Wall Street and Main Street: The growing disconnect between the real economy and stock market

Thirty years ago while studying commerce, we were taught – “Stock markets are the barometer of the economy”.

Until recently, I headed Finance of a major capital equipment manufacturer who supplies to extremely diverse industries. A view from my previous employer provided good insights to the Investor Community concerning many of the B2B sectors – Food Processing, Cold Storage, Pharmaceutical, Water and Waste-water Treatment, Environmental, Railways, Navy, Shipyards, Chemical, Electrical system-builders, HVAC, O&G, Crude Oil Refinery, Mining, Pulp & Paper, Sugar, Starch and so on.

In Consulting career, I am still connected with capital equipment segment, but more in SME (Small and Medium-sized) sector. Thanks to the legacy of my previous job, last Friday I was invited by country's five leading asset management / portfolio management companies - monitoring Capital Equipment sector - to express my views about the state of the economy in general and the state of the capital equipment sector in particular. I had individual – one-on-one - discussions with these five leaders of corporate investment community in India while sitting in Trident Hotel in BKC, Mumbai overlooking the ongoing dismantling of pavilions and show material from the Make-in-India Week Event the previous week.

Carrying varying titles, all those Fund Managers were young (in 30’s), from middle management levels and at times equipped with Engineering degrees from prestigious technology institutes of India. Most of them came in a pretty depressed mood, with shoulders down carrying the burden of the capital equipment industry! Sensex has reached the levels of May 2014 when the NDA government stormed in. If you look at the two years’ graph – it looks more like a hill – with the peak during the first week of March 2015 –exactly a year ago – post-2015 Fiscal Budget. Curiously, all of them had a question about BHEL which on that day, had reached its lowest level for two years. My mention about BHEL bagging a large order worth 1.6 billion dollars from Bangla Desh just a couple of days ago could not cheer them up. They mentioned – but BHEL has huge issues with costs and margins. May be! I tried to share with them my personal experience from my business visits to the large industrial areas of Chakan and Shirwal – around Pune – during which I see a lot of land development and construction activity going on. With competitive federalism – many a States are trying to attract investments. But they were not convinced. I mentioned about the signing of INR 15.2 Lakh Crores (EUR 200 billion) of MOUs at Make-in-India Week event the previous week. They mentioned about the low success rate of 20%. I observed that – that has always been the realization rate of such announcements in India. And even the 20% rate holds the possibility of enormous new opportunities. Nope! They did not buy that. I mentioned that there has been a record growth in actual FDI (Foreign Direct Investment) year-over-year in the recent past. They were more worried about the exiting FII (Foreign Institutional Investments).

How could I be optimistic about the future prospects of Indian economy? – they were surprised! When asked – which sectors have a better chance of growth, I mentioned that food and food-processing sector is going to grow in India with growing urbanisation, increasing middle class, more women in jobs. They opined that – but it is more McDonalds, KFCs and Pizza Huts of the world who are going to role-out their global business models in India rather than leading Indian food companies taking charge. I mentioned that with our demography, growing incomes, and increasing life expectancy I see good chances for pharmaceutical and old-age care industry. Their view was that Indian pharma industry is not going to do well for a long time until they resolve their issues with the US FDA (Food and Drug Administration). With newspaper announcements of launching of rails, roads, bridges and ports every alternate day, I mentioned that Infrastructure sector is likely to grow in my opinion. They mentioned that – but those are just cheap publicity stunts, even tendering of those projects is yet to start. When I asked if they know that, they said they heard so. The mention of potential growth in many other industries driven by Smart Cities initiatives like – electrical mobility, public transportation, construction, waste management, alternative energy, smart technologies – did not convince them. They were of the opinion that – those are just announcements. Plans are to be made yet, and consortiums to be formed, projects to be decided – it is going to take years before we see any movement driven by Smart Cities.

Their pessimism was contagious. Before I could really get inflected, I decided to close the discussions with my opinion about the Capital Goods Industry that they monitor as Funds Managers. I said - with growing middle class, demand for new products – automobiles, two-wheelers, electronic goods, mobiles, white good, food products etc. is growing. With that – new investments in capital equipment industry has to take place. They said – but there are fund availability issues. Industry is already not having sufficient long term funds to invest, and now with the banks writing off their NPAs (non-performing assets), investment scenario looks even worse. A couple of them even said that they do not see investment in new capacities over the next five years.

Most of them left shaking my hand, and with a nervous smile. They did not get to listen what they expected. My view of the economy was too optimistic to be considered. Before they left though, I asked each one of them a question waving at the MMRDA grounds just across the road – what were their impressions about the Make-in-India event the week before where Indian and foreign companies, various Governments, and industry organisations had show-cased their efforts and plans under Make-in-India initiatives. To my disbelief and utter disappointment, not a single fund manager I met had taken pains to visit the event, let alone join industry discussions and participate in conferences. And a majority of them had their offices a stone’s throw away from MMRDA grounds where the show took place. Some offices, I could even see while sitting in Trident.

Then I realised – why in spite of favourable conditions, Dalal Street is heading south since a year. Crude oil has come down drastically over the last two years – this should have significant positive impact on our economy. But it is not visible. Agreeably the Government is hoarding a lot of money saved for future use. But shouldn’t it reflect at least in sentiments? China’s economic slow-down is good news for India. Irrespective of a great disparity in both the economies, India should have at least marginally enhanced her attractiveness as investment destination and manufacturing location? It is not reflected in the Sensex movements. Opening up of Iran – with whom India has strong economic and cultural ties – should be seen positively. Iran – which has been suffering economic sanctions for decades - has huge demand for development of goods and industry backed by enormous oil reserves.

When one analyses a particular industry – one must understand the fundamentals of that industry – industry business models, new developments, innovations and disruptions taking place. An industry is run not only by interest rates, FIIs and international geopolitical events. Over the long run, the industry runs on fundamentals. To understand those fundamentals - say in capital goods industry - one needs to visit factories, analyse the customers, downstream industries. Analyses done while just sitting in air-conditioned offices tend to be as solid as the air. I could also observe a group-think in the investment community. By watching the star-analysts and star-economists in Bloombergs and CNBCs of the world, we often start parroting them. Expert-bias sets in. Instead of re-think, group-think and group-speak sets in. Herd-mentality is expected of unsophisticated, retail investors, but not from the experts.

Presently, we are often seeing the headlines – “Sensex down on global cues”. After a couple of days the headline reads – “Sensex gains on global cues”. Definitely, currency fluctuations could have negative impact on heavy importers/exporters, China slowdown has impact on companies largely exporting to China, Euro scare has impact on companies dependent on Euro-Zone, declining Brent Crude has impact on vendors of Oil & Gas industry, or exporters to the Middle East, and also on our inflows from the Middle East. However, these negative impacts are limited in nature. Firstly, due to our strong domestic demand, and less dependence on global markets, and secondly, due to the offset by the positive impacts of these events.

It is in the nature of stock markets that they move rapidly between depression and ecstasy, unjustified gloom and irrational exuberance. However, unless the market movements have some link with the industry fundamentals, business confidence, demographics and political stability - they may tantamount to pure speculation - by a large but irrelevant and closed community.