Bear Market: Is there light at the end of the tunnel in this bearish market? Vikash Kumar Jain answers

“What has gone unnoticed by the equity markets is the fact that over the last two-three days, yields have corrected by 20 bps. Basically for any significant rally to happen, some events need to happen which cool off the worst fears on yields increasing or inflation being out of hand,” says Vikash Kumar Jain, Investment Analyst, CLSA India.

Just going through your strategy notes. The sentiment seems excessively bearish. Is the light at the end of the tunnel anywhere close or is it a long tunnel because everyone wants to know when the poison is going to get out of the system?

We are not soothsayers but all that we can do is try and see where we stand versus previous instances of fear and that is what this index tries to do. This is our proprietary India Bull Bear Index where we try to measure investor sentiment. While we talk about investor sentiment generally, people think about it more anecdotally, about what they are hearing and what people are doing. What we try to do with this index is try and quantify it and use certain matrices which allow us to do it and put it in historical perspective.

We are right now at what we would want to call 92% bearish reading. Historically, if we work with a 95% bearish reading, it has a reasonable track record. The index does not work if we are in a very deep free fall bear market like say in 2008 or the 2020 correction where a three-month return may not be necessarily positive but in most other normal kinds of pullbacks and corrections, it has worked pretty well. It has a reasonably good track record on one-year returns. There is a median return of about 17-18% after you hit 95% with just about a 90% accuracy in the last nine instances that we saw. So a reasonable track record. So from a perspective of sentiment, we are reaching a point where historically we have had reasonable rallies.

And what is the basis of this because in the last 10 years, the world was different. Every time there was an issue in the world, the US Fed came to the rescue. Inflation readings were very different. So, is it a good idea to look at history and say that what history tells us is an indication of the future?

The world is not different every time. I do not think we have ever had a demonetisation till we had one, we have never had a pandemic at least in our lifetimes till we had one, we never had a GFC. Yes, you can say the Fed is not acting on the side of the market but a lot of these episodes which we have had in the last 15 years are unique. In most of our lifetimes over the last 30-40 years we would not have seen many of these.

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So that is the other side of the argument – buy anyways. I would not fight that. All that I will say is that historically this is how sentiment has worked. Now this is not really valuation, this is sentiment and typically I would say that in all of the historical instances also, fear would have been there and this is trying to measure what is the kind of bearishness or fear that is prevalent.

So I would say that yes, right now, this is largely a financial crisis. It is very different from a DeMonetisation or a pandemic which has hurt everybody and every household. There was a time in the pandemic when we thought that we do not have any historical precedent. So yes, one can always argue on the other side but I would not get into that argument.

What is the right way of looking at sentiment because the basic benchmark of looking at sentiment is that when the retail folks panic, markets historically bottom out. Looking at the flows. it does not look like so?
I would not agree with this. You should look at retail flows. What this does is it tries to measure positioning, tries to measure what we are focussed on just by looking at domestic flows. In fact, this is what I would want to bring out. Look at the record foreign outflows. In fact, anywhere between 60% and two-thirds of EM funds are now underweight India.

I agree that perhaps the next risk to the market is retail participation – whether through mutual funds or direct participation – coming down. But we have been able to manage at least the foreign selling. We have reached a point that perhaps there could be a time that maybe there is some more selling from retail investors and soon valuations could become more palatable for foreigners to start returning.

In fact, last month, India was by far the least favoured market for foreigners. This is where they have sold the most and overall in the last nine months, there has been significant selling. The valuations have now come within 5% of historical average levels. It is a 17-year average. I am not looking at five years, I am not looking at 10 years. There would be some more correction if retail were to give out. That is clearly a risk to the market because mutual fund inflows picked up largely from July of last year.

All of that money is under water, they would be making negative returns on that and so there is clearly a risk that retail investors will start shunning equity markets and if that leads to some selling, foreigners investors could start smoothening that fall because they are already significantly underweight India.

What could be the extent of bounce back this time around and what happens to midcap and smallcap stocks because I am assuming your analysis is centered around benchmark indices?
When I am looking at the sentiment, I do not want to colour myself with what I look for in fundamentals and other things that we talk about. We are discussing it holistically. So, if a rally comes in, how long can that rally continue? The call of how much we could rally is dependent on what happens to bond yields.

We should not forget that we are in largely a macro market and clearly for any rally to sustain much higher – whether it is a bear market rally or it is the start of a bull market – that is something which will be defined by what happens to yields. What has gone unnoticed by the equity markets is the fact that over the last two-three days, yields have corrected by 20 bps. Basically for any significant rally to happen, some events need to happen which cool off the worst fears on yields increasing or inflation being out of hand.

That could be some cool off in energy prices, maybe the upcoming couple of inflation data points show a decline and we believe that inflation in India has peaked. That is the call of our economist but if we get to a similar data point in the US also, then markets could start saying okay fine inflation will come off, maybe it will take time but at least central banks are not as behind as what we are thinking. Only then, would you start feeling more relaxed about yields and that will allow equity valuations to pick up.

Why did you introduce to your India focussed portfolio?
We will not be stock specific but generally we like the real estate cycle. When we are talking about the current market situations. In 2008, practically all kinds of cycles peaked together – whether it was the real estate cycle, the economic cycle, the equity market cycle as well as debt cycle. But that is not the case in India right now.

Our economic cycle is just about picking up and I don’t think globally the commodity cycle has peaked out. I do not think the real estate cycle has reached crazy levels like we saw in 2008. From that perspective. it is more about the equity market cycle which is correcting and the worst is like we had in GFC or in the 1930s is when all of these cycles together peaked out. That is really the worst point. I do not think we are at a point like that currently. It is more about the financial worries that we have.

If we were to see the cash in the market, the seven-day moving average is down from the October 2021 peak. Your report also talks about much lower trading volumes. What does all of this indicate?
People can take various signals out of it. Typically when a trend is very strong, it continues with rising volumes and the general interpretation is that volumes are a confirmation that we are in that trend. On the other hand, if the trend is weakening, that is when people do not want to continue with higher volumes. So, if one adjusts for market cap, we are inching closer to the lowest levels that we have seen over the last 10 years in terms of cash volumes. Perhaps it just tells us that maybe this trend is not that strong and falling prices are not that strong any more. That is the interpretation that I am drawing out which is perhaps a confirmation of how weak the sentiment is already.

Since 2007 you have seen 15 instances of the bull-bear index hitting the bearish zone of 90%. But what is heartening is you have noticed that in all these instances, it has given positive returns at least eight to nine times. So is that moment near?
When we are using any particular indicator, we need to know the limitations of that and out of those 15 instances, three or four times it was hit during the 2008 crash. Basically at that point of time, worries were so significant that this sentiment did not stop there. It did cause some days of sideways action or a little bit of a rally but then it fell again. That is the point where it fell clearly. Also the more recent March 20 correction of 95% bearish reading was hit around early March. The market bottom came in 20 days. But that had another 20% correction.

So if you are in a waterfall kind of a decline, then it does not really pinpoint that this is closer to a bottom. It does not work that well. That is the kind of call that one has to take before using this indicator. I am of the opinion that we are not in a waterfall decline.

There is another report that we did about four-five weeks back where we said that the texture of this correction does not really show that it is going to be a 40% kind of correction. It appears to be a less severe correction. This is the eight month of correction and that is something which we should not really forget.

In the last one year that the Nifty has given no returns and from January 2020 there is a 25% return. There is a saying in the market which is that courses remain the same, horses change. When you see a bombed out rally like this, changes come in the leadership in the market.
We need to appreciate that for some time we are going to stay in a largely macro market. There is a term called synchronicity and our economists did a good job in looking at the markets when macro is driving the market as compared to the micro.

At least for the next few months, that might continue to be the case, the single biggest data point which is going to determine how financial markets in general will move globally. What happens to inflation and what happens to bond yields. What we need to appreciate and this is where blindly using historical average will not work, not with sentiment but if valuations are at levels of 7.5-8% yield that we are talking about, then perhaps the right average valuations for the market is about 5-10% lower than the otherwise 16x PE historical average valuations.

So perhaps somewhere around 15x is the right number. So I would say that what happens to yields will be of supreme importance. Cost of equity is a concept which was largely forgotten for the last decade as money was rather easy to come by. That also means that in a macro market, we will be quite wary about expensive stocks in general. In a rising yield environment, those are the kind of stocks which will not do very well and till inflation worries remain at the fore, we would be very careful.

You should only make exceptions where you believe it is very near term and strong triggers are there. Otherwise stay away from stuff which are very expensive and a lot of the consumption space in India is still around mark. So, that is something that we would want to be quite wary about.

The other thing is in an environment like India, the cost of funds rising or cost of debt rising on a percentage basis it is not as sharp as what it says in developed markets where we were at 2%. If it is rises by 2% that is doubling your cost of debt and that is not something which is happening in India. So from that perspective, still at least for 12-15 months, we do not really see much balance sheet concerns for banks.

If that is something that you can wrap your head around, then that means you should be able to benefit from rising margins in general. Coincidentally that sector also in general is not an expensive sector. I would say stay away from very expensive parts of the market because that is where the whole interest rate environment has changed and many of these stocks will take a much longer period for derating. They will not be outperforming for a long time.

Banks are clearly what we prefer and the very expensive names which were doing very well in the last decade, will continue their long process of derating in multiples.

Consumer names are expensive but in a bad macro environment, these are the companies which have pricing power and will gain market share. This is the business that will remain relevant. So, logically should we not be thinking about them?
Let us try and breakdown what you call the bad macro environment. A bad macro environment is something where commodity prices are elevated, inflation is a big worry and it is not a very comfortable environment because that is a higher input cost for some of them. Some of them really need to continue raising prices to even protect margins.

Second, we are in an environment where generally the belief is on the core economy sector because the capex linked growth push that we have been seeing has improved. What that has done is if we are back to a period where if Nifty is going to give double digit earnings growth, these stocks on the other hand would perhaps give below power earnings growth and have valuations which are far higher. I do not think that that is really the most attractive place to be in.

Following the excesses of the last decade, they will take time to cool off.

On the other hand, there are these core economy names which were largely forgotten and their valuations are possibly much more palatable and that is where growth is really picking up. That is where I would want to be. I do not think that this is the worst. I believe that this will be a speed bump for an economic cycle which is just starting to pick up in India so that is what I would like to position in.

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