El Nino, Inflation and Markets

Inflation has been the talk of the town in 2022 and in 2023 it threatens to be the most dominant factor affecting the global equity market moods. With the widely expected El Nino to disrupt the monsoon season in India this year, Yogesh Supekar discusses the probable impact it may have on inflation and hence on the markets 

With BSE Sensex down by 2 per cent on YTD basis, one would say it is not that bad a start to the year given the headwinds equity markets are facing right now. The Indian markets are seen underperforming the US markets on YTD basis by a small margin. Could 2023 be a different year where the Indian equity markets gain their mojo back and start outperforming its global peers? If we look at the economic growth potential, there is no doubt about the macro triggers that gives India a distinct advantage. However, it is never a smooth ride in one direction be it the stock market or economic growth. 

On the macro front, the latest concern facing the markets is about the poor monsoon as predicted by several scientists. There is high probability of El Nino impacting the monsoon season this year. This usually means that there is little to no chance of above average monsoon and that there is a probability of a drought-like situation. With 70 per cent of the rainfall experienced during the monsoon season in India and India being a country with its huge population dependent on the agriculture industry, the advent of El Nino this time around when the inflation is already bothering the market condition is considered an important factor that could affect the market moods.
 

El Nino and La Nina

El Nino and La Nina are two major climatic phenomena that impact the weather and climate patterns across the world. In India, both these events can lead to significant changes in weather conditions, thereby affecting agriculture, water resources and other vital sectors of the economy. El Niño is characterised by a warming of the ocean surface temperature in the eastern and central tropical Pacific Ocean, leading to changes in atmospheric circulation patterns. This can result in reduced rainfall in India, particularly in the northern and central parts of the country. El Nino events are associated with droughts in India, which can lead to crop failures, water shortages and other impacts on the economy and society. 

On the other hand, La Nina is characterised by a cooling of the ocean surface temperature in the eastern and central tropical Pacific Ocean. This can lead to increased rainfall in India, particularly in the northern and eastern parts of the country. However, La Nina can also lead to flooding and other weatherrelated hazards, which can have a significant impact on agriculture and other sectors of the economy. In India, both El Nino and La Nina events are closely monitored by weather experts as they can have significant impacts. The Indian Meteorological Department (IMD) regularly issues advisories and alerts related to these events, helping farmers, policymakers and other stakeholders to prepare for the potential impacts. 

Economic Growth, Food Inflation and Inflation Risks With the possibility of El Nina this monsoon season, inflation risk is what we have to discount for in 2023. One of the biggest concerns for the markets is the revival of rural demand. If a drought-like situation happens in parts of India it can lead to delay in recovery of the rural demand. Rural economic growth has been the key to the economic growth momentum for India. Food inflation can also shoot up owing to the below average monsoon. This can fuel inflation further. Globally, inflation remains a key risk. However, the market is discounting peaking of interest rates in the first half of CY 2023 and hence equity prices may not react violently to any increase in interest rates in the coming months. 

Food and beverages is the most important category in the consumer price index which constitutes 45.86 percent of the total weight. Within food and beverages, we have cereals and products, milk and products, vegetables, meat and fish, oils and fats and prepared meals, snacks, sweets, etc. as major components. In India the consumer price changes are always extremely volatile owing to dependence on energy imports and the uncertain impact of monsoon rains on its large farm sector. From the market’s point of view, it thus becomes important to keep a tab on food inflation which is linked to the monsoon. 

Inflation Rate

The inflation rate in India averaged 6.04 per cent from 2012 until 2023, reaching an all-time high of 12.17 percent in November 2013 and a record low of 1.54 per cent in June 2017. 

Above average food inflation can tickle the inflation rates higher, thus making it difficult for the bulls to have their say. El Nina improves the odds of higher food inflation. Hence, it will be interesting to observe the various developments on the monsoon front. The Indian economy however remains in good shape and the strong fixed investment in the economy is a positive sign along with good export data given the global slowdown, if we go by the recent India GDP Q3FY23 statistics. 

The manufacturing sector dragged down the recent GDP data while agriculture and services have done well. The lack of global demand is believed to have impacted the manufacturing sector while above average growth was seen in trade, transport and the hotel industry which form a part of the service sector in India. The recent GDP data also reflects strong festive season. However, the data also highlights slower growth in private consumption. The slowing growth in consumption can be attributed to the fading of pent-up demand and high base.
 

Equity Market Outlook

The market seems to be stabilising after the rout in the Adani Group shares. One of the biggest beneficiaries of the stability in the Adani Group shares is the banking sector. Especially, the PSU banks are seen as a bargain with recovery visible in the Adani Group stocks as the risk of default by the debt-laden group seems to have been normalised. The outlook on the banking shares thus remains positive.
 

Services Sector Drives Indian Economy 

According to Suman Chowdhury, Chief Analytical Officer, Acuité Ratings and Research, NSO has estimated the GDP growth for Q3FY23 at 4.4 per cent which is slightly lower than the market estimates of 4.7 per cent. There have been substantial upward revisions in the GDP computation and growth for FY22 which now stands higher at 9.1 per cent (8.7 per cent) and has consequently led to a major change in the base factor. However, the government continues to be confident about touching a GDP growth of 7.0 per cent for FY23 as a whole. The data clearly validates that the services sector is a key driver of the domestic economy at the current stage. 

While the GVA growth in Q3 stood at 4.6 per cent, trade, transport, construction and other services have grown between 8.4-9.7 per cent, a part of which can be attributed to pent-up demand after the dissolution of the corona virus threat. Manufacturing has been a drag, contracting YoY in both Q2 and Q3 of the current year which is partly due to the slowdown in exports arising from the global environment. On the domestic demand front, the fragility in rural demand has expectedly led to a weak print in private consumption expenditure which dropped to 2.1 per cent in Q3 although it still recorded a 9.5 per cent growth in the first nine months due to the base advantage. 

What has been a persistent engine for domestic growth is the gross capital formation arising from public capital expenditure which grew at 8.3 per cent in Q3 and is estimated to rise by 12.6 per cent in FY23. The government revenue expenditure has actually been declining after the pandemic with a contraction of 0.9 per cent in Q3 and 1.0 per cent in the April to December period. The higher trade deficit has also been a drag on the GDP figures in Q3 on expected lines. Overall, the Q3 GDP print has largely been in line with the trend that we have observed in our proprietary Acuite Macro Economic Performance (AMEP) index which has held on to the same levels since November 2022 after the festive activity. 

While there is a lack of momentum in rural demand and weakness in exports, it is partly offset by the steady demand for goods and services in the urban economy. With some support from the base factor, this will help the economy to notch up a print close to 7 per cent in FY23. Going ahead into the next fiscal, the factors that will play an important role are the impact of higher interest rates on urban demand, stability of the monsoon and the absence of the base factor. We have kept our GDP growth forecast for FY24 at 6.0 per cent for now without factoring in any additional risks from the monsoon and external factors.
 

Technical Outlook on Bank Nifty 

Elaborating about the performance of Bank Nifty, this is what Bhagyashree Sawant, Deputy Manager (Equity Research), Globe Capital Market Ltd., had to say: “In November 2022, Bank Nifty successfully negated the double top at the level of 41,830-41,840 and achieved a new all-time high (ATH) of 44,152. However, this optimism was short-lived as the index formed a hanging man (a bearish reversal pattern) in December 2022, which was confirmed in January 2023. As a result, the index underwent a correction in January and February 2023 but found support at the 38.2 per cent retracement level of the previous upward rally, which extended from 32,290 to the ATH. 

“In March 2023, the index has experienced a significant rebound and has already surpassed its February closing level by over 1,100 points. This rebound has been supported by the bounce-back of the index from the 200 days’ EMA support on the daily chart, as well as a prior swing high breakout by the 14-period RSI before the price, showing a positive divergence. Assuming that the resistance zone of 41,375-41,415 is broken on a closing basis, we can anticipate a positive rally up to the 42,000 mark, followed by 43,100. However, if the index fails to maintain these levels, we can expect a correction down to the immediate support of 40,300, followed by a crucial zone of 39,600-39,400, which could serve as a potential trend reversal zone for the index.” 

FMCG Index

Another sector that is showing strength is the FMCG index. Several FMCG stocks with ITC Limited leading from the front are seen making fresh 52-week highs owing to a positive set of numbers and improvement in the profit margins. 

Technical Outlook on Nifty FMCG — Most of the negatives are discounted and the positive set of numbers in the recent earnings’ season can give confidence to bulls to hold on to their long bets. The attractive valuations in the broader markets and in a few pockets of the Mid-Cap and Large-Cap universe make stock-picking an attractive money-making expedition.

As per the technical chart, Nifty FMCG is showing relative outperformance against the other sectoral indices. Interestingly, the all-time high level of 46,400 is the breakout level of 12-week cup and handle pattern. Any rise above this level shall indicate a bullish picture over a medium-long term. Also, the daily MACD is about to signal a bullish crossover. The other momentum oscillators also have a positive bias towards this index. Such technical setup is likely to attract traders in upcoming trading sessions.
 

India Inc. Witnesses Improvement in Margins in Q3FY23 

According to CareEdge, the Quarterly Results for Q3FY23 showed a marginal improvement in the financial performance of the corporates compared with the previous quarter. Net sales continued to grow in double digits on a year-on-year basis while operating profit also recorded a marginal annual growth after contracting in the previous quarter. The easing of cost of raw materials has aided profitability but higher finance and employee costs have limited the upside. 

The operating profit margin recovered in Q3 compared with the previous quarter but was still lower compared to a year ago. Among sectors, automobiles, IT, power and capital goods witnessed strong double-digit growth in both sales and profitability whereas sectors such crude oil, iron and steel, nonferrous metals, cement and textile dragged in terms of overall profitability. Further, the debt servicing capability of corporates, as reflected by the interest coverage ratio (ICR), improved marginally despite rising borrowing costs. 

According to Devang Mehta Head Equity Advisory, Centrum Wealth, “ There are some potentially important events for the Indian equity markets in the next 12-18 months. The state election results, which may swing the mood to the big 2024 showdown, will arguably be the biggest event to watch. But apart from politics, the uncertainty around interest rates, growth in a slowing world, valuations and flows continue to be the biggest factors for equity market sentiment. Inflation data and the resetting of rate expectations is the reason behind the dull equity sentiment currently. Core inflation for the US and India is high and sticky. There’s a reasonably high possibility that the US Federal Reserve and the Reserve Bank of India (RBI) will remain hawkish and raise rates more than expected earlier. However, the market at some point will discount this. Hence, it is imperative to shift the focus on growth and earnings, especially in India. The most pessimistic guy on the street will also not argue on the growth trajectory that India is getting on to with capital expansion, credit growth and consumption. Corporate profitability along with strong policy continuity ensured by the government and refraining from anything drastically populist in a pre-election year will probably be recognised sooner than later. The key aspect is to look at the timing and quantum of foreign flows. One thing for sure is that, they can’t ignore a growth engine like India for a longer period. Also post correction, the markets look reasonably valued, whether on the PE, PBV or market-cap to GDP fronts.”
 

Conclusion 

Inflation, undoubtedly, has bothered the markets in 2022 and continues to do so in 2023. However, we believe that this year the focus will shift, at least in the second half of the year, towards growth. The ambitious plans the current government has laid out for the economy and for various sectors need growth impetus and this would mean halting of a rise in interest rates. Bulls may rejoice any indication of such a move by the Reserve Bank of India (RBI). The markets are forward looking and may start factoring in this indication in advance and hence we believe that the markets may surprise on the higher side in the second half of the year. 

History suggests that El Nino typically results in weaker monsoon but this is not the final word. It is observed by a few experts that El Nino has been responsible for 60 per cent of India’s droughts during the previous 130 years. The El Nino years have been those with below-average rainfall of more than 10 per cent. The recent higher-than-expected inflation print in the US and Europe has led to rising yields. The impact of probable El Nino on crop production and on food inflation is too speculative to quantify right now and hence no portfolio decisions should be based on the arrival of El Nino at this point of time. 

It is a bit premature and we may have to wait for a couple of months to get a better idea on the same. The US Federal Reserve and ECB speakers have maintained their hawkish stance and the inversion of the US’ yield curve deepened as the US 10-year bond yield went above 4 per cent and the two-year yield reached 4.90 per cent. The bond yields in India however remained relatively stable. With the view that the RBI will start reducing interest rates from CY 2024 and inflation expected to stabilise in the range of 4.8 per cent to 5.20 per cent over the next six months, the outlook for the equity market remains positive. 

With the recent correction, the valuation is cheaper than it was a few months back, thus making the risk reward in favour of the long-term investors. The recent performance in the Indian equity market has also been due to a shift in strategy by the FIIs where money was withdrawn from the Indian markets and parked in China’s markets. However, with the strong economic growth story in India and valuation being more attractive today than when the Nifty was trading at its all-time highs, chances are bright that the FIIs will once again start investing in India. The outlook remains positive as regards the equity market.