Wish all the readers a Merry Christmas and a Happy New Year.
I will be back with next page of my Diary on 12th January 2015.
Wednesday, December 24, 2014
2015: Market outlook...the battle continues
Thought for the day
"To succeed in life, you need two things: ignorance and
confidence."
-
Mark Twain (American, 1835-1910)
Word for the day
Rubricate (adj)
To mark or color with red.
(Source:
Dictionary.com)
Teaser for the day
By VHP definition all Pakistani and
Bangladeshi Muslims are converted Hindus.
Then why Bangladeshi Muslims are
illegal in India?
2015: Market outlook...the battle continues
On December 16, 2013 when I sat to write my outlook for
the year 2014, the conditions were mostly reverse of what we have on our
hand today.
In the eternal war between the forces of Fear and Greed, the
forces of fear then had exhausted most of their ammunition, e.g., EU
disintegration, Grexit, PIGS default, hyper-inflation resulting from the Mints
printing money incessantly, Iran reneging, Currency war erupting and
endangering emerging economies, hard landing of Chinese economy, etc. Whereas
the forces of Greed had just got fresh batch of ammunition – stable job market
in US, housing boom in UK and US, stable financial markets in EU, stronger USD,
Chinese growth crawling up, moderate or no inflation, US financials back in
business, lower commodity prices, US energy revolution, and mostly stable &
peaceful conditions in hot beds like Pakistan, Afghanistan, Iraq, Iran, Libya,
Yemen, Sri Lanka (except smaller pockets like Syria).
Filled by hope, the outlook for 2014 therefore was mostly
optimistic.
Sadly it is not the today. In a reversal, the forces of Greed
appear exhausted this time. The global scene has turned windy, wet and depressing
and narrative
has turned scary.
Moreover, the domestic scenario which was filled with hope a
strong government that will be able to deliver very fast on economic agenda, is
also circumspect. The PM, Narendra Modi, appears struggling to bring all his
supporters on the same page insofar as the priorities of the government is
concerned. At least in public discourse Feudalistic
idea of Nationalism seems to be dominating the socio-economic concerns.
Lack of ideas to implement the PM's vision of economic
reforms & development, poor
innovation skills, and extreme risk aversion amongst Team Modi is not
lending any credible support to the forces of Greed either.
The forces of Fear are likely to get fresh ammunition during
2015 when further – the disinflationary impact of stronger USD gains
strengthens its roots, US Fed begins to raise policy rates, EU and Japan
slither deeper into recession, commodity universe continue to sink and the
impact of fall in commodity prices begins to reflect on global financial
system.
Like before, many battles of this ongoing global war will be
fought in India too. Indian politicians continue to side with the Fearful,
providing them with enough ammunition and food to survive.
Inarguably, the investors’ sentiment at present is positive
about the cyclical recovery. But never in history the cyclical recoveries have
began with benchmark indices ruling close to their all time high levels and
bond yields also at such high levels. The current cycle could therefore be
short, shallow and volatile. Investor positioning and market internals are
clearly pointing towards that. The market implied volatility, volumes and
breadth continues to remain low. The volume concentration in top 15 traded
stocks is close to all time high.
My outlook for the Indian equity markets for 2015 is as follows:
(a) The marketplace
will witness an intense battle between the forces of Fear and Greed and in my
view, forces of the Fear will have an upper hand.
(b) 1H2015 may be
more volatile whereas 2H2015 will mostly be calm and cold.
(c) The market will
have more opportunities for traders than investors. The quality stocks may
continue to trade at exorbitant premium and therefore may not offer much in
terms of investment opportunity. The cyclical will continue to be confronted by
the prospects of weak recovery in at least1H2015 and hence continue to move in
a trading range with much higher volatility.
(d) There is little
chance of any material re-rating of Indian equities, so the return expectations
will remain muted in the range of 10-13%.
(e) The bond yields
may not correct much from the current level, as the fiscal pressure may remain
intact and global cost of capital rises.
(f) Save for a
drastic global event like Lehman collapse (not improbable), Nifty may move in a
larger range of 7420 - 9400. Strong trading buying and leveraging opportunities
will therefore emerge in to 7850-8000 Nifty range.
My strategy for 2015 will therefore be as follows:
Strategy: More trading needed to meet return target
·
Retain equity allocation to overweight.
·
Increase allocation to trading from present 10%
of equity allocation to 25%.
·
Target 15% absolute return in the risk portfolio
over next five years.
·
Normalize overweight on global pharma and IT.
·
Continue NIL weight to underweight on global
commodities.
·
Increase exposure to domestic Cyclicals,
excluding minerals and metals, in 2H2015.
·
Maintain overweight on domestic consumers
including consumer staples and healthcare.
·
Stay invested in longer duration debt.
·
Plan for lower tax benefits on financial
investments.
·
Avoid PSU in general. Selective policy neutral
companies could however be considered on case to case basis.
Tuesday, December 23, 2014
2015: Earnings picture still hazy, valuations not crazy
Thought for the day
"Apparently there is nothing that
cannot happen today."
-
Mark Twain (American, 1835-1910)
Word for the day
Beatific (adj)
Giving joy, blessing or
making exceedingly happy
(Source:
Dictionary.com)
Teaser for the day
Could VHP set the clock back insofar
as economic deterioration of India since 19th century is concerned?
2015: Earnings picture still hazy, valuations not crazy
"In economics things take longer to happen than you
think they will, and then they happen faster than you thought they could."
Rudiger
Dornbusch
The dictum of Rudi Dornbusch has proved itself time and again.
It is true for the present state of Indian economy and therefore corporate
earnings also.
The current consensus estimates for FY16 and FY17 corporate
earnings are running at 17-18%. Most of these estimates appear to be
discounting a sharper economic recovery in FY15-FY17 than what the actual
trends so far are showing.
To the credit of analysts, we have seen some serious downgrades
in past three months, the forecasts however still appear more optimistic. In my
view, it is a clear case of hope rather than data driving the analysis.
As per Credit Suisse research, so far, industrials and materials
have driven the downgrades. In fact, over the last two years, seven out of ten
sectors have seen net downgrades to their FY16 earnings.
On disaggregate basis, of late there have been suggestions that
while the commodity producers may see even sharper downgrade post 3QFY15
results, we may see upgrade returning to the commodity consumers, especially
consumers and automobile. The data for November 2014 has shown some promise
especially in core sectors. However, the recent commentaries of the managements
of sector leaders like HUL, Hero Honda, and Maruti is not very encouraging
suggesting a disconnect.
In my view, expecting any dramatic turnaround in at least 1H2015
may cause disappointment. Given the low level of capacity utilization and high
operating leverage, the outlook for revival of capex and therefore industrial
sector remains little hazy.
The financial sector has shown strong earnings growth in recent
quarters. However, doubts over asset quality cloud the earnings' profile of
most state owned banks and NBFCs.
In absence of a material growth in the demand, most of the
earnings growth appear to be coming from cost rationalization, lower finance
cost and expected better utilization.
In my view, we are not likely to see any major surprise on
earnings front during 2015. It will mostly be the continuation of existing
trend - marginal deterioration in 1H2015 and a gradual improvement in 2H2015.
I also do not see much probability of re-rating of PE multiples.
Though, the de-rating is possible, should the global risk aversion accelerate.
Monday, December 22, 2014
2015: Global narrative is scary
Thought for the day
"You can't depend on your eyes when your imagination is out
of focus."
-
Mark Twain (American, 1835-1910)
Word for the day
Larrikin (adj)
Disorderly; Rowdy.
(Source:
Dictionary.com)
Teaser for the day
Should the Representation of
the People Act, be amended to add the following ground for
automatic disqualification of elected representatives:
"If he/she stands or speaks in
the house without explicit permission of the presiding officer."
2015: Global narrative is scary
In past three months the global narrative has turned really
scary. I am sure, Santa this year will have a really tough time, for the number
of prayers are going to be much larger, louder and desperate.
I find myself thoroughly incapable in expressing the fear in my
own words, as I do not feel it with the same intensity, sitting at a distance.
I am therefore reproducing some popular sentiments.
China will be the focus of many, many boardroom discussions
around the world next year. Unlike most previous years, the topic won’t be
whether to double down on China—it will be whether to hold or even reduce
exposure to a particular sector or the country overall. With China experiencing
lower growth, greater competition, and more volatility, it won’t only be
multinational companies having these conversations. (McKinsey
& Co.)
A look at the long-term charts of the DXY Index shows just how
massive the potential reversal of this trend is; and based on Raoul’s roadmap,
the sheer size of the reversal gives us a strong hint of the degree of carnage
that will be wrought upon a world in which the dollar carry trade has reached
somewhere between $5 trillion and $9 trillion. (Mauldin economic)
Greece is back, front and centre — just as it was at the
beginning of the euro crisis in 2010 and at the depths of the euro crisis in
2011. The only difference is that now, after several more years of
depressionary policies have been foisted upon the people of that proud nation,
the likelihood of an establishment victory (and thereby a continuance of the
status quo) is far less than at either of those previous junctures. (Mauldin economic)
Do you want to know if the stock market is going to crash next
year? Just keep an eye on junk bonds.
Prior to the horrific collapse of stocks in 2008, high yield debt
collapsed first. And as you will see below, high yield debt is starting to
crash again. The primary reason for this is the price of oil. The energy sector
accounts for approximately 15 to 20 percent of the entire junk bond market, and
those energy bonds are taking a tremendous beating right now. This panic in
energy bonds is infecting the broader high yield debt market, and investors
have been pulling money out at a frightening pace. And as I have written about
previously, almost every single time junk bonds decline substantially, stocks
end up following suit. (The
Economics Collapse)
In the last two Absolute Return Letters I have argued why one
should expect global GDP growth to be below average over the next decade or so,
why interest rates should, as a consequence, remain low and why equity returns
should also disappoint. (Absolute
Return Partners)
In Europe, so far, Germany has been repatriating gold since 2012
from the US and France, The Netherlands has repatriated 122.5 tonnes a few
weeks ago from the US, soon after Marine Le Pen, leader of the Front National
party of France, penned an open letter to Christian Noyer, governor of the Bank
of France, requesting that the country’s gold holdings be repatriated back to
France; and now Belgium is making a move. Who’s next? And why are all these
countries seemingly so nervous to get their gold ASAP on own soil? (Grant
Williams)
In short, between Europe and Japan, thanks to the BOJ and ECB,
there will be literally no bonds that will make their way from the primary to
the secondary market! Which means only one thing: those looking for the marginal,
and only, source of high quality collateral in 2015, will find it coming right
out of 1500 Pennsylvania Avenue, NW in Washington. And that assumes, very
generously, that that other famous institution located on Constitution Avenue
Northwest doesn't come out of hibernation and resume soaking up collateral on
its own if and when the S&P500 finally corrects from its unprecedented, and
manipulated, bubble levels. (Goldman
Sach via Zero Hedge)
Off-shore lending in US dollars has soared to $9 trillion and
poses a growing risk to both emerging markets and the world's financial stability,
the Bank for International Settlements has warned.
The Swiss-based global watchdog said dollar loans to Chinese
banks and companies are rising at annual rate of 47pc. They have jumped to $1.1
trillion from almost nothing five years ago. Cross-border dollar credit has
ballooned to $456bn in Brazil, and $381bn in Mexico. External debt has reached
$715bn in Russia, mostly in dollars.
A chunk of China's borrowing is disguised as intra-firm
financing. This replicates practices by German industrial companies in the
1920s, which hid their real level of exposure as the 1929 debt trauma was
building up. (BIS
via Telegraph)
Do you remember seeing old pictures of the Great Depression
which depicted “lines?” There were two
types, bread lines and also lines to the front doors of banks. While we don’t see
any bread lines today, trust me, there are bread lines in every single state
and long ones at that. Nearly 50 million people in the U.S. survive on SNAP,
EBT cards or whatever they are called in your state. Can you imagine the
“confidence” it would instill if each day on your way to work you saw massive
lines of people waiting for breakfast? Or, when you came home from work you
turn on your television only to see long lines again, this time for supper? I
can see it now, some reporter out on the street giving us the “good”
unemployment, inflation or GDP news with a line of people in the background
waiting for food. My point? False economic news would be harder to “sell” and
even harder to “stomach” (pun intended). (Bill Holter in
Miles Franklin Blog)
It was during this period at the end of the 1960s and the
beginning of the 1970s that the Bretton Woods system of fixed exchange rates
was breaking down, with key developments in 1971 and 1973. There was much
academic debate over fixed versus flexible exchange rates. More economists
appeared to support fixed rates, but the other side had the advantage of being
led by Milton Friedman. As it turned out, however, flexible rates were not “chosen”
but were what was left when fixed rates collapsed. My take away from that
period most relevant today is that it is foolish to try to save a fixed
exchange rate after it has come under severe attack. I’ve heard talk all day on
the large amount of reserves held by Russia and whether they would be used to
defend the collapsing Ruble. In my opinion, that would be a total waste of
resources. The only cure for a Ruble down 50 percent is to let it go down even
more, until the market recognizes the undershoot. (Bob
McTeer)
Friday, December 19, 2014
2015: Rural income - no material improvement seen
Thought for the day
"Facts are stubborn things; and whatever may be our wishes,
our inclinations, or the dictates of our passions, they cannot alter the state
of facts and evidence."
-
John Adams (American, 1735-1826)
Word for the day
Chutzpa (n)
Unmitigated effrontery or impudence; gall.
(Source:
Dictionary.com)
Teaser for the day
By blocking business in Rajya Sabha,
is Congress vindicating BJP's behavior during 2004-2014?
2015: Rural income - no material improvement seen
Almost two third of the Indian consumers derive their livelihood
directly from the rural economy, including farming, horticulture, animal
husbandry, cottage industry, forestry, etc. The rural economy directly supports
a large number of industrial enterprise, like crop protection, farm equipment,
transportation, food processing, etc.; besides providing material indirect
support to industries like textile, consumer staples, durable, and services
such as financial services, trade and communication etc.
Anecdotally, we know that the health of rural economy is
important from political and fiscal perspectives also. Since independence,
problems in rural economy have invariably led to fiscal deflections and
political instability.
While the budget allocation to the rural sector has increased
steadily, the investment in the sector has been on the decline in past two
decades.
Source: Planning commission
Consequently, we have not witnessed any sustainable rise in
productivity. The agriculture sector growth had remained anorexic and highly
volatile in past two decades.
The rural income had however shown a tendency to rise in past
one decade due to a variety of factor, especially rise in rural wages, higher
support prices for farm produce, rise in demand and prices for animal produce, and
higher farm subsidies.
Most of these drivers have shown distinct signs of fatigue in
past couple of years. The recent commentary by most consumer product companies
suggests that this fatigue is for real and there are no signs of rejuvenation
as yet.
The government of the day has certainly won the battle at WTO by
ensuring continuing subsidy support to Indian farmers. But it might just have
weakened its position in the war against low productivity and structural
reforms in the farm sector.
Record global food production and the early forecasts of 2015 El
Nino conditions are also not helpful for Indian rural income in 2015. Lower
diesel prices is the just one major positive I can contemplate at this point in
time.
Thursday, December 18, 2014
2015: Household savings - lower inflation offers little respite
Thought for the day
"As much as I converse with sages and
heroes, they have very little of my love and admiration. I long for rural and
domestic scene, for the warbling of birds and the prattling of my children."
-
John Adams (American, 1735-1826)
Word for the day
Bespoke (adj)
Made to individual order;
custom-made.
(Source:
Dictionary.com)
Teaser for the day
Will someone tell HRD Minister that
"It is definitely not about your idea of "what is right for Indian
kids".
2015: Household savings - lower inflation offers little respite
In my view change in domestic savings pattern in past one decade
is cause of concern for Indian macroeconomic fundamentals.
Traditionally, domestic savings, especially household savings,
have been a stable and sustainable source of funding for both private as well
public investments. Though liberalization of capital controls has opened the
doors for foreign capital. It still is not a major source of funding.
Source: Planning Commission
More particularly, the decline in financial savings of
households that begun in early 2000's has accelerated in recent years. This has
serious implications for the economy and therefore equity markets.
I believe 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 2nd
lot of household investors. IT boom of late 90’s drew the 3rd 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.
The key cause for this trend could be listed as follows:
(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.
(c) Low growth in
white collar employment opportunities as compared to growth in workforce has
led to phenomenal rise in self owned enterprises leading to diversion of
savings to physical assets.
(d) Rise in gold
prices in 2000’s has definitely contributed to the trend.
(e) Persistent negative
real rates.
I do not see any reason why this trend will reverse in 2015. In
fact there are reasons to believe that household savings may diminish further
in next couple of reasons. For example consider the following:
(a) Consumer prices
for households will remain high. Expenses on items like education, health,
energy, transportation, communication, rental, protein, and fruit and vegetable
shall continue to rise disproportionate to rise in income. Hence the savings
may decline further.
(b) Implementation of
GST will reverse the wealth transfer for at least couple of years. Lower
revenue for the government, hence lower social welfare spending growth; higher
incidence of service tax; disruption of thousands of household businesses to
the advantage of large organized players; employment restructuring as
redundancies rise on a massive scale and skill requirement change.
(c) Factors like lower
investment growth, higher productivity gains through automation &
elimination of redundancies, restructuring of PSUs shall continue to impact the
employment growth, especially for skilled labor.
(d) Lower employment
opportunity may force more and more people towards self-enterprise, leading to
higher household debt.
(e) Given the
sluggish credit growth outlook for at least 1H2015, the deposit rate may
decline further, thus de-motivating higher savings.
(f) Last but not the
least, the trend for changes in consumption pattern shall continue. Bicycle and
Transistor Radio have definitely given way to motor cycle and smart phone as
essential marriage gift (dowry) in hinterland. The running expenses are to be
paid by someone after all - be it the bridegroom, his parents or the bride's
parents.
The economic growth will have to find an alternative source of
funding (no capital control) or a way to grow household savings (lower taxes,
higher rates, cheaper houses/rent, good public health/education/transport, and
farm employment).
I have not seen any proposal for either as yet.
Wednesday, December 17, 2014
2015: Investment cycle not seen reviving in 1H2015 at least
Thought for the day
"The happiness of society is the end of government."
-
John Adams (American, 1735-1826)
Word for the day
Fait
accompli (n)
An accomplished and presumably irreversible deed or fact.
(Source:
Dictionary.com)
Teaser for the day
The wheel turns full cycle. "The Parrot" to make its master sing
2015: Investment cycle not seen reviving in 1H2015 at least
Reviving the stalled investment cycle is the key to the myriad
of problems Indian economy is facing at this point in time, in my view. Simple,
as it may sound; this is the toughest challenge before the government, RBI and
the business community.
In my view, the investment cycle in India is stalled not just
due to normal economic cyclicality. It is congregation of a number of
socio-economic and political factors.
Mostly ignoring sustainability concerns, poor demand assessment,
political impropriety and banker-entrepreneur connivance have led to serious
misallocation of capital and piling up of unviable projects. Irrational and
random political resistance to foreign capital has also impacted the investment
environment in the country.
Y2K led global ITeS boom, easy credit led private investment
surge, Cheap Chinese import led consumer spending and massive government spend
on infrastructure funded by public sector and deficit financing created a
mirage of India shining. The unsustainable higher income-higher consumption and
savings-higher investment effect of all this reflected in data with a lag
during early years of UPA I regime (2004-2007).
The real problem however is that all this liberalization,
investment etc. was done (a) without creating any conceptual framework; (b)
without instituting adequate and appropriate institutional and regulatory
framework; (c) without addressing sustainability concerns; and (d) without making
appropriate financial viability study. This all led to:
·
Rampant corruption in public offices, as
allocation of liberalized national resources to private parties was left mostly
at the discretion of politicians;
·
Widespread obstructions and delays in execution
of mega projects as these projects conflicted with the sustainability objective
and environmental concerns;
·
Advancement of future investment demand impeding
financial viability of projects and creating massive stress in financial
system;
·
Decimation of domestic SME and household sectors
which could not compete with cheap Chinese imports leading to structural
pressure on currency; current account and general employment level;
·
Unmanageable rise in aspirations of youth
population leading to substantial changes in consumption patterns and thus
pressuring household savings and consumer prices;
·
Sharp rise in rural land prices making food
inflation a structural problem.
The consequences are:
(a) Most of the infra
developers and operators are facing serious credit worthiness issues. They are
not in a position to undertake further projects, while the existing projects
are either stalled midway or have become unviable due to a variety of issues.
It is important to note that many of these projects have been
unviable ab initio though few would like to admit.
(b) Banks are not
willing to extend further credit to core sector. The stated reasons are poor
balance sheet and financial unviability of projects. The unstated reason
include the fear and extreme risk aversion amongst individual bankers, which is
quintessentially an outcome of past excesses.
(c) Erosion of banks'
capital base is also a major hindrance in kick starting the investment cycle.
Fiscal constraints of the main promoter (the Government of India); persistent
failure in labor management (unions resisting diluting government stake) hinder
recapitalization of public sector banks.
On the other hand as I write this, a number of large corporate have
already reneged or are on the verge of defaulting on their covenants. The
amount of accommodation loans masqueraded as restructured loan to protract the
default technically are staggering.
A few balance sheets which are strong have the option to choose between
acquiring an operating or partially built asset at favorable terms or undertake
a green field project. To me the choice is but obvious. So how the fresh
investment cycle will get started?
Moreover, we are entering a phase when 2-3years down the line
easy credit situation prevalent in western world may cease. The cost of capital
will start rising for already troubled businesses.
The long term solution lies in opening the Indian markets to
open global competition. The government may provide support to businesses which
have demonstrated their capability to compete with global players. The
inefficient and incompetent should be allowed to fail.
In the short term however, the government will have to undertake
the onus of kick starting investment cycle on itself. The best way would be
create social sector infrastructure, e.g., education, skill development, water,
sanitation and healthcare. The government has rightly initiated some programs
in this direction. The faster and efficient implementation is the key.
Do not expect any meaningful investment happening in 1H2015.
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