Vijay Kumar Gaba: March 2020

Tuesday, March 31, 2020

Nifty Scenario for March 2021

FY20 is the worst financial year since FY09 in terms of year on year Nifty returns. Nifty lost ~25% of its value during the year. Most of these losses have come in past one quarter (Q4FY20), during which Nifty lost close to 30% of its value.

In my view, considering the present circumstances and indications visible presently, the earnings and economic growth outlook remains heavily clouded for next 2-3 quarters. Thus, there are chances that the calendar year 2020 may turn out be a disappointing year in terms of equity returns.

Working on various scenarios for the Nifty levels one year from now, I concluded that Nifty may return 5-8% in next 12months considering flat earnings growth in FY21 and 10-15% growth in FY22; and valuations close to long term average of 17%. I appreciate that 10-15% yoy earnings growth in FY22 appears quite challenging in the present conditions. However, considering the lower base (no growth for 3years) and economic recovery due to easy monetary policy and lower effective tax rates, I am willing to work with these assumptions.

For March 2021, I assume the worst case Nifty level of ~6900, a most likely level of 9100 and a best case scenario of 11500. I am not ruling out an interim fall in Nifty to sub 6000 level.

This implies that I shall be looking at significantly increasing my equity exposure should Nifty fall below 7000 in next few months.

I fully realize that the economic disruption caused by the COVID-19 pandemic shall have deeper and wider impact that may last upto 2years. However, the $5trn new liquidity created worldwide shall support the financial assets, as the commodities prices continue to deflate. In India the government and RBI have started the process to kill the yields. The return on bonds and cash shall be meager, after a spurt in bond prices to adjust for the lower yields. The relative attractiveness of equities and real estate shall definitely increase in 6-9 months period. The FPI selling pressure shall cease in due course as redemption pressure on them eases and fresh liquidity is made available to unfreeze the markets.

AT the present levels of market, I am not panicked - either into buying or selling.

Friday, March 27, 2020

COVID-19 impact on economy

Most brokerages and rating agencies have highlighted the severe impact of the 21 days total lock down announced by the Government of India. For example consider the following:

1. JP Morgan estimates that the lock down will significantly impact 60% of GDP, though the post lock down rebound could be equally sharp. There will some permanent loss, depending on the length of the lock down. It expects global economy to enter into recession in H1'20, and since the India is fiscally constrained, the recovery will mostly depend upon the monetary easing and regulatory forbearance for stressed debt.

2. Deutsche Bank feels that the total lock down has pushed India into uncharted territory. We may see an unprecedented negative GDP growth print in 4QFY20 and/or 1QFY21. The government must announce a coordinated & front-loaded fiscal/monetary stimulus to mitigate the impact of lock down.

3. Jefferies highlights that the total lockdown shall significantly hit the near-term growth. However, there is a probability of a V-shaped recovery post lock down. Fiscal support for the affected workers/business can drive faster recovery. A double digit EPS decline in 4QFY20 may already be in the price.

4. The initial estimates of Nomura suggest that ~75% of the economy will be shutdown, resulting in a direct output loss of ~4.5%. Additionally, there will be indirect effects such as the persistence of public fear factor (even after the lockdown ends), a high risk that the livelihoods of the predominantly unorganised workforce will be hit and a sharp increase in corporate and banking sector stress, which are likely to further weigh on growth is beyond Q2 in H2 2020. It expects the central government to soon announce a stimulus package of ~0.7-1.1% of GDP. Along with the growth hit and poor tax collections, we expect the fiscal deficit for FY21 (year ending March 2021) to balloon by over 1% of GDP from the 3.5% target set in the budget (i.e. more than the escape clause leeway of 0.5% of GDP). Noumra feels that the monetary policy proactiveness has been missing so far; nonetheless it expects at least 50bp of policy easing on or before the 3 April policy meeting, accompanied by a host of liquidity injections and unconventional policy measures to reduce financial sector tightness, including large scale open market operations.

5. ING believes that the three-week nationwide lockdown will significantly dent India’s GDP growth, making this an even worse year for the economy than the 2008 Global financial crisis. This demands a stronger policy response. Until then, the looming economic misery is poised to push USD/INR above 80 in the coming days. As per ING The biggest whammy will be to private consumption, which accounts for 57% of India's GDP. With all non-essential consumption dropping virtually to zero for a week in the current quarter means year-on-year GDP growth plunges to just about 1%, and with two weeks of a hit in the next quarter could push it to about -5%. We would anticipate at least one more quarter of drag keeping growth in negative territory, beyond which the policy support and favourable base effects should drive recovery back to positive growth. While this shaves a full percentage point from the yearly growth in the current fiscal year (ends on 31 March 2020) to our estimated 4.0%, we have revised our forecast for the next financial year to 0.5% from 4.8%. This is a far cry from the government’s expectation of over 6% growth outlined in the FY2020-21 budget, which will surely be scaled back significantly as the Finance Ministry prepares fresh stimulus to stem the crisis. However, citing significant policy support, the official growth outlook may not be as bearish as ours, though we note that official growth tends to be overestimated by about 2%.

6. EMKAY Stock Broker feels many industries/SMEs will be running on zero revenues for close to a month and 'opening up’ after the lock down is likely to be measured. It expects permanent impact of 21 day shutdown even into the longer term numbers, anticipating that the shutdown could push unorganised sector to the brink.

Most other brokerages and rating agencies have expressed similar views and opinions. Both the macroeconomic growth forecast and earnings estimates have been materially moderated.

In my view, it is tough to estimate the actual outcome. The real picture could be very different from what we are anticipating today. For example consider the following:

(i) The lock down condition (total or partial) may continue for longer.

(ii) The bad weather has damaged some Rabi crop in North India. Shortage of labor for harvesting and transportation of crop to Mandi could cause some further damage. This will add to the poor data.

(iii) The nationwide protests against the Citizenship Amendment Law during December-February, had resulted in some serious disruptions, especially in North and east India. None of the forecasters seem to be accounting for that.

(iv) There were many industries, like automobile, who were struggling with high inventory and/or losses. This lock down could actually be a blessing in disguise for such businesses.

(v) Under the pretext of the lockdown, many financial institutions may be allowed to offer concession to the stressed borrowers. This could work either way - it may increase the NPA levels, or it may rationalize the provisioning and IBC proceedings, and actually help both the lenders and borrowers.

(vi) The government may get a reprieve from global rating agencies for indulging into some fiscal profligacy. This can actually help kick start the economy.

(vii) The global supply chain will definitely see a shift from China to other countries. If the government plays its cards right, the elusive capex cycle can start much earlier in India then currently anticipated.

Thursday, March 26, 2020

Portfolio changes

Continuing from yesterday (see here), I would like to share with readers what changes I have made or shall be making in due course, in preparation for the new market cycle. In my view—

1. This new market cycle shall see a correction in the consumer behavior. The growth in the household credit (personal loans or non-corporate finance) since the demonetization (November 2016) has been relatively very high. This has mostly supported discretionary consumption and financial investment, as we have not seen significant growth in real asset building (Real Estate, MSME Capacity Building etc.).

The wealth destruction caused by sever correction in financial asset prices (both equity and debt), persistent illiquidity in the housing market, and stagnant to lower wages may diminish the borrowing capacities of households in short to midterm.

The relative high valuations of most consumer discretionary and consumer financing stocks with relatively lower growth visibility may result in a prolonged underperformance. I shall reduce the weight of such stocks materially in my portfolio.

2. The paradigm shift in RBI credit policy strategy, and dramatic addition to the global liquidity means that the debt yields shall decline structurally in midterm. This combined with the incentive of low tax rates, means that we shall see (a) resumption of capacity building in manufacturing sectors, and (b) rise in activity in real estate sector. I shall be there adding the following in my portfolio:

(i) Corporate Lenders

(ii) Real Estate developers and owners.

(iii) Capital goods manufacturers.

3. In past few years lot of companies have build significant capacities for import substitution. Given that INR has depreciated and is likely to remain weaker for some time (my view is USDINR average to remain between 72.50-74 in the midterm), the attractiveness of these capacities has further increased. I shall be looking at such companies, preferably with low debt. These companies are mostly in sectors like Specialty Chemicals, Agro Chemicals, API manufacturing, and consumer electronics.

4. The valuations in utility space have become extremely attractive, especially if when we compare the dividend yields with debt returns. However, I shall resist my temptation and continue to avoid the public sector companies. I shall chose only from a handful of private players in utility space.

5. Technology is an interesting area. I have been avoiding the largely wage arbitrage businesses in this space and focusing on the digital and AI focused companies. I see no reason to change that strategy, despite sharp correction in valuations. I shall actively look for opportunities in FinTech, ITeS, E-Commerce areas. I would not mind investing in non listed space if some good opportunity presents itself.

6. I shall add significant weight too healthcare segment (API, Formulation, Branded, Local, MNC, Hospital, Pathlogical Labs, Insurance etc) in my portfolio.

7. I will avoid commodities for now. However, later in the year, I shall look at both Cement and Steel favorably.

8. Amongst financials, besides corporate banks, I shall look at NBFCs not focused on consumer financing.

Wednesday, March 25, 2020

Change is only permanent thing

The past 5 weeks have been most horrific period for investors in financial since the five week period in September-October 2008. A colossal destruction of investors' wealth has already taken place.

There is an argument that this destruction is only a notional mark to market (MTM) loss if the investors' continue to hold the securities, as the prices will certainly recover as soon as the COVID-19 is contained; may be in 3-6 months. The proponents of this view are cautioning the investors that selling the securities at this point in time will convert the temporary MTM losses into permanent erosion in wealth.

Some readers have asked about my view on this argument. I have already expressed my views on this issue multiple times in past few months. Nonetheless, I do not mind a reiteration.

I believe that the market cycle in India that started from 2013 has definitely ended. Historically, the sectors and stocks that lead a particular market cycle, are not found to be leaders of the subsequent market cycle. Commodities in the early 1990s, financials in the mid-1990s, ITeS in the early 2000s, infrastructure in the late 2000s, and consumers in the past five years are some examples. Many star performers in these cycles (Andhra Cement, SAIL, VLS Finance, IFCI, IDBI, DSQ Software, Pentamedia, Suzlon, BHEL, Reliance Infra, JP Associates etc) did never recover their losses. Irrespective of the fact whether the investors sold these stocks during panic periods that marked the end of respective market cycles or held these stocks for many more years, their losses have been permanent in nature. In fact holding these stocks longer has only exacerbated the losses.

In my view, we would need to distinguish between the investors in mutual and investors who like to invest in securities directly.

Ideally, those investors who have invested in a mutual fund should not be worried, because the professional fund managers managing their money must recognize the need and time for change and adjust the fund portfolios accordingly. For example, most mutual funds today are not holding stocks of ADAG, JP Group, Suzlon, etc. Most of them would have sold the embattled Yes Bank, Vodafone, Zee Entertainment etc. also. By not redeeming these mutual funds during panic bottoms, investors may hope to recover their temporary MTM losses in due course.

However, this may not be true in the case of individual investors, who refuse or fail to effect necessary changes in their security holdings with the changing times. From my experience I know that many investors are still clinging on to the stars of previous cycles, which have become duds with almost no chance of recovery. For such investors, not selling during the times of panic may actually result in higher permanent losses.

It is also important to note that not selecting a good mutual fund manager may also result in MTM losses becoming permanent losses. A fund manager who is not dynamic and pragmatic enough to read the economic and market trends quickly may remain saddled with the non-performing assets for long, thus causing material permanent losses to the investors both in terms of erosion in portfolio value and opportunity cost.

Personally, I would therefore not buy or keep holding something just because it has fallen 50-60% from its recent highs. My portfolios of my mutual funds will definitely adjust as per the times, because I am confident about quality of my fund managers. My direct equity and debt holdings, I have already changed.

Tuesday, March 24, 2020

Some random thoughts

Making IBC little more pragmatic

Last week while on a visit to Mumbai, I noticed few aircrafts belonging to the now defunct Jet Airways parked on the airport. The aircrafts had gathered lot of dust and pigeon crap. I believe it's more than a year since these aircrafts must have been parked there. The owner/lessee of these aircraft owes billions of rupees to various lenders and operational creditors. The company is undergoing the bankruptcy proceedings and apparently so far no buyer has shown any interest in acquiring the company.

I wonder, why the bankruptcy procedure be made little pragmatic! I feel one of the key purposes of the bankruptcy process must be to minimize the losses to the lenders and operational creditors. If these aircrafts that are lying idle were leased to other airlines till the completion of IBC process, at least some money could have been recovered. Or at least, Jet Airways could have been saved from incurring parking charges (which it can never pay), and machines could have been saved from major overhaul cost due to lying idle (again that cannot be paid by the Jet Airways).

A bureaucrat obviously will never take any initiative in this direction, as it would increase his workload and responsibility. The politicians who travel everyday and see these aircrafts rusting and gathering dust could only take an initiative, as it may require some legislative changes also.

Government may have done a lot by not doing anything

Talking with a senior bureaucrat last week I realized the importance of sophistry in running the government. To my inquisition about the below par performance of the Make in India program, his answer was the best example of sophistry.

He said, "the government went slow on Make in India program. We were never comfortable about creating large capacities using borrowed money to increase our integration to the global supply chain in these uncertain times. Our strategy of going slow has bore brilliant fruits. Imagine, if we integrated into global supply chain like China, and all those factories were shut down due to global demand collapse. All of these would have defaulted on their loans, totally crushing our financial system."

After the God explaining that "sometime inaction is the most appropriate action", this is perhaps the best explanation I have heard.

Clamor for rate cut may be misplaced

A lot of market experts have expressed their anguish over RBI not making an "emergency rate cut". Unfortunately, they are seeking rate cut to comfort the financial markets and not the economy. Their complaint is that stock markets are sliding fast and RBI is doing nothing to stop the slide, even though it has many bullets preserved in its barrel.

These experts appear totally oblivious to the fact that dramatic cuts by some large central banks have done almost nothing to arrest the market slide.

Even, from the real economy view market, a rate cut now would have yielded miniscule results. The capacity utilization levels are running persistently low and demand for new investment is low; the banks and NBFCs are mostly risk averse and not willing to lend; the system is liquidity surplus; RBI is providing 3yr funds at 5.15% and buying bonds to ease the pressure on longer maturities. A rate cut now may only disturb the equilibrium in currency market. I would rather like RBI to cut substantially when things stabilize a bit and banks are willing to take risk. For now, the rate cut would comfort stock markets for 2hours or may be less than that.

Thursday, March 19, 2020

Finding some light in the middle of dark tunnel

The bad things are easier to believe. Haven’t you noticed that?

-Vivian to Edward in movie Pretty Woman

While it is easy and fashionable to highlight the negatives to support the fear already instilled amongst the investors, I believe it would be in order to take note of the improvements that have taken place in recent times which would support the markets on their upward journey, whenever it begins.

1. The current account deficit of India has shrinked to ~1% of GDP for 9MFY20 vs. 2.1% of GDP in FY19.

The recent fall in current account deficit is primarily due to fall in imports due to poor domestic demand and sharp correction in energy prices (crude oil & natural gas). Fall in imports due to fall in domestic demand may not be a desirable way of lowering the current account deficit. Nonetheless, the breakdown of global energy cartel indicates that the lower energy prices may sustain for little longer, helping the recovery of Indian economy in 2HFY21 onwards. In the interim it has cushioned the currency against bulky FPI outflows and provided additional levers to RBI for managing monetary policy to support growth.

Net FDI in 9MFY20 was 2.7% of GDP, which was sufficient to cover the CAD and keep the balance of payment at comfortable level.

2. The asset prices (equity, debt, and precious metals) have corrected materially. The froth that had got built in the valuations has been mostly wiped off. A further correction from the present level will make the valuations attractive again for buying.

3. The corporate rate cut announced last summer is finally beginning to show some impact. Companies like Hindustan Unilever and Bosch have announced fresh capex by forming 100% subsidiaries to take advantage of lower tax rate of 15% for new businesses. Hopefully, we shall see many more companies following the lead and making fresh investment to build new capacities.

4. The global central banks have embarked upon a massive monetary easing program, just like in the aftermath of global financial crisis. The interest rates in US are now close to zero. There are indications that US and many European countries may embark on massive fiscal easing also. This shall eventually inundate the global market with cheap money. Once the fear of COVID-19 subside, a part of this cheap liquidity will certainly flow to the emerging markets like India in search of yield. We shall see the asset prices reflating again this summer, in my view.

5. The mobility restrictions due to the efforts for containment of the spread of COVID-19 have resulted in several households cancelling discretionary consumption like avoidable travel, foreign vacations, parties etc. This could have positive impact on the domestic private saving rate that had been on the decline for past many years. It is too early to assess whether the savings will be notional or material. But nonetheless, one could hope that these savings will be material and may be used for acquiring assets.

I hear lots of people restricted from foreign travel are planning domestic vacations. I also hope that this provides a great impetus to domestic tourism. Unfortunately, the government is not making enough efforts to make it a sustainable trend.

Wednesday, March 18, 2020

2020 not like 2009

The sentiment on the street eerily looks similar to the one we saw during 2HFY09, post collapse of Lehman Brothers. In those days, the rumors of large banks declaring bankruptcy, sovereign defaults, imminent EU breakup, market freeze, sounded absolutely believable. These were not only market grapevines believed by the common investors. Many senior analysts at global investment banks wrote scary reports about these eventualities. Globally reputable, economists and strategists pained doomsday scenario of global economy slithering into a deep abyss to compete with the great depression post WW-I.

In India, many depositors transferred money from private banks to the public sector banks. Investors summoned their advisers for details of their liquid fund portfolios. The fixed maturity plans (FMPs) backed by bank CDs were pre redeemed by paying penalties. Capital protected structured products were also called prematurely by incurring material losses.

Some of the readers have likened the current situation to the 2009 panic sell off. A few believe that going by the reactions of central banks in the developed world, it appears to be already worse than 2009. Many readers have wanted to know my view as to how much worse it could go before the rock is hit.

To all my readers, I would request that I am no Taleb, Rajan, or Roubini who can assess the gravity of situation and make a prophecy almost instantaneously. I am an ordinary micro investor in the local Indian financial markets, who can access the data relating to past trends with some efforts and roughly correlate that data with the present conditions to make a naive assessment of the situation.

My assessment of the present situation is that presently we are nowhere close to the rout in asset prices seen in 2009. In 2009, Sensex had ended 18% lower than the July 2006 level from where the bull market had started. The BSE Midcap and BSE Small Cap had ended the cycle 36% and 41% lower than the starting point.

The current bull market started from end of February 2016. As of yesterday, the Sensex was higher by 36% from the start date. BSE Midcap and BSE SmallCap were higher by 24% and 16% respectively. Besides, the gains recorded during 2006-2008 were much higher than the gains made during 2016-2018. The severity of the fall in 2008-09 was therefore much more intense and deeper.

In my view, we may not a fall like 2006 this time, because of the following four simple reasons:

(a) Foreign investors had pumped in huge money during 2004-2008 in Indian equities. This time they are huge net seller during 2016-2020 period.

(b) The earnings growth fell off the cliff during FY09 to FY11 period leading to de-rating of Indian equities. This time the earnings growth has remained anemic and has little scope to disappoint materially. In fact it may surprise on the upside from 2HFY21 onwards.

(c) Indian's economic growth has seen multiple downgrades in past two years, unlike 2008-10 when the world had great expectations from India's economy.

(d) Presently, the leverage in Indian stock market is significantly lower than the 2008-09.

Nonetheless, we may certainly fall further from the present level, before hitting the rock.