The Markets Can Get It Wrong
Until now, the markets were betting implicitly on a deal happening between the United States and India
On Episode 664 of The Core Report, financial journalist Govindraj Ethiraj talks to Ajay Bagga, Market Expert.
SHOW NOTES
(00:00) Stories of the Day
(00:41) The markets can get it wrong as they did with Trump tariffs.
(02:19) Why investors should temper their expectations.
(03:20) How much did India really gain from Russian oil imports?
(06:18) The markets are digesting tariff tensions.
NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regarding any feedback, you can drop us a message on [email protected].
—
Good morning, it's Friday the 29th of August and this is Govindraj Ethiraj broadcasting and streaming weekdays from Mumbai, India's financial capital.
Our top stories and themes,
The stock markets can get it wrong as they did with Trump's tariffs.
Why should investors temper their expectations?
How much did India really gain from Russian oil imports?
And the markets are digesting tariff tensions.
The Markets Can Go Off
Until now, the markets were betting implicitly on a deal happening between the United States and India and the additional 25% on Indian exports into the US. Effectively a blockade not being imposed.
Now, things might change quite literally tomorrow. But at this point, the markets may have got things a little wrong. And the whole episode offers a good if occasional lesson on how to calibrate your faith in the stock markets themselves.
Nilesh Shah, Managing Director of Kotak Mutual Funds, summed it up effectively when he told Business Standard that he believes the market is still a bit complacent on tariffs and thinks that this is just a short-term tactic that will be sorted out soon, which is why the reaction has been muted. He said the collective wisdom of the market is that it still believes that the long-term interests of India and the US are aligned and this is more of a posturing exercise. But if tariffs remain for a longer period or escalate in some form, then the markets will correct.
And more on that coming up shortly. Another takeaway from this episode, once again at this point, is that when it comes to geopolitics and egos, the classic rules of economics, trade, and markets perhaps don't apply, else we would not be having half the wars we're seeing. Back home, the 50% tariffs that took effect on Wednesday are amongst the highest in Asia.
And those additional tariffs were imposed for India's continued purchase of Russian crude oil and more on that in a bit as well. At close on Thursday, the Sensex was down 705 points to 80,080. And the Nifty 50 was down 211 points at 24,500.
The broader markets were down to the Nifty mid-cap 100 and small-cap 100. Indices were down 1.2% and 1.4% each. Incidentally, Nilesh, I also had another useful reminder to investors.
You will not get the same kind of returns as the last five years. What you will get is moderate returns with volatility. His point is that for 10 calendar years, the Nifty has given positive returns, and the law of averages is bound to catch up.
Meanwhile, economic news or macroeconomic news, Nomura has cut India's GDP forecast to 5.8% for 2025-26 from the current 6.2% in a worst-case scenario where the 50% tariffs on India continue for the rest of the year. And as a base case, however, the GDP forecast has been lowered to 6% if it stays only for three months. So there you are.
The Price of Russian oil
India has saved billions of dollars by stepping up imports of discounted Russian oil in the wake of the war in Ukraine. But punitive tariffs imposed by the US that came on Wednesday will undo the gains with no easy solutions in sight, according to a Reuters report.
The Reuters report quotes analysts estimating India having saved about $17 billion by increasing oil imports from Russia since early 2022. You may of course remember that sanctions kicked in after Russia invaded Ukraine in February 2022. On the other hand, according to that report, the US decision to impose additional tariffs of up to 50% on Indian imports could slash exports by more than 40% or nearly $37 billion this April to March fiscal year alone, according to the Global Trade Research Initiative in Delhi.
Interestingly, CLSA, that's the brokerage report quoted by the Economic Times, says India's gains from importing discounted oil are estimated to be just $2.5 billion per annum, significantly lower than the speculated range of $10 to $25 billion, according to that report. And the report claimed that the benefit from Russian oil imports is less than the exaggerated media numbers. Which of course begs the question, if we were not really saving so much, then why are we buying about 36% of our crude supplies from one country? One answer could of course be that Russian oil exports are sanctioned, and a guaranteed long-term buyer for Russian oil, being India in this case, is way better than no buyer at all.
And this is not to say that India has not saved on buying Russian oil, it surely has, though all these debates do put the question on how much, and we will surely revisit this later. But whatever we saved, it was more for the exchequer and not so much for the consumers at the pump. Other key suppliers of crude oil to India are Saudi Arabia at 14%, Iraq 20%, the United Arab Emirates at 9%, and the USA at 4%.
Meanwhile, there are conflicting reports, depending on who you believe, so we shall not get into that, on whether or not India is actually increasing or reducing its purchases of Russian oil right now. One report from an authoritative agency says that India is increasing or sticking to its current purchase schedule, the other one says the opposite. So let's see.
Meanwhile, oil prices are quoting just under $68 a barrel, and whatever is happening or will happen on the India-Russia oil front is bound to influence international prices.
Relief For Apparel
Well, India has extended an imported duty exemption on cotton by 3 months until the 31st of December.
Apparel industry representatives the Court spoke to earlier had said that this would really not make much of a difference to them and would help more as an effort to stabilise local prices. These duties went up three years ago, and India had earlier announced an exemption on cotton imports two weeks ago from an 11% duty until September end, and that's now been extended to the 31st of December.
Tariffs and The Markets
The markets were down on Tuesday, and then again on Thursday, first in anticipation, and then the realisation that the additional 25% tariffs on Indian exports to the US would go through as scheduled on 27th of August. So how are markets calibrating themselves to this changing order? And did they to some extent get it wrong? I reached out to veteran market analyst Ajay Bagga, and I began by asking him how he saw the market moves in the last few days, and more importantly, his outlook building on the latest quarterly results.
INTERVIEW TRANSCRIPT
Ajay Bagga: It's multidimensional. The scope is quite limited. So, you're talking about 48 to 60 billion dollars of Indian exports being under threat.
Out of that, a lot will get trans-shipped, especially gems, jewellery. Nearly all the big companies have Dubai offices and Antwerp offices. So, shipping will happen from there.
So, it's not that we are going to lose out on the entire thing. As far as textiles goes, a lot of the companies have Dubai offices, UAE offices, Fujairah, Sharjah, and Ethiopian offices. A lot of the electrical machinery companies are setting up Ethiopian offices.
Ethiopia is at 10%. So, we are overestimating the impact and the scale is not that large on a 4.2 trillion dollar economy. Coming to the market, the market has been underperforming on the fundamentals.
So, our corporate earnings growth has not really been that great right after the national elections and the underspend on the infra. That set the tone and now the infra recovery has happened, but the global turmoil has had an impact, especially the IT sector being very huge in our market. That underperformance has also dragged our markets.
Overall, the markets were underperforming. Are they totally discounting the US tariffs? No, because there will be second order effects in terms of job losses and stuff like that.
Smaller companies will not be able to open branch shipment offices. They will lose business. People will lose jobs.
So, there is an impact on the economy and the government is seized of it. That's why the GST cuts are coming. That's why Advair is talking of some kind of a moratorium on loans, some kind of interest subvention schemes.
So, all those will come in. The market was blindsided, A, when this 25% secondary tariff was announced. Second, given that China was given a free pass till November to sort it out and China, Turkey, EU being much larger players than us in terms of buying energy and EU being a huge exporter now to Central Asian republics who don't have the absorptive capacity to take those exports, it's actually going to Russia.
So, it was a very cynical weaponization of trade and singling out India and all of us thought that this can't be happening and we will get a pass as well, just like China, especially when Trump met Putin in Alaska, we thought that something will come of this and we will not need this tariff at all. This 25% will dissolve away. It didn't happen.
So, that way, yes, disappointment was there. But if you see the market reactions on the day before the tariff and then the tariff day was a holiday in India and the day after the tariff, you have not seen more than a 1% correction in the Indian markets, which is more in keeping with the broader trend of the market rather than tariff dependent. In fact, quite a few textile companies went up on the day after.
The stock prices of a few textile companies were actually up because they are figuring out that it's not a complete washout for the season. They have front loaded a lot of their exports. So, if you see, Indian goods exports to the US from April to July have actually gone up quite substantially year on year.
So, we front loaded quite a bit. Second, a lot of our textile majors have multiple country offices. So, goods will be just conveniently shipped out of those companies.
And now, Govind, the whole mechanism is so well oiled after China has mastered this and other countries have learnt this, that actually your goods will be shipped out of your JNPT or Mundraport or wherever, but it will show the documents of the other country. So, it all being electronic, it's settled that way and the money comes into your office in the transshipment country. So, it's very well managed.
It's a well oiled machine. I don't see the big players really suffering. The small guys will get wiped out.
That is a problem and we will have to deal with that.
Govindraj Ethiraj: Right. Ajay, otherwise, you know, we are in the sort of, I mean, you talked about the earning stress. Apart from the tariff factor, which we are now back to reckoning with, we were sailing with a lot of macroeconomic tailwinds.
Positive, obviously. Low inflation rate, low interest rate, good credit rating for India. To what extent is that holding from, you think, particularly from a foreign investor point of view?
Because we are not seeing much flows there and, of course, have not seen for a while now. But is there anything that's shifting in the global landscape?
Ajay Bagga: Overall, if you see, we are not in a favoured direction. In fact, last month's Bank of America Global Fund Manager survey put us at nearly the bottom of emerging markets in terms of preference and in terms of being overweight. So, we were the most underweight emerging market.
Emerging markets have done very well over the last 12 months. They've outperformed the developed markets, but the Indian market has yielded about minus 4% in dollar terms in the trailing 12 months. So, we have been an underperforming market while our valuations are sky high.
So, we are at 20 times one year forward price earnings. So, we are not a cheap market, but not a growth market. We used to be a growth market.
So, people would assign that high price earning multiple. The good news is when we tend to underperform EMs so madly, when we reach about 25% of underperformance versus EMs, then the market normally has reached the bottom. Now, two or three things are coming together, Govind.
One, as you mentioned, the tailwinds, the macro tailwinds are looking quite conducive. The interest rate cuts are still flowing through the economy. They will flow through further.
Liquidity is quite strong. IT has been a drag, but other sectors are doing well. So, macro tailwinds are helpful.
Second, if you look at the quarter one numbers overall, this time was the lowest you can say in terms of estimates versus actuality. So, the downgrades were the lowest for the last eight quarters. So, maybe we have reached a bottom in terms of downgrades happening to corporate earnings.
So, from here on, it should be better. Third, this government stimulus is coming. If these GST cuts actually flow through and the timing will be good because of festival season, nearly 50% of the year's sales happen in these three, four months, September to about mid-January.
So, that will help a lot. And if that consumption boost comes in the economy, it could start a virtuous circle. So, you have a very good tailwind macro.
You have corporate earnings, which seem to have bottomed out. And third, you have a fiscal stimulus coming in where you already had an income tax cut, which was flowing through. And now you have a consumption tax cut, which is imminent.
That should help overall. And we are expecting the second half of the year to show us at least 13% to 14% earnings growth for the broader NSC 500. So, we could see upgrades starting to come in.
IT will remain an issue. So, it will remain a drag on the Indian market. But overall, I think price-wise, time-wise, we have paid the toll that the global investors wanted.
They won't come back in a hurry. They will wait for actual earnings to start showing up. And then you will see.
But just think of this, the domestic investor, domestic flows have held up the market despite the FII outflows consistently through the last two years. When that FII flow turns positive, what happens to this market? Because there is no seller.
There is no seller apart from promoters who are cashing out and making a quick buck, thinking that they can buy at lower prices. And then other FIIs. They have been the sellers.
When the FII selling goes off, then this market starts performing quite well. And I think in the second half, we'll see that.
Govindraj Ethiraj: Right. So, I guess it's a desirable situation where your income goes up and your expenditure goes down. I'm talking about the individual because income goes up because of tax, expenditure goes down because of indirect tax cuts.
Now, the Q1 results that you were referring to, Ajay, is there anything that jumped out at you which gave you sort of specific promise in terms of either a sector or a set of companies?
Ajay Bagga: Oil and gas did very well. Of course, they did all the heavy lifting. If you see, telecom was quite good.
Again, it's a very small sector. Two, three companies are left. Not much to write home about.
Banks and NBFCs, we are looking at doing better from here on. Normally, the correlation with the rate cut is rate cuts come in when there is a recession incipient. And so the first quarter of a rate cut doesn't do well.
And then the economy starts running because the rate cuts flow through. For us, mostly rate cuts come in more because of global or you're trying to take the economy from 6% to 8%. It's not a slowdown, per se, that we face.
So, India, it's difficult to correlate the rate cut to the economy's behaviour. But normally, after the first quarter, when the banks have absorbed that rate cut, where deposits continue to run at old rates and loans get repriced faster, then by the second quarter onwards, you start seeing banks doing better. Wholesale funded NBFCs start doing better.
And then credit gets better. As in a macro sense, you are charging less on the loans. So the credit quality starts improving, the credit behaviour starts improving, and banks and NBFCs start doing.
And since they are 30% of the market, that will help. And that will offset the IT players. Then other things that are looking good still remain the infra players, the construction materials.
Those are doing well. Cement, there is a turnaround coming. Raw material costs have gone down.
And what was not looking good, the FMCG and the consumer durables, automobiles, all three seeing a demand slump happening. But now, if there's a GST cut, say the lower end cars come from 28 to 18, that will be a huge boost. I don't know if they'll do it.
If two-wheelers get even a small cut in GST, on the margin, it makes a big impact. So two-wheelers could do it. Tractors were already doing well.
So they should do well. Passenger vehicles are not doing so well. Commercial vehicles are not doing well yet.
That will be a broader economic thing that will come through or still we have to wait.
Govindraj Ethiraj: Ajay, a pleasure talking to you as always. Thank you so much for joining me.
Ajay Bagga: Thanks, Govind.
