The Budget And Taxes Beat Up The Market

The news on the political front has taken center stage now, but there’s quite some trouble brewing in the markets as well. After a shortened budget, the market has fallen over 5% on the Nifty and nearly 10% on the midcap index in the month of July. In what is a very disappointing budget move, the finance minister has increased taxes, increased fuel cess, added taxes on stock market buybacks and so on. This impacted a lot of people including foreign institutions. Sentiment has already been running low with auto companies and ancillaries hurting due to lack of demand, and the NBFC crowd remaining down due to limited financing, so this has been like adding salt to the wounds.

Foreign institutions sold over Rs. 12,000 cr. of equities in the month, but they have actually ploughed nearly all of that back into one thing: government bonds. And to blame them for a bad month would be folly; if you look at 2019, they have actually invested over 84,000 cr. in this year, with 18,000 cr. in debt and the rest in equity.

But regardless, India is seeing a slowdown. Auto sales numbers remain low, as regulatory costs go up - and in response, the government actually increased registration costs for new vehicles, a further whammy. With BS-6 regulations enforced from April 1, 2020 and the rule that no lower-end cars or bikes can even be sold after that date, production shifts and cost changes are being adjusted to, as sales remain very weak.

It’s not just auto, though. Out of the NSE 500 index, 372 stocks have fallen below what they were last year. And of them, 225 stocks - nearly half of the index - have fallen over 25%. This has been a rough year.

India remains one of the worst performers of the year worldwide, with a negative performance for 2019. But my feeling is that the worst isn’t over yet.

What’s in store for the next few months? There’s no easy way to say, but here’s the list:

• A cut in interest rates: We are likely to see a sharp cut in rates over the coming year, and we’ve already seen the RBI cut three times in 2019. (Positive)
• Resolution of stressed assets: If things go well, we should see resolution of Essar Steel and Hotel Leela and a bunch of other assets in the year ahead. This is good for banks who will see a real recovery, and for the rupee which will see dollar inflow from abroad. (Positive)
• Damage in NBFCs to crystallize: DHFL is continuously defaulting on obligations, and is looking for a haircut in a resolution plan. However, India has not seen a large NBFC resolve yet, and we are likely to see this impact a lot of companies, individuals and mutual funds in this process. IL&FS continues to be in limbo, and will likely go through a long and painful resolution unless the government pushes the agenda faster. (Negative)
• Further Defaults: We are seeing pain in a number of companies, from Sintex to the unfortunate situation in Coffee Day. With damage in auto sales, even auto dealerships have found it difficult to repay. This is likely to worsen in the year, with some of them unable to pay back, even if rates correct now. (Negative)
• Regulatory selling: Changes in regulations by SEBI have restricted leverage or changed the rules for a number of participants, who will have to sell holdings compulsorily. This already has seen panic selling in a number of stocks, and we expect this to continue in this month. (Negative)
  We see this as both a warning sign and an opportunity. We have upped cash levels somewhat, and will continue to find more opportunities and shift stock portfolios accordingly.

Many of you have asked us: Is this time to invest more? My feeling is that the current situation will get worse before it gets better. In that context, the answer is: not now. When it looks really juicy, we’ll post a note. Extreme pessimism is an important indicator and in my opinion, we aren’t there yet. We hope to see action by the government in addressing this sentiment, but let’s not rely on government action alone - every economy will see a slowdown at some point, and it’s important to ride out the panic points, buy at the right spots and wait for markets to recover.

Even in this economy many of our stocks reported excellent results, with JK Paper, Bata India, Bandhan Bank (we have Gruh as a proxy) and even GNA Axles reporting 20%+ growth in profits. In the longer term, what matters is earnings growth, and despite the challenges, we think the market will revalue them properly after this phase is over. It’s going to be a long and rough ride, but we intend to come out of it stronger.

Moving to ICICI Bank as Custodian

We are transferring all accounts to ICICI as a custodian. This is because the current custodian, ISSL has been under duress and we believe it is in the best interest of all parties that we move the custodial process. This requires us to create new accounts for you with ICICI and transfer all your stocks and funds to your new account. You would have heard from Akanksha about this process and we thank you for the quick turnaround.

In this time, we have paused trading for all accounts with ISSL, our earlier custodian, and as your accounts at ICICI are created we will transfer securities and restart the trading on your account. This is expected to take about three-four days after your paperwork is received by us, but please bear with any unforeseen delays. The securities remain with NSDL and all cash reserves are in our bank accounts earmarked for PMS operations.Meanwhile, when shares are transferred you will receive a whole lot of SMS messages; please note that they are for this transfer.

We expect to complete this operation by the end of August. However, if your account is activated at an earlier date, trading on it will resume earlier.

Potential new PMS guidelines?

There are some new guidelines for portfolio managers, given by SEBI. This isn’t yet active. But it may become a reality by the end of the year. The area that will affect some of you is that the minimum investment may increase to Rs. 50 lakh.

However, current investments may continue as long as you want so you will not be impacted and we will not be forced to sell or exit. We await the final rules, and will get back to you when they are notified - I expect this around October-November this year.

And To Conclude

Along with India, we’re seeing a US-China trade war escalate further. There’s been a US interest rate cut last week, but with an almost-stern warning that there may not be further cuts. In the last few days, the trouble in Hong Kong has seen Chinese stocks and stocks on the Hong Kong market take a tumble.

But ask me a year later and there will be a different set of news that will seem to impact markets. We don’t yet see a problem as deep and dark as 2008, when there was more of a global financial crisis. This time it is more local, and nowhere quite as deep. A regular correction is healthy, and even though it looks like it will take more time to get back to normalcy, I believe the Indian economy is one of the best to be invested in for the next 10 years. We’ll prepare for rough seas ahead, and keep enough powder handy for opportunities.

Stay safe, folks. The rains seem to be doing their bits too and the political complications may affect our personal lives as well. There’s a better time ahead - even rough rains don’t last forever.

Rain-fallingly,

Deepak Shenoy