We stand at 5% growth today, unable to perceive a brighter future hereon. Any bonus, be it corporate tax cut or fall in interest rates is simply being folded into the pockets in expectations that only gloom and doom lies ahead. This is the power of perception or as Economists call it “future expectations”- for example, if I fear a pay cut tomorrow but get an extravaganza bonus this month, what will I do? I shall fold the bonus into my pocket and save it for the future or the worse time to come that I have created in my mind based on current pain (that might actually never come). Both ‘recency bias’ and ‘herd mentality’ are at their best play during the top and bottom of the cycle and this time it is no different. However, we believe it is time to clear up our mental spaces and take a fresh look at the future. Let me offer you a perspective on the recent slowdown and why is there a change there in the offering...
But first things first, what has led to this slowdown?
Well, a lot of things. This was a ‘manufactured slowdown’ that started way back in Jan 2018 that finally gave us a real stroke when it bottomed out in June quarter. The biggest drawdown came from high real interest rates that reflect into high cost of capital. The decade after 2014 saw a shift in regime to benchmarking real interest rates to CPI (Consumer Price Index) from WPI (Wholesale Price Index) while, also having an internal mandate of sorts to maintain real interest at 150bps. Thus, if we compare real interest rates benchmarked to old regime of WPI today – an apple to apple comparison, real interest rates pre 2014 averaged at ~0.8% whereas, post 2014 averaged at ~5%. A high uptick that made money very expensive and started eating into credit financed corporate profitability. To add to it, the supply of money was cut. India has not been able to get to the trend rate of growth in M0 or narrow money post demonetization creating a gap of INR 5 lakh crore in the system. To make things worse, credit got crunched, with bank credit in squeeze since 2014 and with IL&FS collapse, the lifeline from NBFCs was also pulled away. And then there were a bunch of stringent fiscal measures Demonetization, GST, RERA – one after the other, which increased policy uncertainty and sacrificed risk capital. Corporates now preferred to save rather than to invest and private investments nosedived. Clearly, social gains and private losses is not a recipe for success.
But things are changing now…
RBI has pledged to be accommodative for as long the growth needs support. Inflation is unlikely to go up so real interest rates will head downwards hereon. Transmission remains a key to success here but transmission is not just staggered, it is negligible. However, the volatility in G-sec yields is likely to settle with yields inching to 6% as fiscal worries are mitigated and yields remain anchored to falling interest rates. That is one green shoot. Other is visible in M0 finally picking up growing at 13% in the previous quarter. Financial conditions are easing – AAA 10 Yr corporate spreads are down to 98 from high of 130, with similar movement seen in other spreads. The big cherry on top is coming from Government who is now considering itself a “wealth protector” and signaling towards we have got your back. Increased expenditure in July-Aug, corporate tax cut, withdrawal of surcharge on FPIs among other numerous measure should revive the sentiment but for now, fear looks dominant with all positives being shoved into the pockets. Are we making start of a good present worse merely by expectations of a worst future? The answer will reveal itself only in hindsight.
The stage is set…
It is time – to take a fresh sip and enjoy the ingredients, without feeling the pain of past and the unseen brunt of future. It is time – to get over the very prominent ‘recency biases’ and ‘herd mentality’. Valuations are at historically cheaper levels with 52% of NIFTY and 61% of Edelweiss Broad Market Universe at cyclically low levels.
We have enough green shoots to set the stage for recovery. As per our hypothesis, in a rate cut cycle, first G-sec yields fall, then corporate spreads ease, followed by recovery in financial markets and finally in real economy. We are comfortably in stage 3 and real recovery in economy will be visible in economy December onwards. It is time.
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