Revulsion is normally the last stage of a bear market, wherein individual investors are repulsed by an asset class and are in the process of vomiting whatever little holdings they have of the asset in question. It is a process that can take time and is extremely painful for market participants, as the asset in question can seemingly have no bottom and just goes down in value on a daily basis. Investors continue to sell down, irrespective of the price. Ultimately, they form a bottom for the respective asset, as they drive valuations down to very attractive levels.
For equity markets in India, for domestic investors and mid-cap stocks at least, we are starting to move towards the revulsion phase of the asset cycle. We are not there yet; but if things continue to move in the direction they have, we will be there soon.
Indian equity markets are the worst performers in Asia this year, with the headline index down eight per cent and the mid-cap equivalent down about 15 per cent. A huge number of stocks are down more than 20 per cent (20 per cent is normally considered the threshold for a bear market). In stock after stock, large blocks are available and one gets a sense that even long-term holders are now throwing in the towel. Volumes in the mid-cap space have shrivelled, and it is next to impossible to exit any position without significant price damage. The mid-cap indices have also significantly lagged their large-cap peers over the past five years, underperforming by more than 400 basis points annualised. The sectoral price action also points to fear and investor discomfort over the Indian economy and the rupee, as once again consumer staples, IT and pharma are leading the way in terms of relative performance. Investors continue to avoid any play on the Indian economy (apart from rural consumption).
Among domestic investors, I detect a complete lack of interest in equities. The locals have been continued and unabated sellers of stock throughout the last 12 months, but more aggressively into the rally beginning this September and are now looking smart. The concept of buy and hold is truly dead and buried as far as they are concerned. Any market rise is to be sold into. Retail and high-net worth investors seem to have taken the view that the rally was a godsend, the foreigners are obviously seeing something that the locals are not, and after five years of no returns they are happy to exit. Almost 4.5 million equity folios were shut in 2012-13 (the highest reduction in nine years); that is almost 15 per cent of all equity folios. Investors are clearly leaving this asset class in droves.
Domestic investors are close to the revulsion phase, as they seem totally convinced that property, gold and fixed income are far better avenues for investment than equities. It is almost impossible to get these investors to even engage with you when talking stocks. They seem happy to sell stocks at any price, and just want out. It is very tough to argue when property has yielded strong double-digit returns (or at least is perceived as having done so) over the last five years and can seemingly never go down in price. Why invest in equities when fixed-income products can give me double-digit returns with a slight drop in rates, goes the refrain. How do you argue with that?
Domestic investors seemed disillusioned for various reasons. First of all, there has been the differential return profile of equities versus the other asset classes over the last five years. Five years in most people's minds is a long enough period to come to a conclusion on long-term asset performance. Domestic investors are starting to realise how deep the damage to India's growth drivers is. We are not coming back to nine per cent growth anytime soon. This is not a cyclical slowdown. Yes, we may accelerate to 6-6.5 per cent growth in 2013-14, but anything more than that is a real challenge. We have to fundamentally change the way things are done in this country. We need branch-and-root reform in governance, regulations, and governmental co-ordination - and there is absolutely no sign of this.
Industrialists in India also seem to be so bogged down by the balance sheet and project sins of the past that there is no energy left to think about the future. There seems to be an unwillingness to keep going that extra mile to do business in India. When we dreamt of a decade of nine per cent growth ahead of us, people were willing to put up with the hassles of doing business in India; at five per cent growth, and many industrial groups in stress due to stalled projects, the difficulty of doing business in India now seems overwhelming. The lack of policy action, crony capitalism and the lurch towards populism witnessed over the last few years have also been unprecedented. While the finance minister is trying his best to change sentiment, he does not seem to be getting the required support from his colleagues in the government. There seems to be little understanding of how serious the economic issues are.
This exit from equities seems likely to continue, as it has now become a bit of a self-fulfilling prophecy. Locals sell equities, especially mid-caps, they do poorly, further vindicating the first decision and, thus, more stock gets sold. Unless we reverse this, we risk making our markets hostage to foreigners. It also keeps reducing the share of household savings in financial assets. How do you get $500 billion of private investment in infrastructure, if most infrastructure developers in India cannot even raise one rupee of equity from the markets?
If things are so bad, how come foreigners keep pouring money into India? What are they seeing that the locals are not? The biggest mystery to me remains these foreign flows; there is no India-specific fund that I know of that has any inflows. Some of the money is from asset allocation shifts; some from sovereign wealth funds; some from global funds playing a risk on environment and so on. These investors continue to have faith that India will get its act together. But even they do not have inexhaustible patience.
We are entering a very critical period for India from a foreign equity investor perspective. If after the 2014 elections, we do not see a sea change in governance and decision making, even foreigners will give up. We need $75-100 billion a year to fund our current account. Any estimate of financing this gap implicitly assumes $25 billion coming from foreign institutional investors on an annual basis. Good luck trying to get that, unless we revive the investment climate and make the much-needed long-term fundamental changes in governance.