Be Careful With Stocks, Foreign Funds Are Now Pulling Money Out

All is not well with the economy

When Modi came to power, three years ago, markets were ecstatic. However, after three years of the present government, you have the GDP come in at just 5.7 per cent, which is in fact a three year low for GDP.

Many argue that the GST and de-monetization were the reasons for the same. However, the economy has been declining for sometime now and it not a temporary aberration.

SBI in a recent report said that the decline was not technical, but real. It is "technically not short-term in nature or even transient," SBI Research report said.

Corporate earnings very poor

When you have Sensex p/e at 23 times, you expect Sensex companies to grow by 10 and 20 per cent. If that does not happen, you suddenly realize that valuations are very rich and you start dumping stocks.

This is what has been happening for many many quarters. Analysts, investors and FPIs are waiting for earnings recovery to happen, but it seems to be an indefinite wait. In fact, it is only going from bad to worse.

If earnings do not recover, there is no way FPIs are going to keep buying.

Banking sector in bad shape

The huge non performing assets in the banking system, has ensured that economic recovery remains stalled. Government banks need capital desperately and so far the government has hesitated to provide the same.

If there is further delay in capitalizing banks, economic recovery could be delayed further. This means that corporate recovery could be delayed and hence selling pressure from FPIs may only increase.

Fiscal deficit remains a cause for worry

One reason why the markets have collapsed last week, is on account of the worry of a fresh stimulus package. The concern is that this could lead to the fiscal deficit widening over the targeted 3.2 per cent for 2017-18.

Once the fiscal deficit widens credit rating agencies do not look favorably, as far as Sovereign Credit ratings are concerned. Only recently, credit rating agencies, downgraded the country ratings of China, citing huge worries over debt.

The state finances are also not very good, only compounding the problem further.

Private investment has stalled

Lack of private sector investments, has been the biggest problem for India. The Chief Financial Officer of India's engineering giant, L&T had this to say to a business daily. "We have already committed investment and have not seen returns flow through, so no board in their right mind will like to sanction further investment, unless there is a viable business plan around it."

Clearly, factories are not operating at optimum capacity, though all along we have been advocating that favorable demographics would play out.

The private sector at the moment is weary of investing and that is a serious problem.

Should you be buying stocks now?

The answer is an emphatic "no". Markets are expensive at trailing p/e of 23.68 times on the Sensex. In fact, the price to book at around 3 times is also very rich. You can pay for these kind of multiples, when corporate earnings are growing at around 20 per cent annually.

In fact, the average p/e of the Sensex in the past has been 17 times. So, clearly valuations are rich and it would not be sensible to buy at these valuations. Buy on sharp declines can be a strategy that investors could follow.