April often turns out to be a pivotal month for stock markets. The start of new FY brings in fresh reason and momentum, with the earnings of the last quarter of the previous financial year also flowing in. But, it is also when the inflation narrative takes shape and it starts with monsoon predictions coming in. April, hence, shapes investor expectations with respect to RBI rates, deficit and oil, rupee, exports etc. but often, all an investor sees is a cobweb of intricately connected events and mumbo jumbo, with few forthcoming investment signals. How do we make sense of this?
First things first. Why is the monsoon important to us?
Seen purely from an output point of view, agriculture has become less important over the years as our services and manufacturing sectors have grown. Farm and allied sectors contributes 15.87% to Gross Added Value (GVA), which pales in comparison with the services sector which accounts for 54.4% of total India’s GVA of 169.61 lakh crore Indian rupees. However, Over 60% of the population is still dependent on agriculture, making it a sector of priority. And 50 % of the farm output is contributed by the kharif crops like rice, cereals, sugar, cotton which are cultivated during the south west monsoon period (June to September). According to NITI Aayog, out of approximately 160 million Ha of cultivable land in the country, only approximately 65 million Ha (41%) is currently covered under irrigation. The area under micro irrigation is only 8.6 million. This explains the importance of monsoon rains. The monsoon replenishes over three quarters of country’s major water reservoirs, which facilitates not only irrigation but also drinking as well as power generation requirements. Nearly 75% of the annual rainfall occurs during the monsoon season confined to the southwest monsoon period.
It all starts in the Pacific.
A crucial element in the south west monsoon predictions in recent years, is the surface temperature of the waters of the equatorial Pacific Ocean. El Nino, the condition of above normal temperatures in those waters, has the potential to create strong changes in wind speed and direction, bringing in unpredictability to monsoons. This April, the Pacific was found to be warm, but the weather forecasters sees lower risk of El Nino as they expect El Nino conditions to weaken after summer. Indian Meteorological department says that the southwest monsoon (June-September) is likely to be 96 percent of a long-term average. Earlier on April 3rd the private forecaster Skymet Weather Services announced below normal monsoon for 2019.
How accurate are these forecasts?
Last year, India received 91 percent rains, as against the forecast of 97 percent of the long period average (LPA). There were extremes too. The north eastern region received 78 percent of the LPA as against the predicted 93 percent, while regions like Kerala received unprecedented rainfall, leading to floods. A Mint report identifies “three areas which needs significant investments, without which India’s weather prediction capabilities will remain poor. These are frequent supercomputing upgrades, increase in weather observation data, and a significant boost in scientific manpower. And these are the three verticals that most foreign nations are working on since long-range weather prediction has now acquired strategic value.” In other words, weather or climate forecasts are not just a means of knowing whether to take your umbrella on your way out, but is a matter of national security, food security, triggers for trade agreements, ideas of investment for big corporations, etc. or even for ICC to decide when and where to conduct a global cricket tournament like the World Cup, so that its investments do not get washed out by excessive rains or heat.
How does stock market react?
When the forecast is for a poor monsoon that stock markets will correct, attempting to price in the crushing blow to economy and growth. But this is not often as straight forward as one would think.
Firstly the quantum of rainfall as projected by the forecast which is a percentage of a historical average, is not as much important as the distribution of rainfall. This means, that even with a below normal forecast, it is possible that the cultivated areas could still receive ample rainfall. This would mean that stocks market which might have fallen anticipating the worst will climb even faster as soon as it gets the wind of such data. And any government spending which might have happened anticipating weak farm output, could add momentum to such pull back. Let us now see where the expectations are, because that is where the money is. Expectations of two rate cuts were being priced in prior to April, riding on the declining inflation. But yields of India’s most traded 2028 bonds started advancing after RBI announced on April 4 that it would be retaining a neutral policy stance. With uncertainty still surrounding monsoon, the rate cut visibility stands reduced, especially with oil continuing to be firm. But it is worthwhile to note that oil’s rally has persisted for the last four months and has scaled over 64% from the 2018 lows, suggesting that the odds are more in favour for a pullback in oil.
The usual understanding is that a poor monsoon weakens demand for two wheelers, FMCG, tractors etc. and also banks to some extent on account of pressures on loan waivers. Let us take the example of FMCG sector. Recently several of the FMCG companies have indicated that the demand is already weak. Price wise, it has been laggard, registering a measly gain of 0.6% as against an 8% gain for the benchmark Nifty index during last 60 days. In other words, even if monsoon pans out to be poor dragging Nifty lower, FMCG may not yield much. Additionally, since inflation has been benign in the last quarter, input costs have been largely softer. In other words, margins are under no specific pressure, and are poised to expand, if rains do not disappoint. Or Let us assume that rains do disappoint and oil continues to climb. Even then there is a winning scenario, some of the FMCG names which have exposure in the Middle East and North Africa region stands to benefit from oil-led rise in demand in those regions.
In short, all these inflation themes are saddled with investment opportunities. Move over elections, let me enjoy my rains.