Vijay Kumar Gaba

Gujarat

Friday, May 17, 2013

Hopes and fears coming true

The markets movement in India in past couple of weeks confirms that our hopes and fears are both coming true.

We had hoped that Indian markets will benefit from the global risk-on mood and participate in the rally that is conspicuously reminiscent of 1999-2001 global rally. The benchmark equity indices appear set to rise another 5% in this melee.

We had feared that the corporate fundamentals may not improve in any substantial measure and hence would only lend a feeble support to the rising valuations; much like 1999-2001.

It is important to note that whenever the long term market returns have significantly outperformed the earnings growth we have seen sharp corrections in the market.

(Source: BSE, InvesTrekk Global Research)

In our view, if the fall in commodity prices and cost of capital does not result in improved profitability over next 2-3 quarters and Nifty continues to trade above 6000 level, we shall see a substantial correction of 20-25% in equity prices.

The YTD weakness in commodities and AUD could be an early indicator of the coming pain in commodities’ world. We have heard some distress calls from Indonesia, Mexico, Australia, Russia, Brazil, and South Africa. Deepening recession in EU area and slowing demand in China indicate that this distress may only rise in the coming months.

So as we said a few days ago, do not be a party pooper, enjoy your dinner, but make sure you are not too late to return home. (Also read: Enjoy your dinner, but don’t get too late and …and save my fears!)

Thursday, May 16, 2013

QE a matter of fact, not going anywhere

It is important to note that “money” is different from “currency”.

Consider it like this:

For a theater that can seat 1200 people, if the owner prints 5000 tickets for one show – the “excess” 3800 tickets will have no value.

Similarly, if the central bankers print “currency” that is more than the amount required for transacting the real goods and services produced in the economy, the “excess” currency will have no value and hence it is not “money”.

The unprecedented bond purchase program of global central bankers, under various schemes and programs, collectively referred to as quantitative easing or QE, has been subject of intense debate in past four years. QE in instant case has two primary objective - (a) lend stability to global financial system which witnessed a complete collapse post Lehman Bros. bankruptcy in 2008; and (b) bring the global economy back to a sustainable higher growth path.

The stability witnessed in the global financial market in the wake of recent crisis in Cyprus does indicate to the success of QE program in bringing a reasonable degree of stability to the global financial system. However, the critics find it worth little use in promoting economic growth and hence call for its withdrawal. Any suggestion of withdrawal of QE usually evokes nervous response from investors.

In our view, QE is now a matter of fact and will remain so till it completely outlives its utility – not likely in next 3yrs at the least, most likely till the time EU economy shows definite signs of revival, Japan achieves its objective of creating nominal inflation in the economy and gets out of decades of stagnation, and global trade rebalancing especially in relation to China makes steady progress.

Insofar as the extent and impact of QE is concerned, there are many sensational reports doing the rounds. We would like to take a rather simplistic view of the situation.

We all know that currency is nothing but an “unsecured zero interest bond” that usually loses its value with the passage of time. Under various QE programs, central bankers in the developed world, especially US Federal Reserve (Fed), European Central Bank (ECB), Bank of Japan (BoJ) and Bank of England (BoE), have been exchanging interest bearing sovereign and corporate bonds with virtual currency – thereby augmenting the state income at the expense of fearful savers. If they are successful in creating acceptable level of inflation in the global economy, they will also make capital gains as the “currency” in the hands of savers depreciates in its value. Moreover, this has created artificial scarcity in the global debt market and hence allowing the governments to borrow at lower cost. (see here)

Those who fear “withdrawal” need to understand that QE is a goose that is laying diamond eggs (gold is not a good analogy these days) every day. Why would someone kill it?

For records, Cumulative bond buying since 2008 by four major central banks alone - the Fed, Bank of Japan, European Central Bank and Bank of England - reached more than $4 trillion this year. Added to existing holdings, that brings their total to $5.2 trillion.

With new Fed purchases of Treasury bonds set to top $1 trillion in 2013 and Bank of Japan bond buying more than half that amount, the year-end total will be about $6.5 trillion.

And as both the Fed's and the Bank of Japan's bond buying will exceed new bond sales by their governments by at least $100 billion this year, there will be fewer bonds around this year than last despite all the new debt sales.

Tuesday, May 14, 2013

Market comfortable with politics

Conventionally one would have expected higher volatility, jitteriness and weakness in the market given the political impropriety leading to legislative impasse and administrative inaction. However, the market has brushed aside most concerns and moved on.

We are however not surprised by the market’s reaction to the political events. We firmly believe that market is not indifferent to the political event and the collective wisdom has assimilated the political environment well. We believe that market is finding the political events constructive and medium to long term positive.

Insofar as the up move is concerned, it has two major drivers – (a) global positive sentiment towards risk assets, especially equity, and consequent larger FII participation and (b) bottoming of macroeconomic fundamentals, in particular inflation, rates and investment demand.

Domestic politics has little influence on global markets and flows. Macro fundamentals do get impacted by the efficacy or otherwise of the political establishment; and here in our view the market is deriving comfort from the recent events. In our view, the Congress party has strengthened its position in past few months and market is comfortable with that. For example consider the following:

(a) We had highlighted in one of our earlier reports that in our view the Congress party has well defined strategy and it is executing it well (see margin note). The recent instance of two ministers resigning on impropriety charges is yet another instance of impeccable execution of this strategy. The Congress party has emerged stronger after each such episode in past one year.

The Congress Party strategy, in our view:

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

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

(3) Present a transformed youth looking party image to people.

(4) Distance itself from the current government and all the impropriety charges it is facing.

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

(b) By electing Karnataka CM through secret ballot, the party has given a strong message of its readiness to accept greater intra party democracy, thus debunking a key plank of opposition.

(c) The party has successfully created a projection in media that incumbent FM Chidambaram is a likely PM candidate, thus diverting the focus from Rahul Gandhi. Our discussion with many businessmen and industrialist suggest that at this point in time many would prefer PC over Modi since they believe PC will try to improve the current system and hence execution will improve faster; whereas Modi would like to first change the system and that might adversely impact the execution part in the short term.

In view of this we suggest the following strategy:

(i) Avoid shorting the market. Though continue reducing/rationalizing equity positions at every rise. Global liquidity will likely remain comfortable, and PC will do better things to strengthen his position – do not position for a collapse in market.

(ii) The deterrent to corruption has also risen. Post Coalgate bashing, CBI would certainly try to redeem its pride. In our view, we might see many Bansal/Singla like episodes in next six months. That might create large bouts of volatility and provide better entry points – buy on days when sky appears falling apart.

Monday, May 13, 2013

No pain, relief or regret?

The cold response of household investors to the ~8% rally in Indian equities in past six weeks has apparently intrigued many pundits. The rally is characterized by persistently low volumes, poor market breadth, low volatility, implying total lack of greed or fear.

On the positive side, it implies that this rally may continue much further than most of us anticipate as so called weaker hands are not participating. On the negative side, it lacks any foundation and is always susceptible to a sudden crash like January 2008.

In traditional sense, we may neither call it “Pain Rally” – since no one was interested in investing even at lower level; nor it is a relief rally – since the mid and small cap stocks or laggard mutual funds with which household investors are still saddled have not participated much in the rally. Our discussion with some investors suggests that it is not even a regret rally – for those who sold stocks or redeemed their MF investments a few weeks earlier.

The so called retail investors have obdurately refused to participate in publically traded equities’ market in past few years. In particular, post 2010 the household participation in listed equities has declined sharply.

We had highlighted in our four part series on household investors’(see I, II, III, IV) the reason for participation of household investors (or lack of it) in stock markets. We do still not see them coming back in a hurry.

The surprising part is that this is not true only for a emerging market like India with all its imperfections and scams. Only 52% of American households now have money invested in the stock market, down from 53% a year ago and 62% five years ago. This is historically quite low.

(Source: Zero Hedge)

Read our special four part series on household investors “Retail Conundrum”

Friday, May 10, 2013

Enjoy your dinner, but don’t get too late

The feel good factor in global equity markets is going strong since past few months. India has also joined the party in past few weeks. Obviously no one would like to see a party pooper at this point in time. Nonetheless, there are some and investors would ignore them only at their risk.

The perennial party pooper Nouriel Roubini said on Tuesday that Stocks aren't in bubble territory as yet, but a "huge rally in risk assets" over the next two years puts markets in danger of a big crash.

But more notable is Michael Snyder of The Economic Collapse Blog, who is flashing the following dozen warning signals:

1. The price of copper has traditionally been one of the very best indicators of the future performance of the U.S. economy. It is down nearly 20 percent so far this year.

2. Home renovation spending has fallen back to depressingly-low 2010 levels.

3. U.S. retail spending is repeating a pattern that we have not seen since the last recession.

4. Manufacturing activity all over the country is showing signs of slowing down. In fact, Chicago PMI has dipped below 50 (indicating contraction) for the first time since the last recession.

5. In April, consumer confidence unexpectedly fell to a nine-month low.

6. NYSE margin debt peaked right before the recession that began in 2002, it peaked right before the financial crisis of 2008, and it is peaking again.

7. The S&P 500 usually mirrors the performance of Chinese stocks very closely. That is why it is so alarming that Chinese stocks peaked months ago. Will the S&P 500 soon follow?

8. The economic data coming out of the Chinese economy lately has been mostly terrible.

9. Things just continue to get even worse over in Europe. Unemployment in both Greece and Spain is now about 27 percent, and the unemployment rate in the eurozone as a whole has just set a brand new all-time record high.

10. Crude inventories have soared to a record high as demand for energy continues to decline. As I have written about previously, this is a clear sign that economic activity is slowing down.

11. Casino spending is usually a strong indicator of the overall health of the U.S. economy. That is why it is so noteworthy that casino spending is now back to levels that we have not seen since the last recession.

12. The impact of the sequester cuts is starting to kick in. According to the Congressional Budget Office, the sequester cuts will cost the U.S. economy about 750,000 jobs this year.

In our view, investors may enjoy their dinner, listen to party poopers and decide when to return home. Make sure it’s not too late.

Read our special series Mandate 2014

Gujarat

Thursday, May 9, 2013

A Wednesday

Thi khabar garm ke Ghalib ke urenge purze, Dekhne hum bhi gaye the per tamasha na hua. – Mirza Ghalib

(The buzz was that I will be publically thrashed today; I also went to see the drama; but nothing happened.)

Wednesday 08^th May 2013 was widely touted by media as super Wednesday. Karnataka assembly poll results and Supreme Court’s hearing on CBI’s affidavit in Coal Block allotment case were widely seen as critical for the political establishment of the country.

However, as it turned out, nothing happened. Karnataka poll results were exactly on the lines we expected. BJP lost. Congress did not make it big. B. S. Yeddyurappa made ignominious exit. Supreme Court censured CBI but spared the political bosses.

Stock markets ignored both the events and moved on. Companies with good results (e.g., HDFC, Lupin) gained; and those giving bad numbers (e.g., Ranbaxy) were punished. A normal day, prima facie.

At least five disturbing trends continued unabated, namely-

(a) As we highlighted in our earlier report, corruption was absolutely a non-issue in the Karnataka election. Despite serious allegation on Law and Rail ministers just days before the elections, Congress won comfortably; especially the urban voters backed the party. Kumaraswamy of JDS who was ousted last time on serious corruption charges gained the most in terms of seats. BSY got sufficient votes to ensure BJP’s rout.

(b) Media vigorously debated the SC order the whole day with many “intellectuals” generously contributing their wisdom to the debate. No one, yes no one, not even once mentioned the name of Anna Hazare, who in his Jan Lokpal Bill had suggested an effective solution for the malaise SC is trying to fix in Coalgate.

(c) SC did come down heavily on CBI in the extant case. But this situation could have been avoided if it had taken suo moto cognizance of the allegations made publically (in and outside the Parliament) by the SP and BSP leaders about misuse of CBI to pressurize these parties to support the UPA II government.

(d) The government showed total disdain for people; refusing to react to the SC observations and concluding the Lok Sabha session ahead of schedule.

(e) The opposition has no plan to request a special session of the Parliament to bring “no-confidence vote” or “impeachment” motion against the government/PM/Law minister.

In our view, the market would be happy if early elections are called, as this government would not be able to transact any legislative business in remaining term and bureaucracy will not cooperate in carrying out the administrative business also.

As for today, expect the market to largely remain unaffected by what happens in Delhi.

Read our special series Mandate 2014

Gujarat

Wednesday, May 8, 2013

Mandate 2014 – Gujarat: Alcohol, Indebtedness and an Avatar

We started the second phase of our “India Journey” from Gujarat. Our team travelled to 11 districts across South, Central and Saurashtra regions of Gujarat.

In our numerous interactions with people in past year or so, we found that mere mention of word “Gujarat” is enough to instigate a debate. Not surprisingly, most urbanites across the country have strong views on Gujarat. Though the opinion is divided on the candidature of Narendra Modi for PMship, majority of people outside Gujarat have a positive perception about the Gujarat growth model. We therefore kept our focus on the socio-economic conditions of Gujarat and what that could mean for India in coming years. Politics inevitably intruded in discussions.

The key findings of our Gujarat trip were as follows:

(a) The most striking observation was the huge socio-economic disparities especially in semi-urban and rural areas.

People suggested that a large part of prosperity in past two decades has come primarily from two sources

(a) economic boom and bust in developed world that has seen substantial rise in remittances from prosperous overseas Gujarati community; and (b) Narmada water that has resulted in higher agriculture growth and astronomical rise in land prices.

Consequently, it has not led to commensurate employment growth and therefore a large part of the population has not participated in the growth.

(b) However, the real surprise was that the rising disparities in Gujarat are motivating the underprivileged people to do well, unlike Karnataka and Maharashtra where it is resulting in disillusionment and unrest. The key difference in our view is the leadership.

(c) Due to enterprising spirit, the household leverage, especially amongst middle and lower middle class is high in Gujarat. “Cash lending” market is vibrant and exploitive.

(d) Most in Rural areas, believed that their Chief Minister is blessed. More than two third believed that the change in weather pattern (more rains, less dust storms) is due to CM only. So much so for the “Gujarat Economic Model”! Exit of Modi from Gujarat may not be seen favorably by rural voters.

(e) We discovered that alcohol business in the state is managed by one of the best supply chains in the country. Global universities which found Mumbai Dabba wala model interesting would be surprised by this, perhaps one of the largest undercover supply chains in the world. RBI trying to curb gold import may also take a lesson from this.

(f) The communal divide is deep in almost all areas. Contrary to popular perception, people believe that but for Modi, the state would have had seen many more riots.

Next week we shall travel to Rajasthan and UP.

Read impressions of Phase I of the tour:

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