Equity markets had a sombre year. Most indices which had recorded strong performances from April 2016 till January 2018 cooled off as the year progressed. However, the Large CAP / Frontline indices are not representing the scale of correction. For example, indices such as BSE Mid cap and BSE Small cap have corrected by -20 to -30% respectively from the peak in January 2018 to September 30, 2018. Needless to say, many individual company stocks have had a far sharper correction in the range of -40 to -50%.
Many reasons are being attributed to rationalise the recent correction in markets, including default led by a large financial institution. However, we do believe that it’s futile to look for reasons; instead we believe that the markets have moved from an expensive territory to a more reasonable territory.
General economic and financial environment
The general economic environment continues to improve, stimulated with numerous reforms. This is also endorsed by the World Bank in its ease of doing business ranking for India, which has climbed to the 77th rank in 2019 from the 142th rank in 2015. However, benefits of these reforms are yet to percolate to the real economy. The key reasons for slow traction are the following:
• Large capacity creation in the previous economic cycle, which is yet to be fully utilised. For example excess capacity in the power sector.
• Impaired lending capacity of corporate banks as they were beleaguered by the NPA problem.
• Slower than anticipated growth in the economy, especially in exports, is a function of global environment.
“The Great Shifts”- as a result of reforms undertaken in 2018, in extension to those we believe that IBC (Insolvency and Bankruptcy Code) in particular- has led to fast track resolution of many cases, which left to its own would have taken a long time to clear. This is leading to resolution of NPA at the larger level. Further, these resolutions shall be a guiding post for smaller cases, which should resolve faster. These resolutions will set the ball rolling in terms of credit flow in the banking system and have multiplier effect on the economy. GST and other reforms are leading to formalisation of the economy and we believe their positive effects will continue.
Recent NBFC crisis
In the recent past, we saw a strong growth in NBFCs’ (Non – Banking Finance Companies) loan books. The reason was access to easy and cheap liquidity and lower competition as part of competition was besieged with NPA issues. This unfretted growth was cheered by markets and the valuation of these companies increased significantly. Same was again reflected in significant increase in weightage of financial companies in many of the indices. One of the key takeaways of the book “This Time Is Different: Eight Centuries of Financial Folly” - a highly recommended read, is to ‘Follow the Credit’. A strong credit growth, over a sustained period of time in a particular segment, causes some excesses to be built up. As Hyman Minsky, a noted economist, says – “Stability breeds instability”. This is because, growing the lending book is the easier part of the finance business, due diligence before lending and recovery of money, is the more difficult part. Many NBFCs saw an opportunity in the retail lending space as banks were cautious, given their tryst with NPAs earlier. We saw number of new finance players raising money from the equity markets and commanding valuations similar to established businesses. Further access to cheap money led to NBFCs expanding their scope of activity to longer tenure lending, though armed with short term liabilities. This led to Asset – Liability Mismatch, which unfolded with the default of IL&FS.
Was IL&FS the reason for the NBFC crisis, the answer is an unequivocal no. IL&FS was just the prick. The fact remains that the balloon had grown to a significant size and the prick could have been any event.
Was this entirely unanticipated, the answer is again no. We did see excess in the financial sector especially the non-banking segment (especially housing, loan against property, consumer finance) and as a result, we didn’t have any exposure in any NBFC segment. However, we believe that the current credit event will lead to strengthening of the banks as NBFCs will find it difficult due to lack of capital and this will lead to a strengthening position of banks. We believe that the ripple of the current crisis could continue to last for some more time. Further, there could be troublesome global events. However, our philosophy will remain the same. Buy when prices fall and sell when they rise.
Thoughts on investing
Volatility in equities is a friend of investors. Buy when stocks are cheap sell when expensive. However it is easier said than done, because human psychology makes investors confident when prices are rising and apprehensive when prices are falling. And hence the most important thing in equities is conviction and conviction comes from research and calm mind.
With the correction in equities markets, some stocks have come in the reasonable price range. That doesn’t mean the prices can still not correct further. It could and that will make stock prices more lucrative and cause people to buy more. Lower prices in equities are good as they give a chance to buy good quality companies at reasonable prices.
— The author is Director & Investment Advisor,
UNS Finvest, Mumbai