"If you're living in your time, you cannot help but to write about the things that are important."
-Ray Bradbury (American, 1920-2012)
Word for the day
Cavil (v)
To oppose by inconsequential, frivolous, or sham objections
(Source: Dictionary.com)
Malice towards none
If Arvind Kejriwal was the face of anti-corruption movement, Hardik Patel represents what?
The Strategy
As the world endeavors to slither out of the current economic crisis (that surprisingly many still believe to be caused by China) a new global economic order takes shape and India’s socio-economic transition to a truly federal governance structure that is transparent and accountable gets established over next decade or so, Indian businesses will face numerous challenges.
Historically, a large majority of Indian businesses have grown on government patronage and/or resource arbitrage opportunities and have been low on innovation, productivity and scale. The politically advantageous socialistic façade of the government, especially during 1950-1990 led to misallocation of resources, trade and capital controls, demand suppression, and protectionism that promoted low productivity. The conditions have changed in past 10-15years but not sufficiently to make a majority of Indian businesses globally competitive.
The following existing trends, which are quite likely to strengthen further in next few years, would suggest that a large number of small, over protected, less productive, uncompetitive, under-capitalized businesses should become extinct in next decade or so.
In past two decades we have seen this happening with small steel and cement plants, textile manufacturers, petrochemical plants, numerous public sector undertakings, NBFCs, etc. There is no reason why it should not happen to (a) small and mid-sized engineering and construction companies which purely survive on administrative patronage: (b) ITeS providers who are pure commodity plays solely focused on wage arbitrage opportunities; (c) mid-sized commodity producers who cannot scale up to compete with global corporations in a more open, price & quality competitive and transparent market; (d) intermediaries who are not adequately capitalized and technologically prepared to serve or compete with large global businesses which are highly price sensitive.
1. Despite a midterm down cycle in commodities, the cost structure of Indian businesses may remain relatively higher due to higher wage inflation, rise in effective tax rates, higher compliance (social, legal, environmental) cost, higher cost of capital and rise in cost of resources like land, minerals, water etc.
2. Given the non-linear growth in consumption demand, the investment demand shall rise faster, in a period when global cost of capital would have bottomed out and begin to rise. India has clearly missed the advantage which China enjoyed by investing and building huge capacities in an era of lower interest rates. This shall force us to be governed by the terms set by the capital providers, essentially opening our markets to global competition. A significant part of consumption business (auto, telecom, e-tailing, FMCG, etc,) is already owned by foreigners. Next phase of infrastructure development see entry of many global developer and contractors.
3. The global competition and rising cost should squeeze the margin and hence force the small and mid-sized businesses out of arena.
In my view, there is little opportunity in India’s traditional SME segment at this juncture. Only the businesses which have shown the capability to take the game in global arena look promising.
I therefore feel that it is pertinent to keep a watch on the periodic macro data. But it is often not appropriate to let these data lead a substantial change in the direction of investment strategy. A profitable investment strategy, in my view, needs to be based on medium to long term growth magnitude and direction.
Insofar as the current medium to long term growth trend in India is concerned, I believe, the trend growth decline that began from FY09 may not bottom before end of FY17, even if we accept the rather bullish estimates of government agencies.
The resumption of up move in medium term trend growth would only lead to a stable growth environment in the country and sustainable gain in equity prices, because a sustained growth over medium term would only-
(a) bridge the output gap and create demand for investment;
(b) lead to creation of productive employment opportunities;
(c) provide fiscal leverage to government for increasing social sector spending and thus increasing the sustainability of growth;
(d) lead to stability in prices as more capacities are added;
(e) lead to sustainable monetary easing as fiscal condition improves; and
(f) lead to rise in private income and savings, thus providing impetus to private consumption;
Too much reliance on savings due to lower commodity prices (especially fuel) in projecting mid to long term trends may not be appropriate.
In my view, the potential growth of India under current circumstances is not more than 6% (old series). Growing at 5-6% in the current direction would not lead to enough employment opportunities and strong consumption story will not remain sustainable. Agriculture, as we all know is still “God” driven. Basing an investment strategy on God’s will alone is not advisable in my view.
(Growth rate as per the old series)
It could be a matter of debate whether the current global economic down cycle will hit the rock in 2016 or the economy will continue to slither down even in 2017. One may also argue over the shape of the recovery, viz., it will be a ‘V’ or ‘U’ or ‘J’ or an “L’ shaped recovery.
However there could be little difference of opinion that the Indian economy would continue to struggle with below par growth through 2015 at the least.
Under the circumstances, for being relevant, any investment strategy has to be focused on the time horizon that looks at least beyond 2016 if not 2017.
I have therefore decided on the following construct for my equity strategy
(a) My portfolio is divided into two parts – (a) Core portfolio (67%) and (b) Tactical portfolio (33%).
The investee companies will be such that have demonstrated capabilities to remain relevant over many business cycles due to their product, market and technology leadership, strong financial position, lower beta to macro fundamentals, proven managerial capabilities.
The core portfolio is constructed with the longest possible timeframe and expectation of returns better than other asset classes, e.g., fixed income, gold, and real estate.
The tactical portfolio will have a time perspective of next economic cycle (likely 4-5yrs) with a little higher return expectation.
(b) I plan to construct my portfolio in over next 9months period.
(c) I will avoid commodities (except cement) and PSUs (except large banks).
(d) I will strongly focus on global competitiveness of the investee companies.
(e) Expensive midcaps are completely "No Go".
(f) Small cap is completely "No Go".
Insofar as the looming specter of rate hike by US Federal Reserve ("the Lift") is concerned - it is yet not a done deal.
The global economy in general and US economy is particular is not ready for it. In fact, there are argument for re-introducing QE and weakening of USD.
So I am not worrying about that as yet.
