Global Markets Run Into A Perfect Storm

It's a sell-off that is reminiscent of 2008 when markets were desperately searching for a bottom, where there was none. All hopes of the 7100 levels holding has been dashed and even the crucial psychological 7000 level has been breached.

It's a worst global sell-off since 2008, except this time the epicenter is not north-America when a liquidity crunch sparked of a global meltdown. Global sovereign wealth funds are selling in huge quantities as oil prices have tumbled to nearly $30 sending budget surpluses of oil producing countries into deficits.

In the sell-off of 2008, the US Fed was quick to restore liquidity and the 'too huge to fail' banks could turn to the central bank for emergency funds. But this time, where do the oil and commodity producing countries turn to?

The outstanding assets of sovereign wealth funds is more than $2trillion and even a fraction of selling at these levels is enough to send the global markets into a major tailspin. There's more pain in the corner as globally oil prices are likely to remain lower on rising supply across the world.

While oil prices plague the global economies, the Indian economy is seeing a disproportionate rise in bad loans with PSU banks as major offenders. In the third quarter, PSU banks have seen a sharp rise in bad loans, and provisions sending their net profit dipping. SBI, for instance, reported a lower net profit of Rs 1115 crore, down 61 per cent the third quarter over last year. Gross non-performing loans increase 95 basis points to 5.1 per cent.

Some other PSU banks are reporting gross non-performing assets of 7-8 per cent. Oriental Bank of Commerce reported a gross NPA of 7.75 per cent the third quarter. Earlier, PNB reported a rise in gross NPAs and a fall in profit. Rising non-performing assets not only hurts profitability as provisions rise, but it also cripples a bank's ability to expand credit in the future due to new capitalization norms.

Little surprise then, the Nifty PSU bank index has halved this calendar year tumbling 53 per cent. This month itself the index plunged 20 per cent wiping investor assets. This is not the end of the bad loan problem. The RBI's new asset quality recognition norms to clean up the banking books could see more bad loans tumble out of the closet the next quarter. Banks are finding it difficult to recover their dues from defaulters.

Coming back to the domestic front, the economic revival is taking a longer time than anticipated. Steel companies are reporting falling profit growth. Many manufacturing units are reporting a fall in profits. With no growth in sight and orders dwindling, the manufacturing sector could take 18-24 months to revive. Companies are not investing in new capacities, and instead seeing a drawdown of inventory due to lower commodity prices.

Manufactured goods could see a slump if local demand does not pick up. Exports are expected to get affected. China's struggling to export in this unforgiving global economy. Big purchases used to be done by the middle-east and now so-called oil rich economies. But with oil prices lower, they are likely to reduce their buying.

Inflows into mutual funds have been robust so far, but the last few weeks are seeing lower inflows. If global investors continue to sell as heavily as they did, domestic investors are not going to be able to support the markets. Small investors also tend to dabble in mid- and small-cap stocks a lot. With the mid-cap stocks falling, domestic fund inflows into this segment are likely to get hit. A large part of domestic inflows has gone into the mid-cap space.

Since its peak, the large-cap indices have lost 23 percent. Prior downturns have been even worse with large-caps sometimes losing over 40 percent. So by all accounts, things could get even worse from here. Unless you are a long-term investor have really deep pockets, you might do well buying and forgetting. But people who cannot see some red in their portfolios could do well to hold on to cash.

Stocks are also extremely volatile. Sharp movements of 800 points indicate that the markets are shallow and there is less liquidity. Some small stocks are seeing continuous lower circuits with no-buyers, and many small investors are stuck in these counters. Even if there's relief rally now, it's likely to get sold again. The rising wind of caution has turned into a storm, and no one knows when the calm will return.

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