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Market cycle will bottom before the economic cycle!

July 2019 has been a tough month for the markets, the benchmark index ended 6% lower , this was one of the worst Julys in the past 17 years for the NIFTY, the pain was worse in the broader market and BSE midcap and Smallcap indices fell 8.52% and 11.16% respectively, during the month. The pain in July also extended to the global markets as the Dow Jones has moved to the red in spite of a rate cut and dovish outlook by the US FED. Pessimism is hitting peak levels in the market and the economic situation is also benign, but however, history has always taught us one thing that the market cycle will bottom before the economic cycle. Although there are various negatives around we expect the market to make a bottom far before the shape of the economy improves because that is the nature of market cycles.  Markets are always ahead of the curve and as investors, we need to follow the signs the market is giving us beyond anything else.  All is not lost and this the time investors must cut out the noise and maintain their poise.

The Trilemma of Flows, negative corporate commentary and policy issues impacting markets

It’s a three-pronged problem, the FPI sell-off is what has hit markets first, FPIs have sold stocks worth $ 2.5bn. The taxation surcharge is what is being pointed out by most plaudits but on closer examination, we realize that from pure taxation point of view the additional surcharge should amount to something in the range of Rs400cr which is a pretty insignificant amount for and FPI who have hundreds of billions of dollars under management.  In reality, it is a sentiment issue, and the sentiments have been impacted by the weak commentary given by most companies post the Q1FY19 results. Most sectors have missed earnings estimates baring a few like cement and select banks, Autos and consumption stocks continue to get hit.  The market is estimating 24% EPS growth for the NIFTY and a good 70% of that are expected to be contributed by banks, and when some banks start reporting poor numbers and bloat their watch lists (read Yes Bank, RBL and DCB bank) the market is ought to get spooked.  Also baring cement production growth,  most high-frequency indicators like auto numbers, PV sales, IIP growth, etc are also not encouraging.

A possible way out of this mess is if the government intervenes and cuts rates further, moreover those rate cuts should also result in a meaningful transmission.  We already saw some small shreds of evidence of this when SBI cut FD rates. Moreover, the Liquidity surplus in the banking system is nearly Rs2 lakh Crore which should also help accelerate the transmission. The 10Y yield is around 6-6.5% while corporate are borrowing 4% higher, the corporate bond spreads have to come down. The RBI has definitely induced liquidity into the system but it is stuck in the interbank levels, when it transitions to the corporate levels we will see some relief.

Secondly, there are talks that the government will consider giving some relief to the SEBI listed FPIs from the super-rich levy if that goes through the sentiments will change.

NIFTY is finally reflecting the current economic reality

As we discussed in our last article, so far optically the NIFTY was still near all-time highs in spite of the broad-based sell-off and slowdown economy, but now some market leaders like HDFC twins and Bajaj twins, Reliance, L&T, etc basically the HRITHIK stocks have also started falling. This has created a dual impact where mid and small caps were anyway in a downtrend and now the large NIFTY stocks have started showing weakness dragging down the headline NIFTY. SO sentimentally there is no respite as all indices are in the red.

The #NIFTY is so polarized that if we constructed a #NIFTY 40 Index ie. Stripped of the top 10 cos and kept the balance 40, the Index would actually be at 9000. #NIFTY is currently at 11k, Since Jan-18, the top 10 market cap cos are up~21.4% whereas the rest 40 is down by ~14.6%. Now the fear in the market is that the Top 10 will also join the balance 40, so convergence will be on the downside.

So far the market was looking overvalued in spite of a weak economic situation, now the market valuation is starting look in line with the economy, so if the fall gets arrested the valuations would reach a level where it aligns with the economic reality and that may enable some investors to take contrarian bet on the market.

The market cycle will bottom before the economic cycle!

The collective wisdom of Mr. Market is stronger than all us investors, eventually, the market will start discounting the future and look beyond the noise in the present. We have been falling for the past 18 months because negative news has been running amok, but markets have a mind of their own and seldom move in tandem with the economy.  Bottoming out of valuations will be the key, after a point the market will stop looking at the next couple of quarters and will start taking the next few years into account. In hindsight,  If we step back and widen our lens, we will find that there are many well run and growing business in our market that is available for single-digit valuations, Mr. Market will take cognizance of this and this happens the market will bottom out and turn.

Excesses on either side are unsustainable, markets have definitely outrun themselves and just like how the excessive bull run of 2017 was not sustainable on the upside, this particular sell-off will not be sustainable on the downside for long and market will have to mean revert.

How low do we go from here!  – NIFTY reaching long term Moving Average support

If one uses a 100period moving average to track the long term trend of the Nifty, then it clear that the market is heading down into support. On the attached chart we can find that the 100ema has provided support so many times from the past that it is difficult to ignore its influence on the trends. Barring two occasions (2008 and 2011), the index never really lost this support on a sustained basis. There were marginal penetrations in 2013 and 2016 but those were reversed very swiftly.

We are now approaching the 100ema once again (at 10785) and we should be going by history, expect the decline to ease off. 

Investment implications

The problems are partly sentimental and partly due to policy issues, however, we expect that the market will bottom out in the next 2 months even though the economy continues to remain in a slowdown. There are many fantastic companies out there that have given meaningful corrections and are only part of temporary slow down.  At Plus Delta Portfolios, we are using this opportunity to identify winners in this pullback. We will be buying the market once the dust settles. We are constantly analyzing the trends and where we see earnings growth coming in the Q1FY20 results coupled with some traces of momentum in the stock we will be ready to enter. This is an excellent opportunity for investors to build a portfolio form a 3-5 year perspective as the margin of safety is very high since we are near the bottom.


Aditya Iyer
Fund Manager – Plus Delta Portfolios

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