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What are the mixed signals from stock market telling investors?

, ET Bureau|
Updated: Jun 24, 2019, 03.15 PM IST
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BCCL
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How should investors navigate this maze of information which can help them make better investment decisions?

Highlights

  • With several conflicting indicators and mixed trends, investors can’t be faulted for their diffidence.
  • The PE multiples of several mid-cap stocks have slid sharply. However, investors should not jump in because this segment remains vulnerable to the slowdown and any liquidity crunch.
  • Experts maintain that the yield curve inversion is merely a transient phase and bond yields should normalise in the coming months.

After the initial euphoria over the return of the BJP government, the equity market is looking uncertain again. There are several reasons why investors are shorn of confidence. The domestic economy is facing a consumption slowdown. NBFCs are reeling under a liquidity squeeze, forcing many to scale back operations. Market breadth remains very narrow.

The trade war between an increasingly bellicose US and an equally unyielding China threatens to escalate further. Crude oil prices remain vulnerable to tensions erupting afresh in the Middle East. Bond markets across the globe have been flashing warning signs in recent months.

Yet, there are some positive signs too. Domestic inflation remains low and interest rates are on the decline. With several conflicting indicators and mixed trends, investors can’t be faulted for their diffidence.

How should investors navigate this maze of information which can help them make better investment decisions? Firstly, it is critical that investors interpret this news flow correctly.

ET Wealth identified six critical signals that are defining the market sentiment. In the pages ahead, we examine each of these trends in detail and interpret the same for readers. Hopefully, this will help them take timely decisions to adjust their investment portfolios to improve their returns.

  • Market breadth continues to be narrow
In the past year or so, only a handful of stocks have actually gone up, while the broader market has been listless. The market breadth, which is the ratio of stocks that are advancing or declining, has turned decidedly negative in the past three months. The ratio of advances-to-declines on the NSE has dropped from 1.08 in March to 0.59 in June. So, more stocks are losing value than seeing an uptick.

More stocks declining than advancing
The market breadth has further narrowed in the past few months.
market-breadth

Experts say this is an outcome of a highly polarised corporate earnings growth. “Only a handful of companies are delivering double-digit earnings growth sustainably. Money is chasing this select set of stocks,” says Kunj Bansal, CIO and Partner, Acepro Advisors. When the market breadth narrows, the markets typically gravitate towards this creamy top layer of ‘quality’ stocks.

5 scrips gave 97% of BSE 100 gains in a year
When the breadth narrows, markets gravitate towards quality stocks.
5-scrips

Analysts expect this phenomenon to continue for some time. The corporate showing in the coming months will give a clearer picture. The festival season will be in full swing and the impact of government spending during the election season will seep through by then.

Ambareesh Baliga, an independent market expert, feels broader market participation is not expected in next few months. “I doubt the market will react positively to announcements in the Budget. Investors are more likely to wait for green shoots to be clearly visible.”

  • Mid-cap valuations revert to discount
When Narendra Modi came to power in 2014, mid-caps were trading at a significant discount to large-caps. But Modi’s election sparked a multi-year uptick in mid-caps. Expectations of faster growth in mid-caps on the back of a business-friendly government sent valuations soaring to stratospheric levels. However, with earnings not keeping pace with the rise in stock prices, the sentiment has now soured against midcaps.

With frontline indices delivering healthy return on the back of a select few bellwether stocks, the valuation differential to mid-cap index is now reverting to near pre-2014 levels. The Nifty Midcap 100 index now trades at a PE of 31.5 compared to 61 barely a year ago. With this sharp correction, the overheated mid-cap segment has now become attractive, say experts. Many are suggesting that investors use this window to hike mid-cap exposure.

Mid-cap valuation premium almost eroded
After the correction, the overheated mid-cap segment has become more attractive.
mid-cap-premiums

The PE multiples of several mid-cap stocks have slid sharply. However, investors should not jump in because the mid-cap segment remains vulnerable to the slowdown and any liquidity crunch in the system. As the market focus shifts back to earnings growth and economic realities, any disappointments will push share prices further down.

Valuations of some mid-caps have declined sharply
Despite the correction, some mid-caps are still not cheap.
Company Current PE 1 year ago PE
Indian Hotels Co 61.1 156.2
Aditya Birla Fashion & Retail 51.7 90.9
Jubilant Foodworks 54.2 85.4
Dilip Buildcon 30.3 57.4
Quess Corp 35.3 58.7
Bharat Forge 20.0 43.1
Godrej Agrovet 29.2 50.3
Sterlite Technologies 13.3 33.3
Sun TV Network 15.0 33.6
Escorts 14.7 32.6

Experts say that investors should stick to quality mid-caps. Vikas Gupta, CEO and Chief Investment Strategist, OmniScience Capital insists the valuations in mid-caps seem cheap on a relative basis. “These were overvalued earlier, and have not really become cheap now. Good quality mid-caps are still expensive,” he says.

Sankaran Naren, CIO, ICICI Prudential Mutual Fund, insists that investors should only take exposure to mid-caps through the SIP route with a longer investing horizon.

  • Consumption demand is moderating
For years, India’s consumption story powered the economy even when private investment flagged or global demand waned. In recent months, however, this consumption engine has developed a snag. Weak consumption metrics across sectors indicate a slowdown in demand. “Even structural trends are subject to cycles and there is little doubt that consumption is now showing signs of strain,” says Vetri Subramaniam, Group President & Head-Equity, UTI Mutual Fund.

Automobile sales have steadily dwindled since October 2018. Nearly all major carmakers have revised sales projections downward citing weak consumer demand. Vehicle makers are cutting back production to clear the piling inventory at dealers. There is also a visible slump in demand for discretionary items like refrigerators, washing machines and other appliances. Even low-ticket essentials like toothpaste, shampoo and hair oil are reporting weak volumes.

Consumer stocks have had a tough time on the bourses. However, barring a few exceptions, valuations have not softened much from earlier levels. On the contrary, several consumer stocks have seen multiples expand. Britannia Industries, Dabur India, Asian Paints, Hindustan Unilever, Voltas, Havells India and Titan Company are now significantly more expensive than before. Most consumer stocks will be vulnerable if earnings growth does not match up to market expectations.

Many consumer stocks have tanked
Weak consumption metrics across sectors indicate a demand slowdown.
Company CMP (Rs) PE 1 year price change (%)
Zee Entertainment Enterprises 338 20.7 -39.72
Mahindra & Mahindra 624 24.2 -31.61
Hero MotoCorp 2,648 15.6 -27.83
Maruti Suzuki India 6,582 26.5 -26.82
Page Industries 20,039 56.7 -25.36
TVS Motor Company 458 32.5 -22.98
United Spirits 539 59.5 -19.07
Godrej Consumer Products 658 28.7 -15.01
Avenue Supermarts 1,298 253.9 -14.67
Tata Power Company 65 8.0 -14.16

The ongoing monsoon will play a key role in how the consumption story pans out. An abundant monsoon is a crucial driver of rural sentiment and discretionary consumption. A week’s delay in onset of rains in the country lends no relief. Further, the India Meteorological Department has suggested that the strong El Nino weather pattern, which will keep rains muted, will likely only fade by August.

This doesn’t bode well for consumer discretionary stocks, as lower disposable incomes will keep demand for high-value items subdued. Says Gupta, “Much of the slack is actually pent-up demand that is bound to come through in the coming months. But things could get worse before improving.”

  • NBFCs facing severe liquidity crunch
Experts say the consumption slowdown has been precipitated by tight liquidity conditions— particularly the cash crunch that has crippled NBFCs. With banks and mutual funds refraining from lending money to many such shadow banks since the IL&FS blowout, these have had to scale down their operations. This has shackled growth as NBFCs accounted for nearly a quarter of the credit growth in the past financial year.

Much of this lending was for purchase of vehicles, appliances and other items. The revival of consumption partly hinges on the time it takes for liquidity conditions to normalise going ahead.

NBFCs are now reworking their business models to tide over the liquidity crunch. The central bank has also proposed norms that will introduce liquidity buffers for NBFCs. As part of the new rules, NBFCs may have to set aside 60% of their net cash flows in government securities starting next year and gradually step it up in a phased manner. This is to ensure that the lenders have enough liquidity to fall back on in case of liquidity stress.

But analysts point out these tougher norms could further crimp NBFCs that do not have a well-managed asset-liability situation. “The financially better placed NBFCs with strong sponsor support and well-established positioning in the ecosystem may be able to withstand it better than others,” says Jinay Gala, Senior Analyst, India Ratings and Research.

Shares of several NBFCs have taken quite a beating over the past year. The fear of a contagion has led many to dump NBFC shares. Equity mutual funds have also cut their NBFC exposure sharply in recent months. Analysts suggest that investors should stick to NBFCs with strong parentage and healthy asset-liability positions.

Several NBFC shares have taken a beating
Fear of a contagion from IL&FS episode has led many to dump NBFC shares.
Company CMP (Rs) PBV 1 year price change (%)
Dewan Housing Finance Corp 77 0.3 -87.7
Reliance Capital 71 0.1 -83.2
SREI Infrastructure Finance 21 0.2 -71.6
Centrum Capital 27 3.3 -51.1
IIFL Finance 161 1.0 -50.9
IFCI 8 0.3 -48.9
Indiabulls Housing Finance 655 2.1 -45.4
Edelweiss Financial Services 176 2.5 -44.8
Indiabulls Ventures 273 8.6 -42.9
Shriram City Union Finance 1,422 1.6 -37.9

Entities like Bajaj Finance, Muthoot Finance, Manappuram Finance, LIC Housing Finance, L&T Finance, among others are better positioned. Other analysts, such as Gupta, suggest investors stay away from NBFCs for now. “Several NBFCs have very opaque structures. These firms have a problem and we don’t know the full extent of it yet.”

  • Deleveraging by Indian companies continues
In the last few years, several highly indebted firms had consciously embarked on reducing their debt burden. India Inc continues on this deleveraging trend. For the third straight year in 2018-19, domestic companies’ net debt-equity ratio showed improvement. In 2013-14, 61 BSE200 index companies had a debt-to-equity ratio higher than one, while 24 firms exhibited leverage in excess of three times.

According to latest available data for these companies, 57 companies have a debt-to-equity ratio higher than one and only 20 companies reported a ratio higher than three. Further, the solvency position of these companies has also improved. Bansal argues, “The deleveraging exercise will separate the men from the boys. Stronger names will emerge leaner and fitter.”

Many companies deleveraged in recent years
The solvency positions of these companies have also improved.
Debt-equity ratio Interest coverage ratio
Company Mar-14 Mar-18 Mar-14 Mar-18
Interglobe Aviation 5.5 0.5 4.3 7.7
Tata Power Company 2.9 1.3 1.3 1.2
Balkrishna Industries 1.4 0.3 26.7 76.3
Century Textiles & Industries 3.0 1.9 1.1 2.3
HEG 1.3 0.3 2.6 29.3
Ashok Leyland 3.0 2.1 0.0 3.1
The Ramco Cements 1.2 0.3 1.7 14.0
Indian Hotels Co 1.3 0.6 1.9 3.1
Jubilant Life Sciences 1.7 1.0 2.2 4.0
Tata Chemicals 1.3 0.7 0.9 5.7
Source: Capitaline. Data as on 17 June

Major corporations including Reliance Industries and Tata Group have also kickstarted a deleveraging exercise. RIL has partially reduced its debt by transferring Jio’s fibre and telecom tower assets and liabilities to two Infrastructure Investment Trusts (InvITs). The conglomerate is also planning stake sales in its refining and telecom businesses.

Tata Steel, which accounts for nearly 90% of the Tata Group’s debt, plans to bring down its Rs 1 lakh crore debt burden to Rs 70,000 crore over the next few years. This process of deleveraging will improve profitability, but will take some time to seep through, reckon analysts. Gupta asserts, “Deleveraging is a lengthy process. It is best to stay away from highly leveraged companies even if they take steps to repair the balance sheet.”

  • Inverted yield curve indicates recession
In recent months, a prominent indicator of economic health has been flashing red across countries. The yields on long-term bonds are now lower than on short-term bonds. The yield is the return an investor gets on a bond. Typically, investors demand higher yields from longer-term bonds to compensate for the higher risk of keeping their money tied up for a longer period.

But when yields on shorter term bonds rise above longer term bonds, it signals that the bond market is expecting trouble ahead. Such yield inversions have preceded several recessions in the past. The recent inversion in the US yield curve is the first since 2007, when the subprime crisis sent the economy into recession.

Some nations are witnessing an inverted yield curve
Countries not showing inversion now have done so in the recent past.
Country 2 year bond yield (%) 10 year bond yield (%)
Lebanon 11.88 11.04
Mexico 7.86 7.64
Canada 1.38 1.43
Japan -0.21 -0.13
Czech Republic 1.45 1.54
South Korea 1.49 1.60
Taiwan 0.49 0.70
United States 1.87 2.11
Singapore 1.70 1.96
Philippines 4.94 5.23
Norway 1.10 1.41

Apart from the US, several countries are witnessing the inverted yield curve. The phenomenon is not limited to developed countries. Even developing economies like Brazil, Mexico, Turkey and Philippines have all flashed red at some point.

Indian bond markets have not ventured into this territory yet. Also, experts maintain that the yield curve inversion is merely a transient phase and bond yields should normalise in the coming months.
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