Before I get to the impact and opportunities from demonetization over short, medium or long term, I would like to put out 3 disclaimers:

  1. Disclaimer on demonetization: The last time we had such an event was in 1978. That was a time when there was no ATM, internet or online banking; there were no cell phones and real estate was not even considered an asset class and yet no one is really sure till date, of the real impact of that demonetization. In reality everybody giving out views on this is speculating a little bit. None of us have any precedent for this from the past.
  2. Short term Disclaimer: Nobody knows what the markets will do in a week, month or even a year from now. Any short term prediction is at best an educated speculation. Close your eyes and make 10 random predictions about 10 different stocks for the next 1 week. Give buy call on 5 and sell on the other 5. You will achieve a 50% success rate!! This is far better than a majority of analysts on the street.
  3. Disclaimer on Recommendations: Do not treat this as a buy or sell recommendation for future for the 2 stocks that I discuss below – Can Fin Homes and IDFC Bank.

In short term market sentiment plays a far bigger role than federal interest rates, China slowdown, oil prices, currency movements, U.S. election and all similar events. The current Demonetization is the perfect case in point.

There is almost a 100% consensus that demonetization is good for the economy, stock market and the country. Yet the market has fallen 5% since the announcement.

The truth is that every once in a while the markets run ahead of their valuations. Then they fall back when something big happens. Over the last 52 weeks, Nifty PE went over 23, three times. It fell back on each occasion for these reasons:

August 2015 – China Slowdown

February 2016 – Bank NPAs

November 2016 – Demonetization

If Nifty was trading below 19, it would’ve come as no surprise if the same demonetization took the Nifty higher by 5%. Valuations had to correct and so they did.

Earlier this week, I had written about the impact of demonetization on various sectors.

Read here: Demonetization Impact on Stock Markets

In this post, I will try to explain the opportunities from demonetization in the long term and also explain why short term predictions are a pure gamble.

Interestingly, the sectors that will benefit the most from demonetization in the long term are mysteriously suffering the most in the short term.

Case in point

Housing Finance – Can Fin Homes (in my portfolio)

Last Friday I said, “why should housing finance stocks fall? If they do fall – you should buy more” (link to that interview here).

Next trading day, Can Fin homes fell 20%. Exactly when it hit the lower circuit for the day, I sent out this tweet:

 

Over the next 3 trading sessions the stock ran up by over 20%. All this within a week!

Now look at this dichotomy – Investors in general are making up their mind about short vs. long on this stock. As a short term investor, you could have got swept in either tide.

The theory being propounded on Monday was that if house prices fall by 30-40%, some of the loans extended by housing finance companies will default. In this post, I have explained why the company will not default even assuming a correction of 30% in real estate prices.  On the contrary, In fact when house prices fall, companies like Can Fin benefit the most because house prices then come in the reach of a lot of salaried and first-time home buyers which is the biggest market for these companies. This expands their loan book. Its Growth!!

Selling this stock for the above reason on Tuesday was a foolish idea. House price correction is inversely related to the stock performance of these companies (unless house prices completely collapse).

And not just housing finance. Consumer electrical, FMCG and anything that requires discretionary spending will post bad results for Q3. Since nobody is buying anything. Here’s the thing – doesn’t everybody know that? Have the prices not already adjusted?

Yes and no. It will depend on street expectations vs. actual results and on the day of the results, stock may move up or down. This is where finance media can play a role in the short term movement of stocks. Further, if more money comes into the system (i.e. the banks) and if a lot of money gets extinguished, it will strengthen government’s balance sheet. Which could mean what?

– The government will have a lot more capacity to build roadsbridges and all sorts of infrastructure projects including power. So should you start buying your favourite infrastructure stocks? I have been buying power stocks for a few months now.

SO HOW SHOULD YOU TRADE AND SHOULD YOU DO NOTHING ON SHORT TERM NEWS ITEMS?

Certainly you should trade in the short term. This is where maximum money is made (and lost) and fast. But your rules have to be well defined. Here is what I follow:

  1. Short term Trading – In the short term (which for me is 1-12 weeks). Focus on 2 things:
    1. Overall market valuation – See discussion on Nifty valuation here. If it is trading unreasonable high, it is just a matter of time before it corrects. Good and bad news happens every day. This is unlikely to change.
    2. Corporate earnings – This is where analyst expectations matter the most. Assess what the results could be like.

Case in Point – IDFC Bank

IDFC Bank – a small bank which will benefit the most from the Demonetization move. The reason is simple- IDFC  got into banking only a few months back and went on an account opening spree. Suddenly all accounts which were barely maintaining the minimum balance will have at least 250,000 cash. Further, despite the long queues in most banks, IDFC bank given its low customer base is able to open new accounts even in this environment. In fact they open an account in 4 minutes! What results could they post for Q3. Think about it!

Read More: IDFC Bank (Stock of the Month) 

That said, it’s a little bit of a speculation as all short term assessments are.

  1. Event based trading – Whenever you trade on news specifics like the current demonetization news, what you are essentially doing is out-beating the thinking of others in a fraction of a few seconds or minutes. What happened to Can Fin this past one week highlights this perfectly. The noise of such news is so loud that at times you may get convinced by the one who shouts the loudest. Make your decision based on good analysis, yours or whoever else but speed will be the key.

As for current markets, here’s my view: