The recent stock market crash would have the portfolio of most of the investors, be it novice or the legendary-bleeding. A large percentage of stocks particularly Small & Mid Caps are trading at 52 week low. The Sensex have lost more than 12% of value within a period of just 2 months.
Period such as these makes us wiser. And people saying “This time it’s different” is bound to repeat the same mistakes.
Rather than we going through our portfolio daily, it’s more important to understand the causes for the crash and keep reminding of these Lessons from the recent Stock Market crash which will make us better prepared in the future.
Sensex in the last 2 months
Let me try to explain the most basic reasons.
Lessons from the recent stock market crash:
1. RISING INTEREST RATE ENVIRONMENT
Warren Buffet on Rising Interest Rate
We are currently in a rising interest rate scenario. What does it mean? The interest rate is rising. Globally more or less, the interest rate moves in sync.
Why is it so important?
1. Since all the borrowing nowadays is based on floating interest rate. That’s why rising interest rate increases the borrowing cost for companies. This impacts highly debt laden companies, NBFC’s who borrow from banks, etc. Basically, cost of capital rises.
2. Both Bond market & Stock market are after the investor money. That’s why in rising interest rate scenario it’s the bond market that get investor preference. (No doubt the return from Shares far outweighs the return made from Bonds when times are good)
3. DCF valuation: While valuing stocks by DCF method, with the increase in Cost of Debt, the equity valuation goes down.
Lessons from the recent stock market crash:
2.DEPRECIATING CURRENCY
Rupee has depreciated by 15% year to date. And the drop is quite significant.
1. Since a large majority of Indian companies import their raw materials to manufacture the end product, the depreciating currency will lead to increase in cost for them & hence lower margins.
2. Those companies that exports most of the goods will be in a better position as increase in raw material cost will be hedged by the increase in the prices of goods & services sold. Thus, maintaining the margin. That is why IT services & pharma companies get a lot of mention in depreciating currency environment.
3. FII (Foreign Institutional Investor) who invest in the foreign markets are exposed to currency risk. While currently almost all the countries are witnessing currency depreciation because of strengthening dollar but the Rupee is one of the worst effected making India the most vulnerable investment target for FIIs. I have tried to explain below with an example. Given the volatility & the currency risk, they are quick to wind their positions & park their money probably in their home country.
Return by FII on different Exchange rate
Lessons from the recent stock market crash:
3. Rise in interest rate in the home country of FII
In a rising interest rate environment, as mentioned earlier bond market becomes attractive.
Also, the rising interest rate in home country, strengthens the currency as money flows to that particular country (US in this case), increases the bond yields. US fed has already raised interest rate 3 times this year & has indicated more hikes going forward. With rising interest rate the investment cost increases for FIIs.
The Quantitative easing taken by the Federal reserve of US to push the growth by pumping money as well keeping the interest rate at almost Zero were pumped primarily in buying into equity markets. With the interest rate in US rising, interest payment on these is also going to get higher.
Lessons from the recent stock market crash:
4.RISING CRUDE OIL PRICES
Since India imports 85% of its oil requirements. The rising Crude oil prices have leads to increase in export expenses. Hence, the Current account deficit is widening (Export-Import<0). The exports are not picking up either.
Also, for the large part of chemical & plastic (polymer) industry, the required raw material are derivatives of crude oil. Hence, rising input cost impacts the margin of these companies.
For transport, we are heavily dependent on either petrol or diesel (derivative or crude oil). So the surging crude oil prices have multiplied the probability of increasing inflation.
The rising fuel cost also dents the sentiments for 4-wheeler purchases.
5.FISCAL DEFICIT
With the looming election in India next year, the Govt is expected to increase popular schemes, be it farm loan waiver, MSP for farmers etc, the fiscal deficit is also expected to get wider. Fiscal Deficit is the difference between Govt’s Expenditure & Govt Earnings. The Govt’s earning from GST is still running below expectations.
Widening fiscal with current account deficit is going to put further downward pressure on rupee.
Coming to the conclusion, the IL&FS default case can be thought to be an outlier which came in with all other indications being negative, thus magnifying the impact. Similar was the 2008 crisis which was triggered at the time of Lehman Brother bankruptcy post the housing bubble.
Also, because of the factors mentioned above, the Q2 FY19 results have started to factor in rising input costs and hence lower margins. Because of the lower margins, the interest payment is going to be affected and hence more stress on Banks & NBFCs.
The whole purpose of this blog was to learn from the current situation & be prepared for any similar occurrence in the future.
Further reading:
What Kind of companies will be good investment for such volatile periods?
1. Companies that export more than it import
2. Totally domestic driven company i.e. companies such as Vmart etc
I have prepared a list of companies that fulfill the criteria below:
Latest Revenue should be greater than ₹100 cr
Latest year forex inflow > 2* forex inflow
For the previous 2 years, forex inflow > forex outflow
By,
Shekhar Yadav