Vijay Kumar Gaba: March 2013

Thursday, March 28, 2013

The retail conundrum - IV

In past three days we have highlighted that the debate on indifference of household investors towards the publicly traded equity is not only inadequate but perhaps misdirected also. Our informal survey of some brokerages who primarily deal with household clients and many of their clients highlighted many structural and systemic reasons for their disenchantment with the listed equities.

In fact regulator and the government authorities took cognizance of some of these reasons in recent past, and we do have yet seen a few steps being taken. But we are still some distance from finding a sustainable cure the malice. Some of the reasons that we found are worth noting and act upon are listed below:

(a) In past two decade, since the capital controls were removed, listed equities have not been able to match the returns provided by traditional sources of investment like real estate and gold. A deeper study would reveal that the rise in market capitalization during these two decades is mostly due to rise in quantum of publicly traded equity rather than rise in earnings or PE re-rating.

(b) The mutual fund and insurance industry has grossly and consistently failed the investors in these two decades. Except for 2-3 fund houses, most fund managers have performed briefly and only during the bubble like conditions.

(c) Regulatory framework has evolved over past couple of decades and is robust enough to prevent any systemic collapse in the trade settlement. However, it has still not been able to effectively break the malevolent promoter-operator nexus, causing frequent cases of price manipulation.

(Source: InvesTrekk Research, BSE, World Gold Council, Value Research)

Tuesday, March 26, 2013

The retail conundrum - III

We find a strong equity culture amongst Indian households. However, factors like fewer employment opportunities, better business opportunities and dismal performance of publicly traded equity have led them to invest more in their own business and/or home equity rather than listed equity.

The need therefore is to reinvent the Gandhian model of socio-economic development by focusing on small household enterprise, rather than relying on Nehruvian model of unbalanced growth and development of large enterprise, that has mostly failed in promoting inclusive growth.

The debate on the household investors’ indifference to the listed equity would be incomplete and totally misdirected if we ignore the structural changes in Indian economy in past two decades.

In our view, post liberalization of trade and commerce in 1990’s, the number of self entrepreneurs has certainly increased in the country. This has coincided with the sharp fall in public sector employment. The aggregate private sector employment level has not been able to compensate for fewer opportunities available in public and unincorporated private sector. Consequently, the total number of employees on live payrolls has fallen sharply since early 2000’s.

The combination of two – lower employment opportunities and liberal business rules – has perhaps forced people towards entrepreneurship. The number of self owned enterprise has swelled in past one decade, implying people are investing in more in equity, but not in listed equity.

(a) As per 67^th round of NSSO survey (June 2011), there were 58million unincorporated enterprises in India (excluding agriculture, construction and those registered under Factories Act). Over 85% of these enterprises are run by the owner himself, without any hired worker. 44% of these were run from the residence of the owner. These enterprises employed 108mn people against just 39mn on the live payroll in organized sectors, including 11mn in private sector. (Source: RBI, NSSO)

(b) These self owned enterprises generated annual gross profit of Rs6283.56bn; whereas all listed companies in India generated gross profit of Rs610.44bn in FY12. 1/3^rd of this profit was earned by top 36 PSUs. Top 100 listed companies accounted for over 76% of this value addition.

The point we are making is that there is a strong equity culture amongst Indian households. However, factors like fewer employment opportunities, better business opportunities and dismal performance of publically traded equity have led them to invest more in their own business and/or home equity rather than listed equity. With most of your net worth in your business’s equity, you obviously need protection of gold.

(Source: RBI, NSSO)

Monday, March 25, 2013

The retail conundrum - II

We find that household investors had began meaningful investment in listed equity in late 70’s at the time of FERA dilution of MNCs. Reliance in 80’s and PSU disinvestment and capital market reforms in early 90’s drew the 2^nd lot of household investors. IT boom of late 90’s drew the 3^rd set to listed equity. In these 3decades households invested 8-17% of their financial savings in capital market related products.

Though the household financial savings started declining from mid 1990’s, 2000 was the key inflection point. Since then household have invested more in physical asserts than financial instruments.

Our informal survey of some broker and household investors highlights multiple reasons for this trend. Some key reasons suggested were:

(a) Fall in average age of house ownership. Higher income levels in urban areas, rise in nuclear families and rise in real estate prices has prompted people to buy houses earlier in their life cycle.

(b) Rise in personal automobile ownership.

(d) Rise in gold prices in 2000’s has definitely contributed to the trend.

With rise in urbanization and affordability, the trend is likely to exacerbate only.

Friday, March 22, 2013

The retail conundrum

Our study suggests that the disenchantment of household investors with publically traded equity has substantial implications for near and mid-term investment strategy.

The small informal survey conducted by us prima facie validates our belief. We however feel a larger study is needed to fully substantiate the findings and evolve a workable strategy for further development of capital markets in the country.

In past couple of years the government and regulators have been consistent in their concern about indifference of “retail investors” towards capital markets. Some part of this concern might be flowing from the de facto failure of almost all disinvestment floats since Coal India. The finance minister has initiated some nominal and mostly unsuccessful schemes to lure them back.

The background for this concern mainly is (a) rising investment in real estate, leading to overheating in some markets (b) persistent high investment in gold leading to rise in current account deficit, (c) failure of infrastructure companies in raising equity leading to lower participation in project bidding and (d) persistent redemption pressure in equity mutual funds and equity linked insurance schemes.

In order to make a factual assessment of the situation and assess the mood of the “retail investors” we carried out a small informal survey involving 32 brokerage firms and many of their clients.

It is important to note that we make a distinction between household investors and small day traders, traders, and speculators.

The key findings of our informal survey are as follows:

(a) We find that household investors had began meaningful investment in listed equity in late 70’s at the time of FERA dilution of MNCs. Reliance in 80’s and PSU disinvestment and capital market reforms in early 90’s drew the 2^nd lot of household investors. IT boom of late 90’s drew the 3^rd set to listed equity. In these 3decades households invested 8-17% of their financial savings in capital market related products.

(b) Post IT bubble burst, the household investors’ participation had been gradually diminishing and has become negative post 2009 for a variety of reasons. What we now have is mostly an assortment of small traders and speculators actively participating in daily market activity.

(c) In past three years the small traders and speculators have moved away from trading in listed stocks, especially small and midcap stocks. Some part of their activity has moved to commodities market where volatility is higher, and cost & margin requirements are lower. A large part of their activity has moved to option segment, mainly Index options. The option segment volumes now constitute over 80% of daily volumes at NSE, against 10% or less prior to 2009.

(d) Many people also cited rampant malpractices and gross underperformance of mutual fund and insurance fund managers as their disenchantment from listed equities.

(e) Surprisingly, most people we spoke to were completely indifferent to the tax incentive available for investing in listed equity and equity mutual funds. Also Contrary to the popular belief, the change in MF load structure had little impact on householders’ preference for equity mutual funds.

On digging a bit deeper, however we find a number of structural reasons that could be attributed to this shift in preference of household investors. In the coming days we shall be discussing some of these factors in detail.

Wednesday, March 20, 2013

The bugle sounded, but elections only in 2014

It had been our consistent view in past many months that the Congress is completely in election mode. They have a strategy and executing that well, so far.

The Congress strategy appears to be focused primarily on:

(a) Diverting the popular debate away from corruption and non-governance to economic (price rise) and social (food and women security) issues.

(b) Weakening NDA and work on reconstitution of UPA.

(d) Keep the government alive till May 2014, and demonstrate Congress’s ability to run governments in adverse conditions and wait for inflation situation to improve a little.

By completely ignoring the concerns of DMK on A. Raja, Kanimozhi and Sri Lanka, the Congress has endeavored to show distance from DMK and thus 2G scam. The other side of this coin could be an attempt to come closer to AIDMK whose leader has appreciated Narendra Modi but has remained non-committal on issue of joining NDA. Similarly, it has distanced itself from Jagan Reddy in Andhra Pradesh, but got promise of support from his mother.

Knowing well that Congress will have to choose between Mulayam Singh Yadav (MSY) and Mayawati before next election, they have been systematically increasing distance from MSY. Steel Minister’s recent statement should be seen in this context. The pictorial proximity to Nitish Kumar is also an attempt to create confusion in NDA’s rank.

There had been a concerted effort led by the finance minister in past 6months to present a reform oriented, progressive, and business friendly image to the media and the world. Sudden influx of youth leaders like Pilot, Scindhia on TV channels and media events, in conjunction with anointment of Rahul Gandhi as crown prince is aimed at conveying the message that the Congress has transformed and should not be judged by the governance record of past 10years.

Promise of support from Nitish Kumar, in lieu of Special Status would make sure that the government completes its full term. DMK withdrawal is inconsequential in that sense. Anyways, even if the government falls tomorrow, it might take 6months to complete the elections and form a new government.

Developments in 2G scam trial took an interesting turn with summoning of CEOs of some telecom companies in NDA period spectrum allocation case. The political ramifications of this will be known in next few weeks.

Insofar as the economic situation is concerned, we can expect it to worsen only, as the priorities of the government would be different in next 12months.

On a side note, RBI did what was most expected and said what is widely known. We regard this as another opportunity missed and see little impact on market or corporate bottom lines in near term.

Tuesday, March 19, 2013

It’s 3AM – too late to sleep and little early to wake up

While we are confident that next 6-9months will provide a great opportunity to build an equity portfolio that will outperform most asset classes in next five years, we continue to suggest investors should not lower their guards as yet.

The way the events in Cyprus (population 1.1mn and GDP USD28bn) have caused panic in global markets, shaving billions of dollar in asset value in matter of couple of days, it is clear that at the moment the global economy is nothing but “fragile”. The fabled economic recovery at best is shallow and confined to pockets.

Moody’s Investor Services yesterday said that China’s local-government financing vehicles face greater risk of default, as regulators warn 20 percent of their loans are risky. Australian and Russian governments are also facing serious fiscal challenges.

US Fed in the FOMC meeting beginning today is also likely to emphasize that the economic recovery is much weaker than anticipated and therefore stimulus needs to continue till the recovery shows some strength.

Indian government also appears to have resigned to the next general election. The almost threatening advertisement blitz by IT department indicates that the government is bothered least about business confidence as of now. Any businessman will tell you that no income tax refund has been processed in past four months and many of them have been arm twisted to pay higher advance tax.

NTPC and Coal India dispute is worsening, suggesting a summer of discontent ahead for power consumers. The discordant notes coming out from UP, Bihar, West Bengal, Tamil Nadu, Andhra Pradesh, Maharashtra et. al. are suggesting that not much efforts is being put in to building political consensus on critical economic issues.

The feeling we get rather points to an active effort by Congress Party to encourage the supporting parties to cause the government to fall so that they can claim the status of martyr and thus become eligible for a sympathy vote in next election.

The market is looking up to RBI governor for a rescue act. He may oblige by 25-50bps repo and even 25bps CRR cut. But at this point in would help only the struggling infra players and stressed SMEs to sail through the rough weather. It would not be a catalyst for igniting an investment cycle in the short term. Historically, a pre-election year does not see many large private sector projects getting initiated. Everyone likes to see the new government and their priorities before making large commitments.

On a satisfactory note, InvesTrekk model portfolio has significantly outperformed the markets in past two months. Our underweight equity, OW cash call has done really well. Even the big bet on gold seems to be turning positive. We are not proposing any change as yet. However, as suggested early this month we plan to restructure portfolio in next couple of months to factor in our macroeconomic and strategy view.

Monday, March 18, 2013

A man who would make you laugh like a child

Dr Kallam Anji Reddy, founder of Dr Reddy's Laboratories and a stalwart of Indian pharma industry in his own right passed away on 15 March 2013.

It is personally a sad moment for me. You do not meet too many people in life and come back thoroughly inspired. Five occasions I had the privilege to meet with this truly modest and humble son of an Andhra turmeric farmer, were some of the most memorable moments of my life – the moments which are firmly ingrained in your memory for life.

Though I would meet him as part of the team of private bankers that managed a part of his wealth, we never talked about money and investments.

The thing I liked most about him was his laughter. He had this amazing ability to laugh like a two year old child on almost everything.

He was always keen to know about the socio-political problems afflicting the country and how he could contribute his two cents to help the wanting. The meetings planned for 10-15 minutes all ran for well over an hour. On one of the occasions he even postponed his lunch to continue the discussions about education for poor girls I was mentioning to him.

After relinquishing his routine responsibilities at DRL, Doctor, as he was affectionately called, had devoted himself to a variety of philanthropic causes, including providing drinking water to rural areas and mid-day meals to school-going children.

Despite keeping a bad health, he was deeply involved and working hard on an Alzheimer drug for past many years. While his modest beginning, hard work, commitment to research and rise to the top rung of fiercely competitive and highly regulated pharma are all well known and documented, very few talk about his innocence and easily trusting nature.

Whenever he would come to Mumbai, he was nostalgic about his graduation days at Mumbai University, when he lived at small place in Matunga and had his food at famous Udupi kitchen near Mantunga railway station.

It may also be not well known outside pharma industry circles that Dr. Reddy Laboratories under his stewardship has produced many successful entrepreneurs who dot the pharma map in India.

For past many years, there had been rumors about him wanting to exit DRL, like Ranbaxy promoters. But he would always laugh out loud and say, “I take my medicines with my name written on these. Why would I want it any other way”.

As reported by a newspaper – “Life did full justice to his enterprising spirit — it threw several challenges his way all of which he gamely tackled. What stood Reddy in good stead were his incurable optimism, his passion, his trust-and-delegate management style, and his ability to continuously seek inspiration.”

Thursday, March 14, 2013

Seeking new horizons

As we adjust to a lower pedestal, new horizons would emerge.

The quintessential adjustment phase of the economic downturn is finally catching up. The signs are conspicuous.

Corporate

Companies are selling core assets, acquired in past few years with great hopes (e.g., GVK Australian Coal, GMR Singapore Power, etc.); airlines are cutting fares to compete with railways, hotels, automobile manufactures, realtors are offering humongous discounts to get rid of inventory; IT companies are delaying calling the new hires; telecom companies are not jumping over each other to capture airwaves; road projects that were awarded with exuberant premiums are getting cancelled; sports and entertainment events are finding it difficult to get sponsors; managements are working overtime in cutting corners to save margins.

Consumers

Consumers are not crowding the red sales; household budgets have reconciled to higher energy prices, rail fares, vegetable prices, service tax on every rupee spent and negative return on savings; savings are settling at lower level, and credit outstanding is rising as the spend on health and education takes a hit.

Government

The government has drastically cut budgets for its flagship Bharat Nirman schemes, MGNREGA etc.; taken many unpopular decisions in a pre-election year like raising rail fares, LPG and diesel prices, hiking effective tax rates for corporates struggling with down turn, etc.

Financial institutions

Usually, the financial institutions, especially those in public sector, bear a substantial part of the cost of adjustment. We have seen in past 5-6 quarters that the “restructured” assets of PSU banks have risen significantly. The banks appear to have adjusted to the reality of “restructuring” and hence are conserving capital (by lending less and selectively).

New horizons

Historically, the adjustment phase has always resulted in durable cost efficiencies, higher productivity, smarter consumption patterns, stricter lending norms, better compliance levels and reformed policy framework.

Material (esp. cement and metal) companies, large banks, consumer (both durable and staple) companies and IT companies have come out much leaner and stronger out of this phase.

As suggested earlier we are closely watching Hindalco, Tata Steel, UltraTech, ICICI, Voltas, Havells, HUL, Dabur, HCL Tech, Tech Mahindra, and Exide for signs of new rising.

Wednesday, March 13, 2013

Lead me to light

The market reaction to the news flow this week has been unwarranted though not completely unexpected; given the overemphasis on the expected RBI decision on policy rates in the next week policy review meeting.

In our view, the economic news flow, viz., February exports & CPI, and January IIP is important to take note but may not be acceptable as indicator to any change or reversal in trend. Moreover, the data was mostly on expected lines, except IIP which anyways is notorious for its wild gyrations and revisions.

The hypothesis that better than expected (though still extremely poor) IIP numbers and elevated CPI for just one month would impact RBI decision dramatically prima facie appears flawed. In our view, we are fast approaching the breaking point where RBI will have to save its concerns for inflation for a later date. The US Federal Reserve which was focused on inflation for many years is concerned about jobs only. They had the luxury of owning USD printing press. RBI could hardly afford any luxury. In our view, a repeat of 2009 is more likely in 2H2013, when RBI did cut relentlessly to support growth.

The following news flow has drawn our attention recently, which in our view ought to influence the policy formulation in coming years.

(a) As per a report in Business Standard many small and medium size pharmaceutical manufacturing firms located in Baddi (Himachal Pradesh) are facing the threat of closure. These units were lured into this location 10yrs back by tax concessions and capital subsidy given under special status state category. Despite huge influx of benefit seekers, the infrastructure in this area could not be developed. The connectivity remained poor. As the tax (Excise and income tax) concessions expire next year, many of the 250 odd units would be incurring losses and face closure. In our view, many industrial units in Kashipur and Rudrapur areas of Uttrakhand may also meet similar fate.

We feel, this should initiate a serious nationwide political debate over the efficient allocation of scarce resources vs. parochial regionalism, and even more important “enablement vs. provision”.

Gujarat model of development based on enablement has attracted more investment and hence created more growth opportunities, rather than the model based on “provision” adopted through special status mechanism. Nitish Kumar and Mamta Banerjee might have few tips to take from Baddi instance.

(b) Chinese government is reportedly considering scrapping some ministries, including the Railways, to check corruption. The Indian government may also want to examine this possibility.

(c) Yet another failed spectrum auction, CBI status report on Coalgate and changes proposed in defense procurement policy ought to lead to some structural changes in governance structure and make it more transparent and accountable.

Tuesday, March 12, 2013

Catch - 22

The current market conditions present a classic dilemma before the investors in Indian equities.

There are reasonable indications to suggest that the global equity rally may extend little further into the summer; and along with the Indian markets may also show strength. However, the trends in macro fundamentals of Indian economy are suggesting a likely deterioration as the summer heats up. The actual corporate performance might also be sub-par in next couple of quarters, leading to another round of earnings downgrades. Even if RBI cuts rates aggressively, it will take at least 2-3 quarters for it to reflect positively in earnings.

In this Catch-22 situation – the investors broadly have two options – (a) continue to remain underweight on equities; wait for the macroeconomic conditions to bottom out and show some signs of recovery; let this rally happen and fizzle out; or (b) participate in the rally by investing in selective stocks that may tangibly and/or sentimentally benefit from the recovery in global economy (mainly US and Japan) and therefore logically participate in the global markets led rally.

In our view, the investors should opt for the second alternative.

To implement this decision, it is important to understand the characteristics and direction of the global rally and identify the likely beneficiaries on the Indian shores.

We feel, the global economic improvement will be primarily led by (a) reduced level of stress in financial system (b) productivity gains through cost savings (mainly energy and wages), & technology innovations, (c) continuation of low rates & benign liquidity and (d) fiscal corrections (austerity in public spending and higher taxes).

These theme shall manifest, inter alia, in lower employment growth (more outsourcing), lower public spending (outsourcing of government jobs, lower defense and security, budgets, lower healthcare budgets etc.,), large scale migration to tax arbitrage jurisdictions (Singapore, Dubai etc.) lower consumption growth and new wave of manufacturing revolution in west triggering a price war with Asian giants like Korea and China.

Thus, the sectors that may lead the rally will likely be – US financials, EM ITeS outsourcing companies, EM pharma, technology innovators, Dubai and Singapore real estate, etc. The losers would include consumers, materials and low productivity manufacturers.

The key risks would include a serious global political crisis leading to failure of economic cooperation seen since 2008; elevated geo-political risks and security threats as defense budget cuts take place in US and Europe, leading to spike in energy prices; and major collapse in commodity world.

We add Voltas, Hindalco, Mind Tree, Siemens, to our Watch List disclosed last week.

We also propose to launch a model macro long short portfolio, with a12-15months time frame, on these assumptions from April 2013.

Friday, March 8, 2013

Who moved my cheese?

In past couple of months, our readers have raised more queries regarding currency than equities. The worries on current account are now universal, well articulated and well documented. The economic survey, RBI policy statement, budget speech, rating agencies’ reviews and professional economic and banking research analysts all have expressed concerns over the worsening current account and its implication for the Indian currency.

We have been regularly highlighting the structural issues that make the current account unsustainable. In our view, besides economic and market forces, the confidence of people in their own currency also impacts its value.

Empirically post 1998 we had witnessed strong Indian sentiments towards the rupee. The sentiment did reflect in substantial rise in NRI remittances, NRIs buying rupee assets, and significant rise in investment in real estate – despite all regulatory hurdles and administrative problems.

This trend has definitely weakened, if not reversed. The preference for USD and gold is seen higher as compared to INR amongst most professionals. The unskilled and semi-skilled labor is currency neutral as they continue to remit money to uplift living standard of their family back home. Besides they do not get much investment opportunities in the country of their work.

Many NRI living in US and EU are finding the local real estate more attractive than Indian properties.

Secondly, the energy revolution that is gradually developing in USA and Canada is attracting a lot of attention even from Indian entrepreneurs. The lure of cheap and sustainable source of energy may likely set the clock in reverse order – driving the manufacturing back to Americas. This could have serious implications for India’s trade balance.

- The technology and process knowledge transfer that had accelerated in past one decade may take a big hit as the manufacturing stays back or relocate to Americas.

- India’s endeavor to transform itself from supplier of raw material and low cost converter may face serious hurdles. Thus, the reliance on imports may rise, whereas the value addition in exports declines.

- The FDI flows might slow down further as new investment opportunities emerge in Americas.

- On the other hand the reverse FDI (Indian corporates investing in overseas ventures) may accelerate.

- The global carbon market may collapse.

- The industrial job growth and wages stagnates.

In our view, though it is very early to draw any conclusion from these assumptions, these cannot be dismissed as purely speculative. The investment strategy therefore needs to factor this in as a note of caution of at least.

Thursday, March 7, 2013

Hold your fishing rods

As suggested in some of our recent posts, we continue to believe that Indian economy and therefore the equity market may hit the rock sometime later this year. We may see a gradual recovery over 2014 and some acceleration in 2015.

The down leg of the economy in next six months would likely be led by fiscal tightening, fall in household consumption and savings, and deferment of investment plans.

Rise in consumer prices especially energy, election in key states followed by general election, still high fiscal and trade gap and fall in external demand due to fiscal tightening in US and EU, are some of the key factors that may support the downtrend.

Historically, the market has reflected the bottom in distress. Sale of core assets by the stressed corporates (already happening), large scale debt restructuring (we need to see some substantial write offs rather than cosmetic maturity extension), and capital restructuring to cleanse the balance sheets usually mark the completion of the process. Banks and the stressed sectors (infra, realty and power in current case), are invariably pushed to the wall.

We therefore see a repeat of 1998-99 in the markets, where the recovery will be led by the global economy and the companies that directly benefit from the global demand, especially US and Japan. We therefore OW IT and large pharma and suggest substantial UW on banks and stressed sectors. A normal monsoon and estimated US$10-12bn spending on elections in next 15months may support consumption demand, especially auto and staples.

Strategy

(a) Over next 6months gradually increase the weight of equity in asset allocation.

(b) Overweight exporters, especially IT and global pharma. Select auto and consumer staples may also be added.

(d) Keep a close watch on the stressed companies which have good assets. The completion of three phase restructuring as suggested above would definitely provide a decent investment opportunity in this sector.

(e) Some of the stock worth considering are:

IT and ITeS (OW): TCS, Mahindra Satyam, Hexaware, HCL Tech, Mind Tree, Polaris

Consumption (EW): M&M, HUL, Dabur, Havells, Exide

Pharma (OW): Dr Reddy, Sun Pharma, Glenmark, Lupin

Financials (Review): ICICI, Yes Bank, L&T Finance, M&M Finance, Manappuram.

Commodities (Review): Ambuja Cement, Ultra Tech, Tata Steel and Hindalco.

Stressed Companies (Review): GVK Power, NCC, IVRCL, JPA,

Wednesday, March 6, 2013

…and save my fears!

As discussed in yesterday’s post, the best case for Indian equities could be a selective rally, similar to 19

However, this rally should not sustain beyond a point in time, if the domestic economic conditions fail to show substantial pick up. This prompts some thoughts on the worst possible case.

In our view, the worst possible case for Indian equities could be as follows. It is important to note that this is not the base case for us, but nevertheless possible.

(a) The pre-conditions for emergence of green shoots of recovery that have been taking shape globally, especially in US and China, subside prematurely; leading to abortion of famous “great rotation”.

US spending cuts, scaling down of Chinese growth estimates, gradual unwinding of commodity trades, and 10% fall in US and German treasuries over past one week, suggest that nothing is a given as yet.

(b) The governments world over are mostly out of fiscal options. The EU, US, and Japanese central banks are determined to back stop any financial or liquidity crisis. However, post Italy election market reaction suggests that the Central Bank Put may not be as effective, especially in case of a political crisis. The much feared “currency war” which is mostly a political phenomenon, could become a reality should the EUR weakens substantially due to political instability, particularly in Southern Europe.

In this eventuality, there could likely emerge new points of vulnerability, especially in commodity world, e.g., Latin America, Central Europe, South Africa and Australia.

(c) Indian economy fails to grow beyond 6% in next two years, thus worsening the unemployment conditions, CAD grows as external demand shrinks, and lower investment keeps domestic supply conditions tight. WPI eases but the consumer prices remain elevated, preventing major monetary easing. Next general elections throw a fractured mandate with none of the two national parties going beyond 140.

(d) Corporate earnings stagnate for another 3years like FY09-FY11, and market gets

In this scenario, with Sensex EPS of Rs1300-Rs1400, market trading at trough period average multiple of 12x, the market will be stuck in 15000-17000 range for more than two years, with occasional violations on both the sides.

The worst case scenario in our view thus projects a scenario for Indian equities, where even the nominal 2008-2015 returns could be negative in absolute terms.

However, we may reiterate, this is not our base case outlook. We shall discuss the more likely (our base case) scenario in tomorrow’s post.

Tuesday, March 5, 2013

As bad as it gets

The union budget 2013-14 presented in the parliament today could at best be described as “short sighted”.

Problem identified

From the Economic Survey presented a day earlier, and the early part of the budget speech, it is very clear that the government has precisely identified most of the problems afflicting the Indian economy. Inadequate job creation, skill deficit, infrastructure deficit, current account deficit, fiscal deficit, declining savings and investments, slowing global growth, persistently high consumer prices, disillusioned youth, unsafe women and child, rising social and economic inequalities being the most prominent ones.

Besides, need for consistency and transparency in policies and tax administration are also emphasized.

No cure offered

The budget proposals of the finance minister however do not appear to be offering solutions. Budget just offers some increments in the allocations to the current schemes, which might be mostly inadequate.

To the contrary, the proposals seem trivial in many cases; introduce a fair degree of adhocism; and completely lack transparency especially in case of provisions that could have negative implications for the financial markets. For example, provisions relating to retrospective applicability of GAAR, taxability of entities investing through Mauritius route, higher tax on income for bond and income funds for individuals, 2% surcharge on MAT, etc. find no mention in speech.

Can kicked to July 2014

A second reading of the speech and budget proposal makes it clear that FM has probably presented this budget against his wishes, just to complete a formality, leaving the task of curing the ills plaguing the economy to the finance minister who will present the next full budget in July 2014 (assuming election will happen as per schedule in April –May 2014). The question is what happens if he remains the finance minister in July 2014? Remember what happened to CWG preparations in Delhi in 2009-10!

Gimme some hope!

Now that the euphoria over “Reforms” unleashed by the government after the incumbent FM took over last summer has yielded the way to “Reality” and the market expectations have been mostly aborted, we find it pertinent to find reasons to stay invested in Indian equities. The task is not easy, especially when you are standing at the precipice staring down at the abyss that lies ahead.

As highlighted in the yesterday’s issue of Morning Trekk, we do not see much reason to increase allocation towards Indian equities at this point in time. Nevertheless, the incorrigible optimist in us believe that the current economic phase will not lead to a structural collapse of “India Story”, and the next 5years will see Indian economy’s potential growth rate improving from the current 6-7% to 8-9%. Which essentially implies that over next 5years Indian equities might provide decent returns to investors.

Remember, the five year period between 2008-12 the benchmark indices have given negative (-)4% nominal return in absolute terms. Taking the impact of inflation and dividends, the return would be (-)30% negative.

In this background we tried to work out the best and worst case for Indian equities in next couple of years.

The best case

The best case for Indian equities in next two years would be that:

(a) The global economy stabilizes, especially US and China, leading to improvement in external demand environment;

(b) the benign liquidity conditions continue to prevail at least till end 2014, keeping the rates low so that investors keep chasing that extra few bps of yield thus sustaining the flows to India;

(c) the next general election in India produce a truly coalition governments where the constituents genuinely agree on a common minimum program and such CMP is implemented in right earnest.

The key risk in this scenario could be sharp rise in global commodity prices, especially energy that would strain the macro fundamentals of Indian economy further.

In this scenario, we could have a repeat of 1998-1999, where a large but selective market rally occurred in new economy stocks, following a global trend.

It is however critical to note that such a rally would be very selective and fizzle out as the valuations of selective sectors become excessive soon.

In this case the exporters, especially IT services and large unleveraged pharma companies could gain substantially. The austerity drive in US and EU may also support more outsourcing of public services to cheaper labor and demand for cheaper pharmaceutical products produced in India.

Monday, March 4, 2013

Markets to slither on the last leg down

Over the last weekend we read 47 budget analyses report, besides the one written by InvesTrekk itself. An overwhelming consensus appears to believe that this budget is inadequate; uninspiring; lacks innovation; and sets too ambitious fiscal target, especially tax collection, deficit and subsidies.

We may outline the likely economic scenario for FY14 as follows:

(a) We may not witness any substantial acceleration in investments during FY14. The fiscal constraints shall continue to constrict public investment, as evident from unimpressive provision for plan capital expenditure. Besides, traditionally no major private projects are initiated in a pre-election year, as the industrialist wait for the new regime to take place and announce their policies. The only area where investment can accelerate is the faster execution of work-in progress.

We do not agree with the opinions that extension of 80IA and introduction of investment allowance could be immediate motivating factors for investment in power and manufacturing sector. Rs100cr plus plant and machinery investment decision is different from buying in end of season 2day sale at a popular retail store.

(b) With no credible plan to check consumer inflation, deteriorating job outlook and lower subsidies, the resilience of consumption should also start withering.

(c) The fiscal tightness, higher consumer inflation, slower savings growth and lower industrial credit demand should continue to impact the money growth. The liquidity conditions should therefore continue to remain tight. The recent hike in deposit rates by banks is a clear indication towards this trend. Even if RBI cuts the policy rates by 25-50bps in next 3months, the short term rates may not react sharply.

(d) The volatility in Chinese data, persistently poor European economic data and recent US budget cuts shall add to the global economic woes. The external demand situation may therefore not improve dramatically in next couple of quarters. The current account and INR will therefore continue to remain under pressure.

(e) Under the circumstances the growth shall continue to remain below trend. Though the massive election spending in next 12months may add few basis points to growth, overall it may still be at the lower band of the projected 6-6.5%.

(f) We may soon see a fresh round of earnings downgrades, especially in banking and industrial sectors.

In our view, the market has definitely completed its up move that started last year. The down move has begun and shall strengthen in coming months as the markets corrects some oversold conditions and short sellers gain some confidence.