Vijay Kumar Gaba: September 2016

Friday, September 30, 2016

Strategy

Thought for the day

"Gratitude is usually the secret hope of further favors."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Lodestone (n)

Something that attracts strongly.

Malice towards none

Everyone gets to retreat back to barracks.

Indian Army can claim "We did it". Twiterrati can finally rest claiming "we are great". Politicians can submit ATR.

First random thought this morning

None of the members of the family of Mr. Bansal were co-accused in CBI's case.

Why even after 2days no process has been initiated against the CBI officers who allegedly drove them to death. Usually an FIR for abetment to suicide u/s 306 IPC is filed immediately on the basis of suicide note.

Is morality again overriding the legality?

Strategy

Based on the assumptions highlighted yesterday (see here), other strategy inputs that I have been sharing with the readers from time to time through this column, and market performance of the 1HFY17, my strategy for 2HFY17 and FY18 would be as follows.

It is pertinent to note, there are some key changes with respect to currency and rate outlook mentioned in my last strategy outline (see here) shared with readers in April 2016.

The strategy

(a) In the past one year, the government has shown strong resolve to afford a good deal of autonomy to the public sector enterprises (PSEs) which have been performing well. However, this resolve is yet to be tested in adverse circumstances, e.g., fuel pricing autonomy if crude price rise above US$80/bbl; or autonomy to banks if political considerations require loan waivers or sale of sick units if unions oppose the move etc.

For now, despite sharp outperformance of many PSEs, I would continue to avoid them. The exceptions could be couple of large banks and couple of other enterprises that may become irresistible due to short term business opportunities. (The change is from complete "no go" to surgical strike.)

(b) Consumption will remain the dominant theme in my equity investment portfolio. I would continue to focus more on consumable services - especially health, retailing, entertainment, and financing.

On product side, I would continue to focus on aspirational products like lifestyle drugs, beer, premium liquor, household upgrade (lighting, tiles, plywood), luxury housing, premium automobile, packaged food (non-basic), etc. (No change in this.)

(c) Technology & pharma will continue to be core theme in the portfolio. Focus will remain on innovators, designers, and engineering services. I would mostly avoid body shops and pure generic plays.

(d) Will begin to accumulate capital goods players (ex power equipment) and only niche EPC service providers.

(e) Would like to maintain a 5yr duration in my bond portfolio.

(f) Prefer USD exposure over EUR and YEN

(g) Mostly avoid commodity producers except cement.

(h) Lower return expectation from equity portfolio to 9-10% plus 1% dividend yield from earlier 11-12% plus 1% dividend yield.

(i) Will continue to avoid SME segment companies a and focus on upper end of the market, mostly BSE200.

Will divulge more in my regular Samvat strategy note later next month.

Thursday, September 29, 2016

Assumptions for Strategy

Thought for the day

"We have no patience with other people's vanity because it is offensive to our own."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Eristic (n)

A person who engages in disputation; controversialist.

Malice towards none

How relevant are SAARC, NAM and Commonwealth in the present context?

First random thought this morning

Watched the video of presidential debate between Ms. Clinton and Mr. Trump. Three observations:

(1) None of the two candidates appear worthy of becoming head of the most powerful state in the world.

(2) The degeneration in the quality of the leadership might be reflective of the general state of American society itself.

(3) Whosoever wins, it will not make any difference to my life.

Assumptions for Strategy

Continuing from yesterday (see here), I may share with my readers the latest assumptions that would, inter alia, drive my investment strategy for next couple of years; and the key highlights of my investment strategy.

Assumptions

1. The monetary policy of most developed nations and meaningful emerging markets will continue to be accommodative till at least 2018; though there is no evidence available to suggest that BoJ, ECB, BoE, SNB, US Fed, PoBC and RBI etc. will need to materially tighten their monetary policy even after 2018.

2. US Fed fund rates may rise quickly and peak in 1.5-1.75% range by end of 2018. The benchmark treasury yields may have already bottomed and may rise to 2 peak in .75-3% range.

3. US GDP growth might peak ~2.5% by end of 2017 and decelerate thereafter as economic cycle sets in. India & China will continue to grow in 6.5 - 7.5% range supporting the aggregate growth for Asian region. EU, UK and Japan may continue to flirt with recession but may muddle through avoiding any major contraction.

4. Brexit may actually not materialize by the end of 2018. The uncertainties and delays might impact the business to some extent.

5. The global consumption of fossil fuels may continue to underperform the supply. Prices of the conventional energy may continue to remain around the current levels, or moderate a little more.

6. Global demand (both consumption and investment) may not rise materially to cause any inflation scare. However, inflation could surprise on the upside if currency & rate adjustments are not managed well and investors move in a herd away from financial assets and into physical commodities. Precious metals in particular may remain in favor.

7. Indian bond yields may bottom around 5.5-5.75% and stabilize close to 6.5%.

8. INR may move between 65-69/per USD. No devaluation either by China or India.

9. The capex cycle in India may finally begin between 2H2017 and 1H2018. Demand for capital goods, industrial credit and EPC services may see material improvement.

10. The consumption demand - especially luxury consumption, credit and construction material (cement, paint, tiles, sanitary etc.) - to become stronger. Residential real estate to bottom out and start picking up....to continue

Wednesday, September 28, 2016

Lower....sooner

Thought for the day

"The surest way to be deceived is to consider oneself cleverer than others."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Bon mot (n)

A witty remark or comment; clever saying; witticism

Malice towards none

War with Pakistan - Seriously!

First random thought this morning

If we go by the media perceptions - US citizens are faced with a dilemma of choosing the best from two worst presidential candidates.

If I have any idea about the psychology of an average American, expect the voters' participation to be extremely low. Yes, avoiding tough decisions to the extent possible is a common American trait.

Lower....sooner

Some of my readers termed my yesterday post (see here) rather alarmist. I think, it needs some clarifications.

If the contention is that I am hinting at a major correction (10% or more) in the benchmark indices in near term, I must say, that is not the idea. My simple point is that there are early signs of global flows turning erratic in next few months. This capriciousness of flows may cause market volatility to rise materially, which I do not like.

Nonetheless, intermediate corrections in a larger market trend are normal and desirable. As of this morning, I do see the current trend peaking within 3-5% of the previous Nifty closing high of 8997 and correcting 7-10% from there. Such a correction would be healthy for the market and an opportunity to increase equity allocation for investors. I shall be sharing my strategy for preparing for the volatility, correction, raising equity allocation and leveraging the portfolio in subsequent posts.

Now coming back to where we left yesterday.

In my view, The US Fed would need to hike rates not for any conventional reason, e.g., to tame inflation or cooling down the overheating economy. This would be more to help pensioners and bring down the prices of financial assets (stocks and bonds) in sync with the economic reality.

In past five years, Fed has erred materially in estimating the growth of US economy. The realized growth since 2011 has been almost 50% lower than the forecast. Now, the long term median real GDP growth forecast is below 2% against over 3.5% in 2011.

The corporate earnings have been broadly following the macro growth trend. As per some estimates, S&P500 profit peaked in September 2014 and has fallen 19% since then. However, S&P value has continued to rise through multiple expansion. Currently S&P500 is trading at ~25x or close to bubble territory.

Similarly, the rally in US bonds is also beyond rational explanation. With the shrinking tax revenue, rising fiscal deficit and burgeoning public debt, the yields on US bonds may have some solid reason to move up.

The full employment theory of some Fed members might only be partially correct. An overwhelming majority of new jobs are reportedly part-time and contractual. Besides, the denominator is the 4.9% may not be reflective of the true position of workforce. A large number of people are above 60yrs of age but still offering themselves for work. Secondly, there are many who are out of workforce because their skill sets obsolete.

I therefore believe that while the rate hike may be necessary to prick the bubble in the financial assets, the Fed may not be able realize its dream of 3% federal funds rate and 4-4.5% benchmark 10yr yields.

The normalization may occur at much lower levels and much sooner than most expect....continue

Tuesday, September 27, 2016

I do not like roller coaster rides

Thought for the day

"A wise man thinks it more advantageous not to join the battle than to win."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Albatross (n)

A seemingly inescapable moral or emotional burden, as of guilt or responsibility.

Malice towards none

Is India rushing too hurriedly into the Paris deal, or NOW is the time to do it?

First random thought this morning

A large majority of Indians seem unable to decide whether Indo-Pak rivalry is about religion (Hindu-Muslim) or about geo-politics. The perception about and the response to the conflict are therefore mostly confused.

An occurrence of violence evokes extreme religious fervor. An initiative for peace evokes even stronger response from the people living on either side of the border!

Let's first decide what we want - (a) Friendship (peaceful co-existence) ; (b) Enmity (perpetual war); (c) Reunion (Unification through agreement or force)

I do not like roller coaster rides

Irrespective of the state of indecision at US Federal Reserve, the market participants appear preparing for a December hike in policy rates.

There is enough evidence to suggest that the market is now finding the rate hike inevitable. It is no longer a matter of "if", but just a question of "when".

The flattening US yield curve suggests that bond holders are now beginning to prefer longer maturities believing that a hike by Fed hike is inevitable and higher rates will keep inflation under check over mid to long term. (see here)

Chinese authorities have approved trading in credit default swaps (CDS) for local debt. This shows that they accept much higher delinquencies in the local bond market as US rates begin to rise, causing pressure on consumer demand (hence Chinese exports).

The central bankers that have been big buyers of US treasuries, believing these to be the safest haven, have been on a selling spree in past few months. Chinese and Japanese central bankers have sold US treasuries consistently for past three quarters, a record selling spree. (see here)

The reasons for such selling could be multiple. For example selling could have been necessary:

(a) to fund the local fiscal deficit as oil economies and Japan struggle with growth;

(b) to fund the demand for outflow of capital (e.g., in China) as local economy struggle;

(c) to defend local currencies as exports slow down and USD supplies contract due to lower US trade deficit; end of QE program of US Fed and easing US fiscal deficit;

(d) to prepare a war chest, should a currency war is unleashed.

Nonetheless, one major reason is that US bond rally is seen coming to end with the Fed hiking rates.

It is noteworthy that while many Central Banks have lowered their US treasury stock, none has been reported buying gold aggressively. It is clear that central bankers do not anticipate any material rise in inflation in near to midterm as they expect that higher rates will stem any chance of inflation getting out of control.

The question before a tiny investor like me, who does not have any dollar asset, but is invested in equities of Indian companies that may have material exposure to USD assets, liabilities, revenue and/or expenditure, is what should be the strategy under the current circumstances.

In normal course a stronger USD, consequent to Fed hike, should not be a problem for me. However, given that Indian rate cycle may be diverging from the US rate cycle for a year or two, capital flows may become a major challenge. The volatility that may result from a sudden drying up or even reversal of flows would put markets on a roller coaster. I am too scared of such rides....to continue

Also read:

Another false alarm

Monday, September 26, 2016

Nifty: Breakout in October?

Thought for the day

"Why can we remember the tiniest detail that has happened to us, and not remember how many times we have told it to the same person."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Eutaxy (n)

Good order or management.

Malice towards none

Winter is certainly arriving early this year and promises to be harsh

First random thought this morning

Take one common person from the streets of Lahore and Delhi.

I will wholeheartedly support all war cries against Pakistani people, if any one of the studio experts, warmongers rallying at social media and feudal lords of Mumbai, could tell me any difference between these two persons.

Nifty: Breakout in October?

On past many occasions we have observed that the change in monthly average trading value is a useful leading indicator for Nifty movement in the coming month.

Any divergence in the monthly movement of Nifty and monthly average traded value is usually bridged in the next following 1-3months, depending on the movement in VIX.

If VIX also moves sharply with Nifty, then the divergence may take little longer to bridge. Otherwise, the convergence is seen in 4-6week period.

The following chart of Nifty movement since February this year shows that the convergence An analysis of past six months would show that the divergence is usually bridged in the following 4week period.

MTD in September 2016 Nifty has gained 1% from August closing, whereas the MTD average trading value is higher by 2% MoM. Presently the value of Nifty (8831.55) and monthly trading average for September MTD (8831.52) are the same. Any further correction in Nifty from here will lead to widening of divergence and improve the chances of a converging pattern next month.

I see the up move facing some resistance around 8866 level and a strong resistance around 8978-8999 range. 8774 is immediate support and 8630-8640 a strong support base.

A close above 8774 this month shall see Nifty breaking 9K barrier in next 4-6weeks and mark a new high, before a meaningful correction sets in.

As suggested last week (see here) Bank Nifty appears to be losing momentum. Watch closely for a weekly close outside 19560-20340 range to decide the next course of action. Near term banks are avoidable for trading.

Friday, September 23, 2016

Another false alarm

Thought for the day

"There are various sorts of curiosity; one is from interest, which makes us desire to know that which may be useful to us; and the other, from pride which comes from the wish to know what others are ignorant of."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Eponym (n)

A person, real or imaginary, from whom something, as a tribe, nation, or place, takes or is said to take.

Malice towards none

Tell me more about Brad Pitt and Angelina.

Fed, BoJ, Uri, Trump-Hillary, Cauvery, RBI et. al. can wait.

First random thought this morning

It feels miserable to hear some of the senior retired Army Generals sitting in TV studios and seeking a jingoistic response from the government to the cowardly terrorist attack on Indian Army.

These officers seem to be suggesting that for decades Indian Army has never retaliated to the unprovoked killing of our soldiers from the elements transgressing from across LoC.

This is totally unbelievable. Anyone who has spend even one hour at a border post would know that the Men posted there do not necessarily seek permission from New Delhi for responding to a fire from across the border.

Another false alarm

In past few years many experts have highlighted that the uncertainty and fear created by US Federal Reserve and its officials through their official and public utterances is causing more harm to the global markets than the eventual policy direction probably would. Through its latest statement also, Fed has left the markets guessing. Giving people on both sides of the line some reasons to be excited.

On the other hand the Bank of Japan (BoJ) and the European Central Bank (ECB) are not leaving anything to the imagination of analysts. They are consistently highlighting that the economic conditions continue to be challenging, requiring continuous monetary support. Both have pledged "whatever it takes" stance on almost every available opportunity.

The fourth large pillar of global markets - China, has never been vocal about its policy stance. However, it is seen that in past few years, the response of the People's Bank of China (PBoC) has mostly been reactionary - adjusting its policy stance to the stance of other global central bankers. Though the de-valuation of CNY has been a matter of concern for competing economies, of late not much noise has been raised over it.

Given the high degree of economic interdependence of US, EU, Japan and China over each other, anyone material divergence in monetary policy stance could cause potentially cause serious disruptions in global markets.

So leaving 25bps here and there, expecting any major divergence in next couple of years at least would not be reasonable, in my view.

The following three point that stand out unambiguously (from the point where I stand) from the latest policy decision of the Bank of Japan and the Federal Reserve of US may be noteworthy:

(a) The unconventional monetary policy tools being used by various global central bankers have mostly lost their effectiveness. Japan and most part of the Europe continue to struggle with poor economic growth and lack of inflation, despite near Zero interest rates and trillions of dollars worth of money printed and injected in the financial system since the last global financial crisis, popularly symbolized by the collapse of US investment bank Lehman Brothers.

(b) US economy appear stable, but not growing at desirable pace. In the absence of support from other larger economies like China, Japan and EU - the pace of US economic growth is expected to normalize much below the levels seen in past few decades. The "new normal", as some prefer to call it, is materially moderate than the historical averages. Whatever growth may come, it would be mostly through productivity gains rather than higher demand. The desired trajectory of Inflation therefore could be difficult to attain on sustainable basis.

Thursday, September 22, 2016

NDA may not be learning from UPA's mistakes

Thought for the day

"We would frequently be ashamed of our good deeds if people saw all of the motives that produced them."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Chimerical (adj)

Wildly fanciful; highly unrealistic, e.g., a chimerical plan.

Malice towards none

Now if the government has decided to change some conventional datelines, why not adopt calendar year as uniform financial year for businesses and the government. If for nothing else, for the sake of ease of doing business!

First random thought this morning

Rahul Gandhi says he neither believes in caste system, nor endorses it. Well if truly means it, it is quixotic.

In the current political context, especially in view of the forthcoming UP election where caste consideration are prominent in selecting candidates and whole electioneering process, if he wants Congress to make a fresh beginning by rising above caste based politics, it is truly chivalrous.

However, for a person aspiring to be PM of 125cr Indians, denying a deep rooted social system, just because past 100-150years have seen it being misused and manipulated for petty political consideration, could be an act misplaced enthusiasm.

NDA may not be learning from UPA's mistakes

The latest NSSO report on the Economic Census in the country raises a number of questions on the government programs, policies and priorities. For example, consider the following:

(a) About 96% establishment have less than 5 workers. Another 3% have 6-9 people employed. Only three states - Tamil Nadu (13.81%), West Bengal (11.07%) and Maharashtra (10.02%) have more than 10% establishment with 10 or more workers.

Most of the legislations relating to employment and social security provisions (ESI, EPF, Gratuity, Bonus etc.) apply only to the establishments with 10 or more hired workers. Implying that only ~1% of the total private work force is eligible for statutory social security benefits.

(b) Live stock accounts for 87% of the agri sector related establishments. The whole of it cannot be dairy farming.

The whole beef related controversy must be reassessed in this light. It may just not be a religious issue. It might have serious socio-economic and even political implications.

(c) Out of 1.87mn handicraft/handloom establishments, employing 4.2mn people, 79% were family affairs without any hired worker.

From my experience I know for sure that a large number of these establishments employ household children as workers.

In my knowledge none of the legislative provision or policies designed to prevent child labour and promote child safety and security deals adequately with a parent employing his child for his business, as the child is not a hired worker in this case.

(d) About 36% of business establishment were operated from the home of the Self Owner, while another ~18% are operated from outside the home without any fixed structure.

From my experience I know that most of these business establishments may not exactly be "authorized" from civic and town planning view point. This creates number of problems from everyone. Grocery and other daily need shops operating from homes; tailoring shops; automobile repair shops create nuisance for the neighborhood; pose environment and safety hazard; put pressure on civic amenities like power, water and sanitation; motivate corruption; and above all lead to serious problem of child labor, underemployment and disguised unemployment. Town planners, civic administrations, and government must recognizes & accept this phenomenon to find acceptable solutions.

(e) Retail trade (~35%) and Manufacturing (~23%) are dominant non-agricultural activities in the country.

Congress party positioned itself aggressively for FDI in multi brand retail without taking this segment in confidence and explaining them that it would lead to better employment opportunity for them; and lost elections. NDA is repeating that mistake....to continue