The Australian Bureau of Meteorology and the U.S- National Oceanic Atmospheric Administration have issued a La Niña watch for 2016.
El Niño refers to the large-scale ocean-atmosphere climate interaction linked to a periodic warming in sea surface temperatures across the central and east-central Equatorial Pacific. La Niña episodes represent periods of below-average sea surface temperatures across the east-central Equatorial Pacific.
Extended and strong El Niño occurrences have generally resulted in deficient Indian monsoons and sharp drops in agricultural production. Conversely, La Niña occurrences have led to bountiful rainfall and large above average increases in agricultural GDP growth rates which have translated into above average GDP growth rates as well.
In order to alleviate rural distress, India needs bountiful rainfall, with proper spatial and temporal distribution. Consequently, a La Niña event could provide a major boost to consumption, investment and GDP growth.
Given the historically strong positive correlation between La Niña years and India’s GDP/agriculture dependent/rural sectors, Deutsche Bank Markets Research analysed more than 30 years (since 1980-81) of monsoon data and associated key economic indicators to assess the impact of La Niña. The conclusions:
- Bountiful rainfall in La Niña years.
Average annual rainfall in La Niña years (officially identified by the government - FY89, FY99, FY00, FY08 & FY11) has been 5.3% above long term average vs. a mean of 4.6% below long term average in non-La Niña years. The Indian Meteorological Department has forecasted 2016 monsoon rainfall to be 106% of long-term average assigning 94% probability to normal or above rainfall.
- Robust performance of rural economy.
Consequently, rural economy has also posted strong growth during La Niña years. For e.g. Agriculture GDP in La Niña years grew at an average 7.8% yoy vs. an average of 2.3% yoy in non La Niña years. In the past two years agriculture GDP growth has averaged an anemic 0.4% yoy on account of an El-Nino influenced drought.
- Food grain production growth in La Niña years averaged 9.6% yoy compared to an average 1.2% yoy in non La Niña years.
We also note that the positive impact of La Niña is amplified further if it is preceded by an El-Nino year, a situation similar to the current year. Based on long-term data of El Niño and La Niña events, there is significant statistical evidence of strong El Niños being followed in quick succession by a La Niña.
- GDP rises sharply in La Niña years.
The broader economic indicators i.e. GDP, private consumption and investments growth also exhibit similar trends in La Niña years, averaging 8.9%/7.4%/10.4% yoy growth - significantly higher than average growth of 5.8%/5.2%/7.2% yoy respectively in non La Niña years.
- Rural interfacing stocks perform strongly.
We have also analyzed the price performance of rural-interfacing stocks during the past three La Niña years (FY00, FY08 and FY11) and conclude that most rural-interfacing stocks provided strong returns in La Niña years.
- Positive performance is front ended to 1H.
As far as rural-interfacing stocks are concerned, the positive stock performance is largely front ended in 1H (Apr-Sep). This could be largely on account of an anticipation of good rainfall. However, several stocks tend to give up some part of 1H gains in 2H (i.e Oct-Mar). For e.g. M&M, Hero Motocorp, Shree Cement, Dabur, HUVR, Jain Irrigation, Coromandel have yielded following average returns in 1H and 2H of past 3 La Niña years: 25%/-4%; 16%/-15%; 73%/-23%; 42%/-12%; 17%/-3%; 31%/-4% and 85%/-13% respectively.
- Importantly, most of these stocks have sharply outperformed Sensex during 1H of past 3 La Niña years.
Asian Paints and Shriram Trans Fin have provided positive average returns in both the 1H and 2H at an average of 40%/7% and 36%/28% respectively, outperforming Sensex in both the halves.
In addition to the likely positive monsoon rainfall, the government’s renewed focus on rural India in the budget should compound the benefits. In the FY17 Union Budget, government had raised allocation to Ministry of agriculture by a sharp 94% yoy, while allocation to Ministry of Rural Development stayed at an impressive 4.4% of budgeted expenditure. There was also a clear thrust to rural infrastructure with allocation to the flagship rural road program budgeted to rise 33%yoy from Rs 142 billion to Rs 190 billion - the highest allocation under this scheme since FY12. The government also announced a 0.5% cess on taxable services for the welfare of farmers.
With rising likelihood of La Niña and an empirical record of rural-interfacing stocks performing well coupled with government’s renewed focus on rural India, we believe that following stocks stand out as key beneficiaries of an increasingly likely normal/above normal monsoon rainfall: Hero Motocorp, M&M, Dabur, HUVR, Bajaj Corp, Shree Cement, Ultratech, SHTF, Jain Irrigation, Coromandel.
The above is an extract from the India Equity Strategy report “Rising likelihood of La Niña: positive surprises ahead”, by Deutsche Bank Markets Research.
