much bigger economy. The Arab Spring also continues without clear resolution. While crude prices have come down on the basis of lower demand, more trouble across West Asia and North Africa could lead to another spike owing to fears of supply disruptions.
While the Europe situation remains unclear, it’s likely that most major institutions will continue to eschew risk. The India growth downgrades last week makes it even more unlikely that they would invest here in the current situation. Indeed, foreign institutional investors have sold in substantially larger quantities during the last fortnight.
This puts further pressure on the rupee, which has hit a succession of new lows. If reflexivity holds in the currency market, the chances are high that the long USD-INR trend will continue till the rupee is extremely under-valued. If Europe implodes, a short EUR-INR position could also become lucrative at some stage.
Part of the reason for the downtrend is the reluctance to embrace reforms even in a situation that is fast-deteriorating. The Reserve Bank of India may try to do something positive in its policy review on June 18. But large policy rate cuts appear quite unlikely, given the inflation trend. The market won’t respond in any marked degree to less than substantial rate cuts. It will probably not respond positively to anything short of major reforms that promise to control the fiscal deficit and/or stimulate growth. Nothing in the recent past suggests that the political establishment is willing to take such action, or that the Opposition will allow it to do so.
In valuation terms, the market still appears over-valued at current levels. A 15-20 per cent drop would be required to hit fair-value at around Nifty PE-13-14 (about 4100-4200 Nifty), given the current earnings projections and growth trends. Given reflexivity, the market could bottom even lower than that.
Technically, the market is well below the 200-day moving average (in the 5050-5075 zone) and it’s holding up above support at the 4750 mark. If 4750 breaks, the next support would be 4500-4550. If that breaks, the market would be headed for multi-year lows. Traders and investors alike might be happier if this happens quickly.