The truth(?) behind the 6.8% Jan ‘12 IIP growth number

The Index of Industrial Production (IIP) published by the government each month is supposed to give an idea about what is going on in the economy. The Jan ‘12 figure of 6.8% came as a positive surprise, because the IIP number for Dec ‘11 was only 2.5%, and the consensus estimate for Jan ‘12 was about 2.1%. Naturally, the much higher figure seemed to indicate that growth was returning to the Indian economy.

The stock market should have celebrated the news – but didn’t. Were market participants ‘selling on news’, or did they ignore the news as unbelievable? Digging a little deeper into the published data raises more questions than answers.

Manufacturing growth was at a respectable 8.5%. But that growth was largely due to a whopping 92.6% growth in food products and beverages; 56.1% growth in printing, publishing and reproduction of recorded media; and 29.9% growth in medical, precision and optical instruments, watches and clocks. Minus these three items, manufacturing growth would be negative.

In plain English, the above data means that Indian citizens consumed almost twice the amount of food and drinks than what they did in Jan ‘11. Surely, population increase and rural prosperity through the NREGA scheme had roles to play. But 92.6% growth is hard to believe. So is the data that indicates a sudden rise in reading books, newspapers and listening to music and watching movies at home.

A growth in medical instruments may be explained away by the proliferation of modern hospitals and clinics. But why the propensity for buying watches and clocks? Of course, the published data has the following disclaimer: “Indices for January ‘12 are Quick Estimates.” May be the data collection was outsourced and improperly supervised.

More intriguing are the areas of de-growth. Electrical machinery and apparatus fell by –30.5%. Office, accounting and computing machinery fell by –14.1%. Radio, TV and communication equipment and apparatus fell by –13.8%. India is definitely not shining if electrical machinery, computers and communication equipment are showing de-growth.

As happens almost every month, these ‘Quick Estimates’ get revised subsequently. Which means these initial numbers don’t count for much and don’t indicate any trend. The collective wisdom of market participants in ignoring the Jan ‘12 IIP growth number proved correct in this instance.

Why did the stock market fall despite a good IIP number?

India’s Nov 2011 IIP (Index of Industrial Production) came in at 5.9% – higher than the consensus estimate – raising hopes of a quick return to the growth path. Considering the Oct 2011 IIP of –5.1%, there was a huge 11% swing month-on-month.

The stock market should have celebrated by spiking higher – specially since both the Sensex and Nifty are in the midst of rallies from their recent bottoms. Instead of doing the obvious by rising, both indices lost ground. Not much, but enough to cause consternation among small investors.

What is going on? Is this just the way Mr Market behaves to separate investors from their hard-earned money?

There can be a few logical explanations, which are mentioned below:

1. Both the Sensex and Nifty are in the midst of prolonged bear markets. Good news tend to get ‘discounted’ quickly and bad news causes renewed selling during bear markets.

2. Infosys – which is generally considered to be one of the bellwethers of the Indian stock market – announced better than expected Q3 results, but disappointing Q4 guidance and got hammered. Its high weightage in both indices caused the fall.

3. Oct 2011 IIP number was unusually low – but one must remember that it was a festival month (Navratri and Diwali), which meant lower production days due to the holidays. Nov 2011 IIP was comparatively much better, but some of the new orders may be due to inventory replenishment. Lower growth usually leads to inventory draw-downs (companies tend to let their existing inventory get depleted almost completely before placing new orders).

4. Technically, both indices retreated after facing twin resistances from their 50 day EMAs and DTLs (refer last Sunday’s post on Sensex and Nifty chart patterns).

5. All of the above.

Stock markets don’t necessarily move according to logic. In the short-term, sentiments can, and often do, overrule the fundamentals. So can a rush of buying or selling by the FIIs. What should small investors do?

Remember an old saying: “Buy the rumour; sell on news.” There is no better example of that maxim than today’s price action in the TTK Prestige counter. The company announced impressive Q3 results, but the stock lost more than 7% after the ‘good news’!

The stock market is in a state of flux. After 14 months of down trend, small investors are becoming impatient to buy in the hope of a trend reversal soon. Please be aware that interest rate is still high. So is inflation – though food inflation has turned negative. Stock markets don’t reverse trend till the first few interest rate cuts happen.

There is a clamour for a CRR rate cut from all corners. If the Nov 2011 IIP figure is the reality, i.e. economic growth is back on track instead of what has been mentioned in point 3 above, then there is no reason for the RBI to cut the CRR – let alone cut the interest rate. A rate cut may stoke the inflation fire.

In other words, there is no need to turn bullish yet. Await Q3 results of the big guns and RBI’s policy announcement on Jan 24. You may miss the absolute bottom by being conservative, but in a bear market it is better to be safe than sorry.

RBI pauses interest rate hikes – why did the stock market dive?

Stock markets and interest rates have a love-hate relationship. Markets love low interest rates, but detest high interest rates. ‘Low’ and ‘high’ are relative terms. As a very rough thumb rule, a Repo rate of 5% or lower can be taken as a ‘low’ rate; 7% or higher can be considered a ‘high’ rate.

In Jul ‘08, the Repo rate (the interest rate payable by commercial banks when they borrow money from the RBI) had peaked at 9% – more than 6 months into the previous bear market that lasted from Jan ‘08 to Mar ‘09. Thereafter, Repo rates and Reverse Repo rates (interest rates payable by RBI when they borrow money from commercial banks) were gradually reduced till the Repo rate hit a low of 4.75% in Apr ‘09.

By Mar ‘09, when the Repo rate was at 5%, the stock market reversed direction and started rising. The ‘lag’ effect of interest rate changes are evident from the above data. Bear markets start well before interest rates hit their peak; bull markets start before interest rates drop to the bottom.

The next increase in the Repo rate came only in Mar ‘10, when it was raised from 4.75% to 5%. The bull market was already a year old by then. Thereafter, 12 more rate increases – the last of them in Oct ‘11 – took the Repo rate to a high of 8.5%. By then, the bear market from the top of Nov ‘10 was almost a year old.

Why do stock markets hate high interest rates? Because the cost of doing business increases for every one, and profits take a hit. Capital expenditure is postponed, which hurts growth and in turn, hurts profits. When earnings decrease, EPS reduces. P/E ratios become higher, which induces selling of stocks and shifting of investments to bank fixed deposits at high rates.

Two months back, RBI last increased the Repo and the Reverse Repo rates by 25 basis points (0.25%). The stock market had expected the hike, but appeared to celebrate the news by moving up. That seemed to go against logic. Stock markets are supposed to hate high interest rates. What may have caused the celebration was a hint by the RBI that they may not raise rates further if inflation rate started to moderate.

Inflation rate has started to drop, though it continues to remain high. Food inflation has fallen quite remarkably – whether due to seasonal reasons or high ‘base effect’ or both. The high interest rates caused GDP growth to slow down and de-growth in IIP (Index of Industrial Production). So, it was no surprise that RBI left the interest rates unchanged, and hinted that rates may be lowered henceforth to spur growth. Instead of celebrating, the stock market dived – again appearing to defy logic.

What happened? Many market players had expected a cut in the CRR (Cash Reserve ratio – the percentage of total deposits that commercial banks have to maintain in cash) to inject more liquidity into the financial system. But a combination of an inflation rate that is still high and a fast depreciating Rupee against the US dollar may have forced RBI’s hand in keeping the CRR in tact. That perhaps caused disappointment that led to the sell-off today.

During a bear market, the slightest bit of ‘bad’ news causes a disproportionate amount of negative sentiment. Even if the news isn’t bad for the long-term but appears to be bad in the short-term gives a good enough reason to sell. The opposite happens in bull markets, when the slightest bit of ‘good’ news sends the stock indices soaring. That is an unlikely occurrence at least for another 6 months. Till interest rates are reduced significantly, the bulls will not return.

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