Can markets digest a large supply of stock issuances?

With the corporate tax cuts, the incentives that have been planned for export and housing benefits and the lower than expected income tax/goods and services tax (GST) collection, we might already be staring at a fiscal slippage of over Rs 50,000 crore.

Markets have turned a corner around recently. I had previously written that between January 2018 and September 2019, two stocks essentially drove more than the entire movement in Nifty (they contributed to 450 points of the total index movement of 350 points, implying that stock number 3 to 50 essentially resulted in the cumulative drop of 100 points in the National Stock Exchange's 50-share index -- Nifty).

The polarisation of Index was not only stark in terms of sectoral performance (with Consumption, Information Technology, and Insurance being the loved sectors, and Capital goods, Metals & Mining and Pharmaceuticals being the hated ones), but it was also visible within different companies in the same sector (mid-cap IT trading at single-digit multiples versus price to equity (PE) in high 20s for large-cap IT and so on).

Over the last two months or so, however, the index performance has been more broad-based.

More than 30% of the stocks in the BSE-500 Index have managed to outperform the index, and 15% have returned twice the index returns.

The September quarter-end results were marginally better than the subdued expectations we went in with, and there were more upgrades than downgrades in forwarding estimates within coverage companies of brokers. Markets are back to expecting high teen growth in the markets’ earnings for FY21, and year-end target for Indices suggest a decent upside.

Nevertheless, the true test of any bull markets is in its ability to absorb the new supply of paper that the government, promoters and selling shareholders are looking to offer. Here is where it will get interesting over the next few months.

The recent tax collection data of the government shows that we have reached 93% of the targeted fiscal deficit for FY20e within the first six months of the fiscal year itself. That, in itself, would not have been alarming (it might be difficult for the reader to digest that the six months’ deficit has routinely been over 90%), had the corporate tax cuts not been announced in late September.

With the corporate tax cuts, the incentives that have been planned for export and housing benefits and the lower than expected income tax/goods and services tax (GST) collection, we might already be staring at a fiscal slippage of over Rs 50,000 crore. This number assumes that the government will be able to raise Rs 1 lakh crore through divestments of various public sector entities announced by the government recently.

Including the slippage; we might well be looking at Rs 1.5 lakh crore of divestments in the run-up to March 2020.

Secondly, a lot of initial public offerings that happened by March 2018, the minimum public shareholding was not brought up to 25%, and they were given three years to do it.

In theory, many of them will have time to meet this requirement till March 2021; in practice, it is safe to assume that promoters will not wish to wait till the last month to raise capital.

We could possibly be looking at Rs 20,000 crore of those capital raises soon.

Lastly, many corporates are in the market to raise risk capital, in order to shore up balance-sheets given that the market going is smooth. That number in my calculation (when clubbed with stake sale by an MNC after the merger of its India business) could top Rs 50,000 crore.

Cumulatively, we might be staring at a supply of paper topping Rs 2 lakh crore. Compared to that, the average foreign institutional investor (FII) plus domestic institutional investors (DII) flow over the last decade has been just over Rs 80,000 crore, with the highest flows of Rs 1.4 lakh crore.

There is a serious chance that the supply of capital may fall short of its demand, thereby putting some pressure on the overall markets.

I started the article by saying that the true test of any bull market resides in its ability to satiate the demand for capital. From that standpoint, we are entering very interesting times in the next few months.

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