Vijay Kumar Gaba: July 2014

Thursday, July 31, 2014

There are few things money can't buy

Thought for the day

” There are only two mistakes one can make along the road to truth; not going all the way, and not starting.”

- Buddha (563-483BC)

Word for the day

Flippant (adj)

Lacking proper seriousness or respect; showing inappropriate levity;

(Source: Dictionary.com)

Teaser for the day

What does our constitution says about functioning of Judiciary?

Does the spirit of constitution afford the executive the luxury of choosing judges of their liking?

There are few things money can't buy

A careful analysis of the incumbent NDA government (I actually prefer to call it Modi government for obvious reasons) would make it clear that the economic agenda of the government is laced with socio-cultural considerations. While it could be a matter of concern for some left inclined observers and economists, I do not find any element of incongruence in this.

I strongly believe that economic growth and development must be accompanied by socio-cultural uplift in equal measure. Given the poor human development index and socio-economic disparities in India, it is even more imperative.

My problem is that the agenda of government does not sound convincing to me. The programs outlined by various ministries and departments are merely sketches of technical and financial details. There is no hint of the resolve that the government or BJP leadership would need to catalyze mass social movement to achieve objectives like Ganga cleaning, general cleanliness, gender equality and women safety and dignity etc.

I firmly believe that no amount of money or administrative effort could achieve these objectives unless a large section of the people is mobilized to support the campaign.

Primary reasons for pollution of the holy Ganga and Yamuna rivers is discharge of unprocessed domestic and industrial wastewater, and other wastes into the river from the towns located along its banks. Big industries, Factories, Peoples living in colonies, slums and rural areas everyone pollute this holy river. Agricultural residues, insecticides and pesticides also contribute to the pollution of the river.

My experience of travelling along the banks of these river, from origin to dissolution, suggests that no amount of administrative control and regulation of waste could revive these rivers unless at least 400million people vow in the name of their respective Gods to keep them clean.

Similarly, no amount of Nirbhaya fund, special forces, special courts, and severe punishment can ensure equality and safety of our women, unless people at large themselves decide to shed their feudal instincts and prejudices against girl child in particular and women in general.

Building smart cities is a good idea. Making 100 of them is even great idea. But the government need to understand and accept that smart cities are not merely about technology and infrastructure. It is more about smart people who are dedicated to quality in life and fully compliant. I would like to know what effort government is planning to make people smart and compliant.

During a quick four hour tour of Delhi on Tuesday (during Eid, rains and traffic jams) it occurred to me that while most of the vehicle operators (including 2W, 3W, 4W) might have official license to drive, but very few of them might actually know driving. Operating a vehicle is not driving - to me it is common sense. Similarly, forming a government and becoming PM/minister is not necessarily leadership/governance.

My suggestion - we need both Gandhi and Patel. A little more Gandhi - who can engage billion people and lead their movements on the ground not on twitter alone.

Wednesday, July 30, 2014

This one may take some time

Thought for the day

”Three things cannot be long hidden: the sun, the moon, and the truth.”

- Buddha (563-483BC)

Word for the day

Euthenics (n)

A science concerned with bettering the condition of human beings through the improvement of their environment.

(Source: Dictionary.com)

Teaser for the day

Did Sonia Gandhi invite Narendra Modi for Iftar party hosted by her?

If not, does it bother you?

If yes, and Modi did not attend, does it bother you even more?

This one may take some time

The return on investment in publically traded equity is broadly a function of 3 factors (a) earnings growth; (b) changes in price earnings (PE) ratio and (c) dividend. Amongst these earnings growth is primary driver for a sustainable up move in equity prices. The higher PE ratio and dividend yield usually follow the higher earnings trajectory.

The 50%+ gain in benchmark indices since September 2013 is function of improvement in earnings profile of Indian companies and PE rating. However given that the improvement in earnings profile is still marginal and is not indicative of improved pricing power (better margins not because of cost control) higher RoE (higher creditworthiness) and RoA (better capacity unitlization), the PE re-rating could mainly be function of improvement in sentiments due to macro improvement (especially CAD, fiscal balance, INR stablization, and lower core inflation) and political changes, since September 2013.

The corporate fundamentals would need to show material improvement over next 9-12 months to sustain this PE re-rating. In my view, we may see corporate fundamentals improving over next 9-12months and market may continue to trade at current multiples over next couple of years.

Sunday, July 27, 2014

Alternatives becoming less attractive

Thought for the day

” Do not dwell in the past, do not dream of the future, concentrate the mind on the present moment.”

- Buddha (563-483BC)

Word for the day

Ardor (n)

Great warmth of feeling; fervor; passion

(Source: Dictionary.com)

Teaser for the day

All those who watched Salman Khan starrer "Kick" on weekend are still finding it painful to sit!

The movie is a part of Bhai and Nadiadwala's campaign against "sedentary lifestyle".

No pun intended.

Alternatives becoming less attractive

One of the primary conditions for a sustainable bull market in equities is relative lower expected return from alternatives like gold, fixed income, USD and oil etc.

In past six months return on Indian equities has materially outperformed gold, crude oil and USD. Considering that energy prices have remained mostly stable during recent war like situations in Ukraine and Palestine, and substantial rise in Non-OPEC oil supply in past couple of years, the general outlook of energy prices are not really bullish.

In view of the stability returning to global financial markets and US successfully unwinding its bond buying program, manly global brokerages like Goldman Sachs, SocGen etc. have extremely bearish outlook on gold prices.

The USD is becoming increasingly undervalued against most currencies. It is at a 40 years low on a real broad trade-weighted basis, it is not expected to appreciate in any big measures given that the Fed is suppressing real government bond yields through quantitative easing. Therefore, the USD will have to be more undervalued on a PPP basis to be in equilibrium.

Domestically, With the new benchmark yield on the 10-year government securities coming in at 8.40% per annum, compared to the prevailing yield on the existing 10-year at 8.69%, fund managers and bond dealers expect the rate of interest to come down in the next few months. Since several lenders benchmark their lending rates to the 10-year gilt yield, changes in this benchmark rate leads to tweaking in lending rates in the market.

Equities therefore offer relatively better return profile at the moment!

Friday, July 25, 2014

Greed overwhelming fear

Thought for the day

”It seems, in fact, as though the second half of a man's life is made up of nothing, but the habits he has accumulated during the first half.”

- Fyodor Dostoevsky (Russian, 1821-1881)

Word for the day

Farceur (n)

A joker; A wag

(Source: Dictionary.com)

Teaser for the day

Will the caged parrot make his master Sing?

Greed overwhelming fear

One of the critical condition for a sustainable bull market is the exuberance and optimism of investors and traders. Greed of investors and traders as defined by his eagerness to take higher risk for some extra return usually leads to PE rerating of the market. A greedy investor or trader ventures out of his comfort zone and explores newer opportunities. P&L, especially projected topline of P&L, becomes the dominant evaluation matrix against the balance sheet in fearful days.

I identify this market condition from sharp performance of smallcap and midcap stocks versus benchmark indices.

From this angle, we are currently deep into a bull market. Though by strict technical parameters, NIFTY is very close to overbought zone and is more likely to correct in near term. The risk reward from 1-3months perspective is negative at 5-1 (downside 500points for an upside of 100points). The small and midcaps could correct even sharply. However from 3-5years perspective the risk reward is extremely favorable at 1-8 (500pts downside and 4000points upside).

Broader markets substantially outperformed post May election results

Sensex PE getting rerated

Thursday, July 24, 2014

Low volatility - higher prices

Thought for the day

” There is no subject so old that something new cannot be said about it.”

- Fyodor Dostoevsky (Russian, 1821-1881)

Word for the day

Laden (adj)

Burdened; loaded down.

(Source: Dictionary.com)

Teaser for the day

Could the Maharashtra Sadan event have material impact on Maharashtra state legislative elections scheduled later this year?

Low volatility - higher prices

For a bull market to occur many pre-conditions need to be satisfied. Some of these conditions could be listed as follows:

(a) Lower volatility;

(b) Greed overcoming fear;

(d) Sustained improvement in corporate fundamentals, especially earnings growth led by pricing power (better margins not because of cost control) higher RoE (higher creditworthiness) and RoA (better capacity unitlization), and ability to raise funds at favorable terms;

(e) Stable macro environment

(f) Stable political environment

(g) easy liquidity conditions.

Lower volatility - Positive

Implied volatility as measured by India VIX has shown a strong inverse correlation with Nifty in past 6years. The current rise in equity prices is accompanied by substantially lower implied volatility. This suggest that the recent rise in equity prices is sustainable and has more strength to move further up.

Wednesday, July 23, 2014

Put money on the table

Thought for the day

” Deprived of meaningful work, men and women lose their reason for existence; they go stark, raving mad.”

- Fyodor Dostoevsky (Russian, 1821-1881)

Word for the day

Facsimile (n)

An exact copy, as of a book, painting, or manuscript.

(Source: Dictionary.com)

Teaser for the day

Is it right time for the Congress Party to transform into a federation of regional parties (Each state with its own Congress) versus a unified central command?.

Put money on the table

Investment strategy, like any other, requires clear definition of goals and timeline for achieving those goals. The goals need to be defined considering the likely challenges on the way to achieving such goals. Defining goals which are subject to even foreseeable eventualities would make strategy a sub-standard piece of mere academic interest.

For example, an investment strategy which defines its goal as "to achieve 50% return over next three years subject to geo-political concern in middle east, recurrence of financial crisis in peripheral Europe, slow down in Chinese economy, spurt in global commodity prices, and failure of government in managing consumer inflation and therefore persistent high interest rates, etc." has little meaning

In my view, none of these eventualities would qualify as an black swan event notwithstanding the severity of their occurrence. In fact, as I write this morning, I find that all these absolutely are within the realm of possibilities and may occur during next three years.

An effective investment strategy needs to account for all these and define the goals accordingly.

Insofar as my investment strategy is concerned - it may be explained in two sentences.

(a) Indian equities are in an uptrend that will last longer than any previous bull market. So I put my money on table.

(b) Over next five years my portfolio should give returns 10% higher than the nominal GDP growth recorded during that period.

This strategy accounts for all likely eventualities, including

(i) Rate hike by US Federal Reserve in winter of 2015,

(ii) Fresh cold war between US and Russia intensifying further with decibel rising to all time high level before 2016 presidential elections.

(iii) Frequent skirmishes in Middle East, and Pak-Afghanistan region as local forces compete with each other to capture the space vacated by US/NATO forces.

(iv) China and Germany escalating effort to enhance their area of influence over global economy and strategic affairs. Remember the first world war broke out exactly 100years ago on 28th July 1914.

(v) Inflation and rates persisting around current level for another year at least before showing a marginal tendency to come down.

(vI) INR weakening gradually from current level and therefore the imported inflation continuing to bother policy makers and consumers alike.

To reiterate, in my view, Indian equity market is now meeting most conditions required for a sustainable bull market. I shall deal with some of these in next few days.

Tuesday, July 22, 2014

Money debasement is norm, tighter policy exception

Thought for the day

”It is not possible to eat me without insisting that I sing praises of my devourer?”

- Fyodor Dostoevsky (Russian, 1821-1881)

Word for the day

Moniker (n)

A person's name, especially a nickname or alias.

(Source: Dictionary.com)

Teaser for the day

How Jaitley's "Growth for poverty" is different from Nehru's "unbalanced growth" model?

Money debasement is norm, tighter policy exception

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” - Milton Friedman

In classical economic theory inflation is always a monetary phenomenon. Seasonal factors or sudden supply shocks affect prices to a limited extent. Such instances of price rise are invariably temporary and self correcting.

In recent times, however we have seen multiple challenges to this classic economic theory of money and price equilibrium. Since 2008 most central banks, especially those in developed countries, have generally followed supper expansionary monetary policies.

Bank of Japan (BoJ) and European Central Bank (ECB) in particular have targeted higher inflation with unprecedented expansionary monetary policies. The effort so have yielded only marginal result. The inflation trajectory continues to remain much below the desired level both in Euro Area and Japan.

(Source: Ice Cap, shows money printed since 2008)

In Indian context, while money growth has remained high for two decades (M3 grew at 17.2% during 1991-2009), we have seen a distinct downtrend in recent years. Currently M3 growth stands close to 13%. In past few year, RBI has monetized just under one fourth of the fiscal deficit.

The price levels have remained stubborn despite tighter money policy. While the price rise could be partly explained by supply side bottleneck, seasonal factors, and global supply shocks due to geo-political concerns, the general rise in price levels over past one decade still needs explanation.

Consistent debasement of money has been a popular tool of successive governments in India. There appear to be no change in this policy paradigm, despite seemingly tighter policy followed in last couple of years. The stickiness of inflation needs to be seen in this context also.