Finding stocks with an upside will be difficult

The Index of Industrial production or IIP for February 2017 was down 1.2 per cent year-on-year compared to February 2016. The slowdown surprised because the professional forecasters’ consensus was for modest growth. As many as 15 out of 22 industry groups had negative growth year-on-year. 

In terms of usage classification, basic goods was up 2.4 per cent but capital goods was down 3.4 per cent, consumer goods was down 5.6 per cent and intermediate goods down 0.2 per cent. The sub-sector, non-durable consumer goods was down by 8.6 per cent. In terms of groups, manufacturing was down two per cent year-on-year, mining was up 3.3 per cent and electricity was up 0.3 per cent. Manufacturing holds about 77 per cent weight so that was enough to swing the IIP into negative territory.

Cumulative growth for April 2016-February 2017 was only 0.4 per cent. This is much lower than 2.4 growth for the previous financial year 2015-16. Over 11 months, the index of basic goods, intermediate goods and consumer durables registered growth of 4.2 per cent, 2.1 per cent and 4.7 per cent respectively. But, the index of capital goods and consumer non-durables declined by 14.0 per cent and 2.9 per cent, respectively.

The IIP is notoriously volatile. The insulated cables segment for example, has a small weight of 0.12 per cent but it causes huge volatility since production is lumpy and it's reported only when an order is despatched. The insulated cables segment was up 241 per cent in February. 

Some other segments are also very volatile. Tobacco products fell 43 per cent year-on-year. Food & beverages saw 22 per cent decline and computing machinery was down 21 per cent. Plastics machinery, ship building and sugar machinery were all down by close to 50 per cent. 

Are demonetisation effects showing up? It’s hard to tell. After a small decline in December 2016, the IIP was up 3.3 year-on-year in January. Economy-watchers will struggle to smoothen out volatility in monthly numbers. But, a couple of trends can be seen. 

Low capital goods production usually equates to a flat investment cycle and that's backed up by bank credit at multi-year lows in 2016-17. Low FMCG consumption (consumer non-durables in the IIP classification) implies low rural demand and a probable negative impact of demonetisation. 

This is not news. Credit disbursal has been low and the investment cycle muted for several years. Most professional forecasters don't see a big pick up in private sector investment this financial year. FMCG companies have seen flat or declining sales through several quarters.

There were hopes of a rural rebound based on a good monsoon but demonetisation may have aborted that. FMCG stocks are high-valued in terms of PE and better FMCG offtake would depend on the monsoon in part, and also a return of consumer confidence in rural/ semi-urban parts. 

Inflation data across February-March is also a little troubling. The Wholesale Price Index (WPI) rose 6.55 per cent year-on-year in February. The Consumer Price Index or CPI gained by 3.81 per cent year-on-year in March versus a gain of 3.55 per cent in February. The Reserve Bank of India's medium-term target is four per cent with a band of +/- 2 per cent tolerance. March was a five month high for the CPI but it's been up through fourth quarter, 2016-17. The CPI will surely breach four per cent before the monsoon comes and that means no rate cuts in the near future. 

The 11-month trend is more reliable than the one-month numbers. But, both point in the same direction and that is flat in terms of growth. It will be hard to find stocks that have an upside at prevailing valuations if there is no serious growth acceleration.