Create a corpus for turnaround stocks MARKET INSIGHT

Park money in short-term funds to buy shares on sharp corrections

Trading this week is likely to be dominated by specific results. However, demonetisation will have created several interesting effects. First, it throws linear projections out of the window. Analysts looking at October-December 2015 and July-September 2016 cannot make judgment calls about OctoberDecember 2016 from that data. They will be guessing how much of an impact the cash crunch had on specific businesses and there will be massive error factors built into those calls. Apart from regional and rural/urban variations in the cash crunch and wide variances in the cash component of specific businesses, there is also consumer confidence.

Consumers postponed some big-ticket purchases and, maybe, got out of the habit of making some small purchases. For example, December 2016 saw a very sharp drop in automobile and two-wheeler purchases. Anecdotally, the lack of change meant demand for a whole basket of fastmoving consumer goods (FMCGs), and also for low-end prepaid mobile coupons, etc., saw a downturn.

How long will it take before consumers start making those big-ticket purchases again? That depends on confidence in the pace of recovery. Consumers have to believe that their earnings will be enough to pay equated monthly instalments (EMIs). How long before the situation rectifies and consumers start making small purchases that depends on the Reserve Bank of India (RBI), which hasn’t exactly impressed with its efficiency.

It’s important that demonetisation is an ongoing process. We can’t take the results of October-December 2016 and make easy projections about January-March 2017, let alone about October-December 2017. The stock of currency in circulation will improve in 2017-18. The split of notes will also matter — we’ve already seen how inconvenient ~2,000 notes are. We have little idea of how much the stock will improve, in what timeline, and of plans regarding the extent of remonetisation. Do the powers that be intend to put the same amount of cash back in circulation? How do they intend to split whatever cash has been released, in terms of denominations? Given the chaos of the past two months, there’s reason to believe the powers that be don’t know either!

Arguably, analysts could write off the second half of 2016-17 as an aberration but the lack of credible projections is also very important because the market responds to forecasts. The uncertainties mentioned above imply wide variations in independent projections and forecasts, and a large factor of doubt in corporate earnings guidances as well.

Again, under normal circumstances, markets hate uncertainty and we’d expect a situation like this to result in bearish sentiments. But, these are not normal circumstances and there are some reasons why the market could absorb terrible results and poor forecasts, and still be bullish. One hope is, of course, the hope of massive sops in the Union Budget. While the Budget will, very likely, be oriented to socialistic giveaways, there could be corporate tax concessions or breaks in terms of personal income-tax rates. Reassurances on the Goods and Services Tax (GST) could also build optimism. India Inc desperately wants some sort of GST to be nailed down and pushed through after six years of shilly-shallying and delays.

A second possible boost to sentiment could come from political surveys and opinion polls that suggest the ruling party will do well in the coming elections. The converse is also true — polls that suggest the Bharatiya Janata Party will do badly will have a dampening effect. Note that neither the GST timelines nor election results are predictable at this point. But, the political narrative about GST or elections could be massaged to create some bullishness.

There is another reason why the market could be optimistic. Dreadful corporate results are expected in many sectors. If the results are not as dreadful as anticipated, there could be a relief rally. Note that better than expected (but still poor) results will not be any more indicative of future projections than results that are worse than expected.

There is one point some traders will note. There will be a general economic slowdown. This is already factored in. That slowdown will result in contractions across several sectors. The contractions will, in themselves, create a low base. That means those sectors will see pronounced rebounds, as and when recovery does occur. This is a statistical quirk. But, it is also a statistical quirk that beatendown companies give huge returns when there is a turnaround. In a six to 12-month timeframe, that is worth gambling on. A ‘turnaround corpus’ could be parked in money market mutual funds, to be switched into equity in stocks where prices fall sharply.