Where are the Indian markets headed?

By Indroneel Das

The Indian markets are trading at all time highs and you won’t even have to ask for an analysis of the market to get one these days. TV news channels, all previously preoccupied with politics, sports, and maybe even daily soaps, now have news flashes that report the new highs that the market is making. This is is one of the characteristics of what we call a ‘bull run’ and everybody can relate to it because everyone, in some way or the other, is positively impacted by the bull run – the most direct way is, of course, making money by just being invested in the market.

The pertinent question right now is- where do we go from here? The markets might range around their current levels in the short run, but in the medium run, they look set to go only one of two ways. The first one is the one that’s easier to digest- that the markets will continue to climb, and the NIFTY will climb ‘Mount 40k’ (a term popularised by us bankers, to represent the NIFTY 40,000 level). If this happens, then anyone who has a reasonably diversified equity portfolio will also make more money than he can from anywhere else, in an equivalent amount of time. The other option is that our castle comes crashing down because it was weak in its foundation. This correction, though highly speculated and feared, doesn’t look very likely to happen. To understand this, we need to have a basic understanding of what makes up our markets- the few fundamental sectors and their current vibe which will eventually drive their fate.

Petroleum and natural gas sector

India runs a sizeable energy deficit and therefore imports huge amounts of crude oil. One of the major contributors to our GDP is the refining of this crude oil. Lower global prices for crude oil, as is the case currently, means better Gross Refining Margins (GRM- the key metric for refiners) for them. The selling price does go down too, but demand increases a lot when prices are low, so business volumes aren’t affected when they supply oil further downstream.

The last quarter has been a great one for our domestic refiners. RIL Petrochemicals did really well, and so did BPCL, HPCL and IOCL (these are all oil refiners). With non-OPEC production on the rise, and in the absence of any global cues that signal a significant rise in oil price, the refining business and the benefits that accrue to every industry because of lower overheads (due to lower fuel and running costs) should ensure that oil & gas stays in good shape, and keeps the domestic economy happy too- so they’re going to be a good bet in a consumption driven economy like ours.

Banking and financial services have a positive future

It’s no secret that banks, especially ones in the public sector (PSB’s), are in a soup with the current situation of Non-Performing Assets (NPA’s). The provisions that the PSBs have had to make for the increasing NPAs that are constantly being unearthed have pushed most PSBs into losses. Although SBI is a silver lining and its recently reported Q4 net profit shows a 123% jump, year on year. Relatively sensible banking and a diversified stream of income ensure that SBI’s gross NPAs are easing out. The private banks, though their share of the total NPA pie is quite small, are a matter of concern because their share of NPAs is increasing. The gross NPAs for PSB’s surged about 20% from last year, while the gross NPAs rose about 75% for private banks, taking their share of NPAs in the total NPA pool from 9% last year to 12% year.

However, the poor asset quality of private banks is concentrated among a few banks only. All in all, while the NPA problem won’t disappear overnight, it won’t bother us forever either. Among the PSBs, it is and will continue to lead to increased consolidation and recapitalisation from the government. Among the private banks, the banks with solid asset quality and a healthy business model from the ground up will lead the charge. The banks who deal with the NPA problems effectively, have a rural focus, and continue to engage in digital innovations are expected to do well.

Retail and FMCG industries are witnessing an upward trend

These sectors are all unified by the fact they are all going to benefit as incomes rise, lifestyles improve and India’s growth story unfolds. However, these are demand-driven, consumption based industries which were all hit due to demonetisation and the impact that it had on consumption. They are all also expected to experience disruptions in the supply chain due to the implementation of the GST. However, they also share one more thing in common- that they are all poised to grow. Agreed, input prices, especially for automobile manufacturers are on the rise (cost of metals are going up), but that is a cyclical factor, whereas the demand for the products in a country like India is fairly stable, if not always on the rise. As long as that holds, and the market places its bet on fundamentally strong businesses- ones with an established brand name, constant innovations in line with demand (or ones that even shape demand) and solid management, all seasonal and cyclical factors will be rendered irrelevant in the long run.

IT and Pharmaceutical services look towards the West

There are other important sectors, such as Pharmaceuticals and IT & IT services, but they are best left untouched right now in terms of putting your money in them. Suffice it to say that uncertainty looms large over IT & IT services, and we need to wait for sometime before things clear out on the Pharmaceuticals front- in terms of how the US FDA’s outlook towards key Indian players shapes up, the extent of consolidation of the distribution channels for generic drugs in the USA and most importantly, if the current pricing pressure in the US markets sustain.

If these factors turn out well for Indian pharmaceuticals, they can be a real source of growth. As far as a market crash is concerned, remember that the markets don’t necessarily crash when the prices are high. Prices are relative, and the market will crash if high prices aren’t supported by earnings. A metric, called the cyclically adjusted price-to-earnings is useful in this regard, and it shows that we aren’t at abnormally high levels. The last time we were at these levels, we didn’t have the earnings or future earnings outlook to show for it. This time, we do. At least for now.

Featured image credits: Hindustan Times