DISEQUILIBRIUM: Live dangerously

The razor’s edge effect. That is what imperiled equity traders must be thinking of as they sally forth daily in an uncertain market. Robust global growth and better than anticipated corporate earnings momentum tell you that fundamentally equities remain the way forward in terms of asset class rotation. But that could be counter intuitive for the interest rate cycle also appears to be tightening as the inflation ogre returns to threaten the equity rally. Unpredictability and doubt are definitely in the air. Rock solid jobs data in the US took the tech-heavy Nasdaq up 1.8 per cent to 7,560.81 to hit intra day and closing records, erasing the losses from last month’s correction on Friday. The Nasdaq 100, which is made up of the 100 largest companies in the Nasdaq composite, also reached a record high. Friday marked the first time since January 26 that either index reached a record high. Shares of Facebook, Amazon, Netflix and Google helped lead the gains.

Concurrently, Dow Jones rose 440.53 points to close at 25,335.74, with Goldman Sachs among the biggest contributors of gains to the index. The 30-stock index also closed above its 50-day moving average, a key technical level. Abundant liquidity means that the US has returned to its Goldilocks Economy days for the first time since Bill Clinton’s presidency. All this came despite  president Donald Trump signing two declarations on Thursday, which would roll out tariffs on steel and aluminium imports. The tariffs are expected to take effect in 15 days and will put a 25 per cent charge on steel, and 10 per cent on aluminum. Canada and Mexico, however, are exempt. So, has the equity blowout of the first couple of months this year ended? And with it the pain and trauma?

Not necessarily for the India story is at variance with what is happening in the western world. Even as the US seems to have come to terms with a rising interest cycle, it is sangfroid primarily because Friday also marked the nine-year anniversary of the bull market. Back home, we are testing new lows in a falling market as a clutch of bank scams have once again thrown into stark relief the porosity and permeability of the Indian banking system. In parallel, rising bond yields means that Indian Public Sector Banks heavily and arguably  over invested in government securities as part of their treasury operations may find a nasty little shock awaiting their books in the fourth quarter ending March 31. This may be much worse than what happened in the third quarter, here is a gander at the blood on the balance sheets:

Andhra Bank posted a Rs 532 crore net loss in Q3

SBI reported a shocking Rs 246 crore net loss in Q3

Central Bank of India losses widened to Rs 1664 crore in Q3

Syndicate Bank registered a net loss of Rs 870 crore in Q3UCO Bank reported a ninth straight quarterly loss of Rs 1016 crore in Q3

Corporation Bank recorded a net loss of Rs 1240 crore in Q3

India Ratings reckons  impaired assets to peak at 12.7 per cent by FY19-FY20, while credit costs to witness a slow and gradual recovery (FY19 forecasted: 178bp; FY17: 253bp), due to ageing of a large stock of non-performing assets (NPAs) added over the last four quarters (FY17: INR4.2 trillion). The profit and loss account for most PSBs would also be under

pressure on account of the accelerated provisioning requirement on the accounts identified by the regulator for reference to the National Company Law Tribunal under the Insolvency and Bankruptcy Code in FY18. In Ind-Ra’s view, post the Reserve Bank of India’s asset quality review and annual divergence exercise, most of the large levered corporate exposures have seen a fair bit of recognition either in the form of NPAs or restructured assets. However, a meaningful proportion of mid-size stressed corporates (1.6 per cent of bank credit as of September 2017) continues to be standard on bank books with absolutely no form of recognition and could slip to the non-performing category in the next 12-18 months. Ind-Ra also notes additional assets of around 1 per cent of stressed assets (as of September 2017) could slip into the non-performing category, primarily from the standard restructuring and failed strategic restructuring schemes, most of which would be completing 18 months’ time in the next three to four quarters.

Markets are a function of events, liquidity and of course forward earnings potential of the companies that make up the indices. One is constantly hearing jargon these days from global and domestic investors on how one should buy the dip, use the dead cat bounce to reload etc; all truisms for staying invested. Easy liquidity was behind a global equities rally with an impetus seldom seen in recent years. But as easy money becomes scarce and interest rate up cycle is unleashed, this equity heavy party may come to an end. Volatility and wild divergence may be the new order. The fear factor stems from a convergence of rising bond yields both at home and abroad, inflationary pressures and worries and interest rate tightening. The sharp correction seen in February may be over for the short term, melt down may return to melt up, but the road is strewn with imponderables as the ramp up will be slower and more arduous in 2018.

In India, the counter weight to the Foreign Portfolio Investors is the Mutual Fund Systematic Investment Plan. Everyone is hoping against hope that the folios keep rising and the redemption outflows don’t happen. AMFI data fro February probably the best barometer to know what is happening —  mutual fund inflows declined around 60 per cent yoy and 89 per cent mom, led by decline in inflows into money market schemes. The inflows in the money market scheme declined 85 per cent yoy and 99 per cent mom to Rs1,223 crore. The decline in the money market scheme may be due to normalisation, as investors had pulled out around Rs1.4 lakh crore in December, 2017 and then poured in Rs 96,552 crore in January, 2018. The good news, however, is that the inflow in equity schemes has increased around 6 per cent mom and 152 per cent yoy to  Rs16,268 crore. This is a healthy sign indicating that investors are continuing with their systematic investment plans in Indian equities. India has to fix its banking plumbing, one way or the other, one cannot continue to hide camels and elephants under the rug. These systemic shocks present the singular threat percept which can derail any stock market rally. This can only come from governmental unfettering. As long as babus are involved and professionalism doesn’t enter the board rooms, these Aesop’s Fables will continue to roll out shaking investor confidence. India's mono typical problems remain its own. Otherwise this rot will  metastasize faster than ever before.  Risk, reward ratio is the best and only way to invest, meanwhile government companies are going to be squeezed for dividend, they are a good basket to focus on for the present. 

Sandeep Bamzai