Forward looking

A bull or a bear phase influences earning estimate and Goldman Sachs’s post-election forecast only reflects this reality
By Mohan Sule
The heat and dust raised by investment bank Goldman Sacchs’s advisory to go overweight on India on indications that Narendra Modi is set to become Prime Minister post May 2014 Lok Sabha polls brings into focus the forward-looking statements made by companies and market intermediaries. The Securities and Exchange Board of India has banned primary market fund-raisers from forecasting financial numbers, restricting them to historical performance. This is to prevent issuers from painting a rosy future to justify over-the-top valuations. However, listed companies as well as analysts tracking them can offer next quarter or full-year guidance. Savvy investors take exposure to a counter on the basis of its capacity going ahead rather than relying solely on the trailing 12-month valuation, which factors in all the possible developments in the period. Only naïve investors will believe that the fluctuation in prices is purely a function of the financial performance of the stock. Companies are vulnerable to external shocks like policy changes and man-made or natural crises at locations of plants and markets. For example, civil turmoil and cyclone. Importers and exporters have to live in fear of foreign exchange volatility that not only tracks domestic fiscal and monetary policies but also global events beyond the control of the country’s policy makers. The rupee plunged on flight of foreign investors following hints by the US Federal Reserve that it might wind up the liquidity injection.
Due to these non-quantifiable variables, projections can go wrong. Even proprietary models can throw up misleading results. This is not solely because there is something amiss in the formulae as predictions cannot be based just on increase in output and orders. The possibility exists of irrational exuberance creeping in during a bull-run or overt cautiousness during a bear phase. The tone and tenor of top managers’response to analysts’ questions during conference calls, too, unwittingly weigh on the analysis. Guerrilla attacks by competitors can disrupt calculations and so also delays in commissioning projects or disruption in production due to labour unrest. Therefore, Goldman Sacchs can be excused if it has based its assessment by combining the euphoria generated by opinion polls capturing Modi’s popularity with historical data that suggest his tenure could result in reduction in corruption and implementation of growth-oriented policies. Some companies maintain a studied silence on ‘sell’ recommendation. The UPA II coalition, particularly the Congress party, instead seems to be behaving like those companies that want a positive spin on their performance despite the current numbers and outlook not justifying such a view. Instead of scolding the investment bank, the focus should be on the warning by rating agency Standard & Poor’s of assigning India to junk status after elections in view of the deteriorating financials, particularly the fiscal deficit.

Just like companies, governments, too, do not take kindly to downgrades. S&P’s US head “resigned” two weeks post the agency revising the sovereign rating of the US to AA plus from AAA in August 2011 after the US Congress voted to raise the debt ceiling. Yet, the dollar held steady due to flight of capital to the US from the euro zone region enveloped in the sovereign debt crisis. No one fears a US default like some Latin American countries earlier. Very few are even willing to consider how the US is going to pay the debt. In fact, during the government shutdown in October this year, S&P did not change the county’s rating. Thus, gut feeling and sentiment can overwhelm scientific data. India is not in the same position as the US. It is still vulnerable to flight of capital, though the external debt, up 21.2% of GDP last fiscal from 19.7% in FY 2012, is considered modest compared with more than 100% of the Asian Tigers during the 1997 currency crisis. However, there is the bottoming-out effect. Trade deficit narrowed to a 30-month low in September 2013. The Reserve Bank of India has attributed the phenomenon to decline in imports of gold and robust exports. However, critics interpret it as fall in demand from industry due to slowdown and boost in realisation due to the depreciation of the rupee. Thus, data can be read both ways. It is likely that economic activity will revive in the next six months on continuation of the Fed’s bond-buying as there is worldwide consensus that an abrupt withdrawal can damage the global economy and recovery in the US and euro zone. The resultant surge in stock prices could be viewed as the percolation of the burst of recent reforms by the government or optimism on the prospects of a Modi-led government.