The nationalization of US mortgage agencies Fannie Mae and Freddie Mac sparked a huge rally in equities on Monday and the Indian market was no exception.
What do Indian stocks have to do with a bailout of US mortgage lenders? Well, the hub of the global credit crisis lies in the US housing market, and if the bailout helps to stabilize that, it would help big US banks, which in turn could lead to more risk appetite and fund flows to emerging markets such as India. That’s the tenuous logic on which the current rally is based.
The argument looks plausible, but is overshadowed by many uncertainties—not the least the fact that previous attempts at solving the crisis by the US government, or the central bank have also led to similar rallies, which fizzled out all too soon.
For instance, the Fed funds rate cut of 50 basis points on 17 August 2007, followed by another 50 basis points cut on 18 September 2007, led to a two-month rally in the US that took the Dow Jones Industrial Average from a low of 12,455 points in August to a high of 14,279 in October.
In India, those rate cuts led to a huge rally that took the Sensex from its low of 13,779 in August 2007 to its peak of 21,206 in January.
But rate cuts have lost their potency these days and subsequent rallies have been the result of more direct action. For instance, the Sensex moved up from its close of 14,809 on 17 March as a result of the bailout of Bear Stearns by the Fed. At that time, too, the hope was that the worst was behind US banks and equities rallied worldwide.
That hope took the Sensex up all the way to 17,735 on 5 May. But the rally faded swiftly, falling to a nadir of 12,514 on 16 July, when the US Treasury’s promise to bail out the US mortgage agencies, the US market regulator’s decision to limit short-selling in financial stocks and the fall in oil prices led to another big move upwards.
But this time, the run-up was less euphoric, which fizzled out after hitting a peak of 15,579 on 12 August, with the Sensex falling back to 14,002 on 28 August.
How long will the new rally last? Note that the rallies have been getting shorter and shorter after each bailout.
But the latest one is the mother of all bailouts, with reports saying the US government could lose tens of billions of dollars. What it will do to the dollar and inflation is anybody’s guess.
But just for the moment, let’s set aside our doubts about whether the bailout will be sufficient to mend the holes in banks’ balance sheets, stabilize credit markets and shore up the US economy.
Assuming it does, will it not shore up demand for oil and commodities as well? And if that happens, it may not be all that positive for the Indian market.
Consumer goods stocks have outperformed Sensex both ways
FMCG (fast moving consumer goods, including soaps and other personal care products) stocks have the rare distinction of outperforming the Sensex both on the index’s way down from its January highs as well as during the bounce-back from its July lows.
Moving Fast (Graphic)
Between January and mid-July, BSE’s FMCG index fell by 24%, much lower than the 40% drop in the Sensex. And since mid-July, it’s risen by 19.4%, higher than the rise in the Sensex.
The Healthcare (down 8%) and IT (down 16%) indices did better during the fall, but stocks of companies in these sectors have risen at a much lower rate since July.
The demand for FMCG shares this year is being led by good monsoon on the one hand, and an increase in disposable income on the other.
The distribution of rainfall this year has been fairly good and this augurs well for rural demand, one of the main drivers of incremental growth for FMCG companies.
Rural consumers also benefited from the farm loan waiver, which should have an impact on their disposable income.
Besides, the government’s generous tax cuts and the implementation of the Sixth Pay Commission has led to a significant increase in disposable income.
Concerns that high inflation would impact volume growth and also lead to ‘down-trading’ have also come unfounded, going by the trend in FMCG sales in the past few months. Now, in fact, these companies seem to be in a sweet spot.
According to a recent report by Lehman Brothers Inc., “Margins are likely to rebound in the coming quarters, due to: Pricing action by companies across all products and segments, and; cooling off in the prices of all major raw materials.”
FMCG companies had recently taken price increases to tackle inflationary pressures, after which prices of many raw materials have fallen.
If prices of commodities such as oil remain where they are, much of the price increase may flow into the bottom line. What’s more, one of the main worries of the market—high interest rates—hardly affect FMCG companies.
But note that most FMCG stocks currently trade at 25-30 times trailing earnings, and given the current environment where valuation multiples are expected to further contract, the upside may be limited.
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