Vijay Kumar Gaba

Besides other things one thing that the year 2020 has established is the need for global manufacturing to rebalance its over reliance on China. This need was being felt for past many years, but the following factored appeared to have reinforced this need in 2020:

(a)   Major global economies like US, Japan and India took some aggressive tariffs and non-tariff measures to correct the imbalances in their trade with China.

(b)   Pandemic induced mobility restrictions exposed the vulnerabilities in the global supply chain and prompted businesses to diversify their manufacturing more widely.

(c)    Geopolitical aggression shown by Chinese establishment is now increasingly perceived as potent risk for global supply chain. Political unrest in Hong Kong has may have also embellished this perception.

A recent survey conducted by UBS highlighted that “70% in the China CFO survey and 86% in the US CFO survey said they had moved or plan to move a part of their production out.”

Amongst Asian countries, besides Vietnam, Taiwan, Japan, Korea and Thailand, India is seen one of the preferred country for relocation of manufacturing facilities. India is seen o have lowest manufacturing costs amongst peer, but some skepticism remains about the ecosystem and administrative hurdles. Despite a strong commitment of the top leadership to encourage manufacturing base in India, the progress on the administrative level is perceived rather slow. It is important to note that low labor cost does not necessarily lad to overall lower cost structure, if the overall ecosystem (regulation, taxes, logistics, infrastructure etc.) is not favorable for manufacturing.

The events of Winstron, Narsupura (Bengaluru, December 2020) and Delhi (Violent protests by farmers, January 2021) are not good omen for this though. Rejecting these events as mere local politically motivated events might be mistake best avoided; because we are already in the midst of transition. The decisions are being already taken in board meetings. No one can deny that sometimes a newspaper headlines on decision day might impact a 30-40yr plan.

Global economy

The year 2020 witnessed the global economy contracting by 3.5%, the worst peacetime performance after the great depression. IMF has recently forecasted a “strong” (5.5%) revival in 2021 and “normalization” (4.2%) in 2022. Which essentially means the global economy would be growing at less than 1% CAGR over two years (2020-2021). This rather long pause in global growth means serious setback to the development goals of poverty elimination, climate change and inclusion. The fact that this “pause” in growth could only be achieved with trillions of dollars in fiscal and monetary stimulus, highlights that the legacy of global financial crisis (GFC) and subsequent quantitative easing might have materially weakened the growth drivers of the global economy in past few decades, e.g., development of human capital, globalization of trade and commerce, poverty alleviation, productivity growth, etc.

The new global survey of 295 economists from 79 countries, commissioned by Oxfam, reveals that 87 per cent of respondents, including Jeffrey Sachs, Jayati Ghosh and Gabriel Zucman, expect an "increase" or a "major increase" in income inequality in their country as a result of the pandemic. (see here)

In Indian context, IMF is now forecasting a contraction of 8.5% for FY21 and a growth of 11.5% for FY22. This implies, like global economy, Indian economy would also be growing at less than 1% CAGR over two years (2020-2021). This “pause” in growth over two years comes at the expense significant fiscal leverage (rs30trn stimulus), and massive liquidity infusion.

The latest Oxfam report highlights that the pandemic induced lockdown may resulted in massive rise in socio-economic inequality. While the formal sector workers mostly escaped unscathed or with small salary cuts; the job losses in informal sector were massive. “Out of a total 122million people who lost their jobs, 75%, which accounts for 92million jobs, were lost in the informal sector. The disruption in school schedules may result in massive rise in school dropout young population, further widening the socio-economic abyss.

As per Oxfam, "Only 4% of rural households had a computer and less than 15% rural households had an internet connection. Only 6% of the poorest 20% has access to non-shared sources of improved sanitation, compared to 93.4% of the top 20%.

Global Trade

IMF sees global trade rising by 8.1% in 2021, after an estimated 9.6% decline in 2020. The rebound is much weaker, as compared to post global financial crisis (GFC) rebound in 2010-2011. The recovery would look even insipid if we factor in poor trade growth during 8yrs preceding the pandemic (2012-2019).

In a recent update, ING Bank highlighted—

“With freight rates signaling capacity constraints in world trade, it’s likely that trade volumes won’t be able to rise much further – even to serve catch-up demand – when countries emerge from the second wave of lockdowns. Capacity may only come back on stream slowly as shipping liners wait until the global recovery is more firmly underway before bringing back inactive ships. Even then, containers being unavailable where they are needed will drag on volumes for some time. Capacity constraints mean that trade volumes won’t be able to rise much further even when countries come out of lockdowns

In the near term, limits to global trade growth are likely to be a modest headwind for GDP compared to the far more disruptive domestic lockdowns. More important will be higher freight rates and import prices building inflationary pressures over the course of the year.”

The present state of global economy and trade is therefore far from Blue Sky; even though the dark clouds may have dispersed for now. A bullish bet on sustainable global recovery to beyond “Pre Covid sub optimal levels” might be premature as of this morning, in my view.

A sharp rise in inflation, as presently anticipated by a section of global economists and investors, forcing monetary tightening; could however lead even the recovery to Pre Covid level, halting in its strides.

 Over the last weekend, I attended a lecture on the doctrine of Karma, read couple of books on philosophy of investment, and observed zillion of nuggets of investment advice, apparently written by highly successful investors and/or advisors, on my social media timelines. Admittedly, all this was quite befuddling for me. Everything, I read or heard caused an overflow of conflicting thoughts and emotions. I spent the entire Republic Day holiday in extricating the entangled thoughts. I am not sure, if I attained any degree of success in my endeavour. Nonetheless, I understood the following very clearly–

(i)    Like any other Karma, the process of investing in financial products is personal to every individual. No two individuals will have exactly same investment plan – strategy, goals, process and outcome. The similarities between religion (morality, ethics etc.) and investment end here.

(ii)   Investment advisory issued (free) to common public is mostly a redundant function, inasmuch as it does not take into consideration the individual circumstances of an investor.

(iii)  Financial investment is a tiny subset of the one’s overall life. The life path one sets for himself does impact the investment plan. But vice versa may not be true. If investment plan (strategy, goals, process and likely outcome) begins to drive the life (cart before the horse), it is a huge problem.

Doctrine of Karma

Karma is perhaps the most popular word of Indian origin that has been incorporated in global lexicon. This is despite the fact that the doctrine of Karma is intrinsic to Indian belief system of rebirth and salvation and does not fit the practice of Abrahamic religions (Islam, Christianity and Judaism) and most other traditional religious belief system across Africa and Latin America.

By most simplistic definition, Karma means Acts performed by a living being. The doctrine of Karma says, insofar a living being is engaged in the eternal cycle of rebirth, the condition of present and future lives is determined by his/her Karma of past and present life.

While performance (or otherwise) of Karma is completely individual, the common goal of all Karma, performed by all living beings is to obtain release (salvation or Moksha) from this eternal cycle of rebirth. Each one has to accumulate enough good Karma that will be sufficient to secure a release from this cycle of rebirth.

The doctrine of Karma is thus motivation to live a moral & ethical life. This also explains the pain, suffering and existence of evil.

Investment advisory

Investment advisory is function of formulating a financial plan for a person or group of persons. This involves, evaluating the financial conditions of a person, setting investment gaols, making an investment strategy to achieve these goals, and assisting the person(s) in executing the plan.

Investment advice thus is very personal service. It is less likely that an investment advice shall be equally relevant for two persons or group of persons. It is therefore very important that while accepting a “common” investment advice, one needs to be extremely careful. Let me explain this by way of an example:

A “common” investment advice is that by investing in an Index Fund (passive investment), one can earn a steady return over a much longer period of time. Nifty has given CAGR of ~9% over past 30years. These 30yrs have seen extreme volatility, many wars, multiple scams, global crisis, pandemic, many droughts, extreme political instability (and stability), etc. Even in USD terms, CAGR of Nifty over past 30yrs is close to 5%. This sounds very good.

Now consider the following:

(a)   Nifty witnessed 18 corrections of over 10% in these 30years. These corrections ranged 10 to 60% from the peak level before correction. (See the chart from latest CLSA report below)

If a person had the investment plan period of less than 30yrs, there was a decent chance that he would have made much lower returns. For example, If someone invested in Index ETF in April 1992 (Nifty 1281) and redeemed his investment in September 2001 (Nifty 854), he would have lost over 30% on an nine year investment. Similarly, investment made in Nifty ETF in January 2008 (Nifty 6279) would have yielded just 1.5% CAGR if redeemed in March 2020, a good 12years later.

I appreciate that taking peak and bottom level of indices to state my point may not be appropriate. But it does not change the point. Investment in financial products is not like Karma. One wants to see the outcome of investments over a finite period, usually not as long as 30years.

We do not invest in stocks, with the idea that the profits will come, if not in this birth, may be in next birth; May be I would die before enjoying the fruits of my investment, but my grandchildren will certainly enjoy it. This may be an eventuality. But this is usually not the plan.

Therefore, while investing in an index fund, I must be mindful that only that part of my investment should go in Nifty ETF which I would not be forced to redeem in case of an emergency or contingency, especially if this emergency happens to be a macroeconomic event that might cause a sharp temporary fall in equity prices.

(b)   One must realize that protecting the savings from inflation is one of the primary goals of financial investments. In past 30years (and even in past 10years), India’s average consumer price inflation rate has been above 7%. Adjusted for this Nifty 30yrs CAGR may be under 2%. Does not look glamorous by any imagination!

The short point is that “common” (free) investment advice might be applying the doctrine of Karma to financial investment also. It may be assuming equity investment to be a perpetual endeavour, lasting for generations. Unfortunately, it is not the situation in most cases. People usually invest in stocks for generating some additional income (dividend plus capital gains) in foreseeable future. Their investment plan needs to be prepared accordingly.

I received lots of comments on the yesterday’s post (Investing lessons from down under). Most commentators agreed with my view that a good portfolio must be a balance of consistent compounders and emerging businesses; whereas few expressed strong disagreement. Unsurprisingly, amongst those disagreeing were both types of investors – those who prefer to stick with consistent performers; and those who prefer emerging businesses with a potential of abnormal returns in short to mid-term.

I find myself totally disinclined to argue with any of the commentators, since I strongly believe that investment is essentially a personal endeavour. Each investor will have a different strategy based on his/her personal circumstances, requirements, and aptitude. The widely followed investment strategies are basically templates. Individual investors customize these templates to make an investment strategy most suitable for them.

I however would like to discuss one thing that stuck me hard while reading these comments. I found that most commentators (I believe they all are investors) are not sure about the primary goal of financial investments. Upon enquiry, I received the following answers:

·         Wealth creation (40%)

·         Become rich (25%)

·         Higher profit (25%)

·         Others (10%)

I wonder if these are correct definitions. What I have read in management books is that “goal” of a financial plan must be quantifiable and definite to the extent possible.

·         “Wealth” itself is a vague term. Various people define it in different ways. There are many who even refuse to consider “wealth” as a pure financial term. “Wealth Creation” is even more vague.

·         “Become rich” is even more vague. “Richness” in financial terms, is purely a relative term. It may have entirely different connotation for persons living in Mumbai and Madhubani. This goal is certainly not quantifiable.

·         “Higher Profit” is also a relative term and could be infinite. It could mean higher than alternative avenues of deploying savings. It could also mean higher rate of return than a targeted person or institution.

In my view, the core of investment strategy is to define a definite quantitative goal. Some examples of these goals are as follows:

(i)         Preservation of capital in real terms (inflation adjusted)

(ii)        Return on investment of 10% more than the nominal GDP growth

(iii)       Return of 5% in USD term, since I am saving for my child’s US education

 The recently concluded tour of Indian cricket team to Australia has been remarkable in many ways. I am sure, the cricket administrators, analysts, strategists and guides in the country would analyse the outcome of tour from the viewpoints of future playing strategies and improvement in fitness regime, and career path for the young promising players who may not get adequate opportunities due to limit of 11 playing members in the national team.

On my part, besides thoroughly enjoying two months of engrossing game of cricket, I have drawn some key inputs for investment strategy purpose from this tour.

Pujara vs Pant debate is meaningless

One of the prominent topics of discussions, before final day of the Brisbane test, was the “slow” batting of Cheteshawar Pujara; though the victory at Gabba ended this debate with tins of praise being heaped on Pujara for his grit and resilience. A loss or draw at Gabba might have seen strong criticism of Pujara.

On the other hand, Rishabh Pant, who has been consistently the target of critics for his irresponsible batting, was praised as true successor of Dhoni - A great finisher and match winner.

I find nothing new in this discussion and criticism. Players like K. Srikkanth, Virendra Sehwag, Yuvraj Singh, Kaluwitharana, Shahid Afridi, etc. have always faced this kind of criticism. The fact is that competitive cricket needs to strike a balance between entertainment and classical game. For every Gavaskar a Srikkanth; for every Tendulkar & Dravid, Sehwag & Yuvraj; and for every Jayasuriya a Kaluwitharana is needed. The balance between classical techniques and aggressive innovation is consistently leading to evolution of the game and keeping the interest of spectator alive.

Applying this analogy to investment strategy, we must understand that constructing an investment portfolio is like making a cricket team. The portfolio must strike a balance between safety, liquidity and returns. While anchoring the portfolio with consistent compounders, investors must keep trying the new businesses which could be potential winners due to their innovative methods and technology. Of course the failure rate in this endeavour will be high, but one winner will more than compensate for these failures and enhance overall portfolio return.

Just to illustrate, HUL played a Pujara for 10yr (2001-2010); ITC is playing the same game for past seven years; and RIL played it for six years (2011-2016). For these, the balance was provided by the likes of Bajaj Finance, Page Industries, Divis Lab, Eicher Motors, Havells, HCL Tech, PI Industries etc. Many rising stars though failed to live upto the expectations, e.g., IDFC First Bank, DHFL, Yes Bank, JP Associates, Suzlon, etc.

One pertinent question here would be what should be the proportion of Pujara’s and Pant’s in a balanced investment portfolio!

Well, for that one would need to sit with her/his investment adviser and work this out.

36 all out and 325/7 on fifth day Gabba pitch (January 2021) are both exceptions

On 19^th December 2020, the fabled Indian batting line up wilted under pressure and was all out for a mere 36 runs in Adelaide. One month later on 19^th January 2021, a much depleted team scored 325 on the fifth day Gabba pitch facing infamous hostile Australian bowling. The both performances are true but not normal. These kinds of performances do occur once in a while, but cannot be key parameters for evaluating the standard of Indian team.

The benchmark indices fell by 40% from peak in two months (February-march 2020) and have risen over 90% in past 10 months. The sharp fall and fast recovery, both are not normal conditions. These deep oscillations do occur almost every 10year, but cannot be a key parameter for investment strategy. Only a trading strategy can factor in these kinds of oscillations. As such these are more relevant from risk management viewpoint of brokers and lenders, rather than investors.

 The recent macroeconomic data indicates that Indian economic activity may soon reach to its pre Covid level. The latest reading on Nomura India Business resumption Index is 93.4, just 6.6% below pre Covid induced lockdown level. The media headlines and official commentary claims it to be a “V” shaped recovery, implying that one year may have been lost, but Indian economy is nearly back to “normal”. There is section of experts which is terming it to be a “K” shaped recovery rather than a “V” shaped one; implying that one part of the economy has raced much ahead while the other continues to slide.

Some noteworthy data includes:

IIP growth is now back to February 2020 level. In December, e-way bill collections rose by 15.9% to 6.42 crore in December 2020, the highest since April 2018. The mobility to work places ticked up in past 8 weeks, as shown by Google mobility index.

Elsewhere, China has reported positive growth of 2.3% (yoy) for 2020 as a whole. UK, USA and many other European countries have seen fresh surge in cases of infection and have re-imposed some mobility restrictions, hampering the process of economic recovery. In past couple of weeks the US job data has been disappointing.

These data certainly a matter of relief. However, in no way it makes me comfortable. I know from my travels and interaction with people that for a significantly large section of population, the normalization will take years, if not decades, of “high” economic growth. Besides, the amount of stimulus that has taken to bring the economy back to “pre Covid” level may not be available to take it back to pre global financial crisis (GFC) level; exatly we want to be.

For now, Indian economy is like a middle aged person suffering from chronic asthma and diabetes, who has just returned home after a successful open heart surgery.

One of the distinct childhood memories is about the Uncle, who used to visit foreign countries for work almost every year. After every foreign visit, he would host a family dinner. At the gathering he would explain the difference between heaven (Europe and USA) and hell (India). He would make every adult regret for taking birth in India and make every child aspire to settle abroad.

We (me and my brother) were usually not interested in what Uncle is saying. Our interest was limited to the last act – opening of goodies bag post dinner. He would very generously distribute the “gifts” he had brought from “foreign”. These gifts would invariably include – bathroom sleepers, shaving and dental kits, cosmetics and writing instruments picked from the hotel room he had stayed and flight he had travelled; bottles of perfume; some clothes; small toys; and souvenirs, mostly bought from dollar stores (this I know in hindsight after travelling myself). Three essential things were bottles of liquor bought from duty free shop, a wrist watch and some electronic gadget (camera, oven, juicer, VCR etc.). These items he would offer to sell. (In hindsight I know that he would recover the cost of his entire trip and gifts by selling these items.)

Presentation of Union budget, every year by the finance minister, always reminds me of the generous uncle. A great build up before the budget presentation; a long speech; a strong feeling of regret for being Indian middle class; distribution of some goodies for the poor; and higher taxes to meet the higher expenditure. Since the dream budgets of 1996; the same story has been repeated for past 25years. Almost every time, people end up disappointed and disillusioned after the fine print of the budget are explained to them the next morning.

Notwithstanding the outcome, the charade of pre-budget shows, writings, representations, expectations and analysis is repeated enthusiastically. Hopes are rekindled only to be shattered. This year is no different.

The grim reality of Union Budget 2021 is that the government is terribly short of resources and extraordinarily high on promise. To meet the promise, additional resources would need to be raised. The government knows it well. The businesses know it even better. Rest all (consultation with stakeholders etc.) is the Uncle’s dinner to sell the duty free liquor and gadgets.

For those who are expecting the finance minister to take out some bazooka from her tablet (this year budget is digital, hence no briefcase), I have stated this earlier also and would like to repeat:

The scope and importance of Union Budget has diminished materially over the past two decades.

·         Initially the changes in tax rates were made only through the Finance Bill which is part of the budget exercise. However, many springs ago the government assumed the power to change the rates of excise etc through notification outside the budget. Subsequently, the GST subsumed most of the indirect taxes and the power to alter GST rates has been exclusively vested in the GST Council. The Union Budget has no role to play in GST rates now.

·         The boundaries for rates of customs duty are now mostly set in accordance with the WTO agreements. The union government can change these rates to safeguard domestic industry from unfair pricing by overseas suppliers or to stabilize the domestic prices in times of abnormal supply shocks. These changes could be done whenever a need arises. The union budget has little role to play in this.

·         Post implementation of the 14th Finance Commission recommendations, the onus to implement a large number of welfare schemes has been transferred to the respective state government.

·         The petroleum products' pricing has been mostly deregulated and the budget provides no subsidies for the transportation fuel now.

·         Most of the public sector enterprises, like NHAI, Railway Subsidiaries, Oil & Marketing companies now raise resources directly rather than through the budgetary support.

·         The corporate tax rates were restructured materially in August 2019. It would not be reasonable to anticipate any further concessions in corporate tax.

·         Higher energy and food inflation may warrant some concessions in the personal taxation, especially for the smaller tax payers. Inflation scaled increase in basic exemption limit and standard deduction may be considered. But this will be subject to resource constraints.

·         The government has announced a National Infrastructure Pipeline (NIP) of Rs1.02trn in December 2019. This proposal was strengthened through various stimulus packages announced during the course of 2020. This obviously takes out almost all major projects from the union budget.

·         Disinvestment of public sector undertakings a continuous process. Though a provision for receipts from this head is made in the budget, there is no evidence of any correlation with the actual disinvestment proceeds and budget provisions, in past 30yeras of disinvestment process.

·         Telecom spectrum auction and bank recapitalization allocation are other two key items watched closely. Again, in past 20yrs, there is no evidence of any correlation between the actual allocation and budget provisions.

Analysis of various reports indicates that market participants may be expecting the following from Union Budget 2021:

(a)   Significantly higher government expenditure, especially on infrastructure building. Setting up of a specialized development finance institution (DFI) is also one of the key expectations.

(b)   Additional tax concessions to middle classes especially salaried people.

(c)    Concessions for housing sector, especially higher interest rate subvention; higher cut off limit for definition of affordable housing; additional concessions for developers of affordable housing projects including extension of tax holiday beyond March 2021.

(d)   Review of taxes on investment (STT, LTCG, Dividend Tax)

(e)    Continued suspension of FRBM till FY24.

(d)   Fresh (higher) allocation for bank recapitalization.

(e)    Cut in excise duty on automobile fuel.

(f)    Some progress on Bad Bank formation.

The fears of market include the usual wealth tax, estate duty, additional tax on tobacco products.

Clearly, the expectations this time are running quite low. Just for the sake of a good omen, I would also expect the following from the finance minister:

(1)   Make capital gains (Long term and Short Term) tax rate uniform across all asset classes. This will allow rationalization of asset allocation process by removing tax arbitrage between asset classes.

(2)   Formula to link the basic exemption with some objective criteria (e.g., inflation, per capita GDP, house price index, education and healthcare expense per household as per latest NSSO survey, etc.) This will make the taxation structure more equitable and end the need to speculate over exemption limit before every budget.

(3)   Refrain from imposing additional taxes and cess to cover the cost of Covid vaccination and stimulus.

I would however be not disappointed if FM refuses to oblige me by meeting any of my expectations. I know this is an exceptional year and she has many strings to balance.

Also read

What Finance Minister Needs To Do To Make History: The 10 Big ‘Asks’ From Budget 2021-22

You should be happy if there are no increases in income taxes: Kotak MF

Travel, Tourism sector expects pathbreaking Union Budget for post-Covid recovery

More income tax incentives for housing purchase necessary to revive realty sector

The latest earnings season has started on a very buoyant note, led by some IT companies. In line with the high speed macro indicators, most brokerages have upgraded their earnings estimates in past one month. The present estimates are building in a very strong earnings recovery over FY22-FY23. The estimates for the current year FY21 have also been upgraded sharply from a contraction of 5% to 12% to a growth of 5% to 12%. Currently, the market is estimating an earnings growth of 24% to 38% in FY22 and another 18% to 22% growth in FY23.

It is important to note that these estimates assume GDP growth of -7% to -7.5% in FY21; 9% to10% in FY22 and 4 to 5.5% in FY23; interest rate bottoming in FY21 and elevated inflation of 5 to 6% over FY22 and FY23.

This implies less than 3% CAGR of GDP over three year period of FY20-FY23. Whereas, the present estimates imply ~19% CAGR in Nifty EPS over FY20-FY23. Apparently, there is disconnect between the macro forecast and earnings forecast. In past two decades at least, there is no precedence of such strong earnings growth with a dismal economic growth.

Furthermore, the estimates assume a strong recovery in earnings of financials and materials, from a very low base. Just to give a sense, Kotak Institutional Research estimates 473% (yoy) growth in Banks PAT and 860% rise in Metal’s PAT in Q3FY21. Construction Material (86%) is the third fastest growth forecasted. These three sectors probably have the strongest correlation with the macroeconomic growth and stability. Next 9months may be a case of low base effect, but with 3% economic growth, higher interest and inflation, it is tough to fathom these sector continue clocking sustainable high growth.

So in all likelihood the earnings estimates for FY22 and FY23 will fall in due course, as has been the case historically. Credit Suisse highlighted in one of their December report that EPS estimates fall 10 to35% from the level that is first estimated.

In my view, therefore, it would not be advisable to consider aggregate earnings as a key factor for investment decision. Better would be focus on the companies where sustainable earning growth visibility is very high. Of course these stocks will also fall in case of a broader market correction, but the chances of their bounce back would be much higher.

I shall therefore remain agnostic to sectors and size of companies. I would rather focus on individual companies for investment. Sustainability of growth would be my key consideration in selecting the company.

Will jet fly high again?

One positive impact of Covid-19 pandemic for me is that it has increased my productivity significantly. I am saved from excruciating travel, which many times is completely unnecessary and avoidable. I am able to devote the time, money and energy saved from travel to useful and productive tasks. I am reasonably confident that this positive impact of the pandemic may sustain in foreseeable future also.

In last two days, I did video meetings with five corporate managements, located in Gujarat, Maharashtra, Andhra Pradesh and Bengaluru. In pre pandemic era, I would usually travel to meet companies for understanding their businesses. A one hour meeting in Bengaluru would mean, waking up at 3AM to catch a 6:50 flight, and reach home by 10PM. No longer is the case. I logged in at 3:58PM for a 4PM meeting from the comfort of my home; and was done at 5:10PM, well within time for the evening tea with my wife. Saved, Rs15000, 20hrs of time, 1500 calories, and stomach ailment from eating out.

There is no doubt that I would like this arrangement to continue in post pandemic era also; and limit my work related travel to only “unavoidable” category. Also, I have absolutely no reason to doubt that there are numerous other people who are happy with the present arrangement and would like this to continue.

Now, this thought brings me to some recent uber bullish analysis on airline and hospitality stocks, and sharp run up in the prices of a defunct airline, which hopes to start its operations in 15-18 months. I need to assess whether I would increase my leisure travel significantly to compensate for my lesser work related travel.

Is Tesla, Lehman of 2021?

Michael “Cassandra” Burry, the trader who made a fortune by taking a massive short bet on subprime credit during 2007-08 mania; and inspired a best seller book (The Big Short, Michael Lewis, 2010) and a block buster movie (The Big Short, Adam Mckay, 2015), has been a role model for many traders. I have seen many young traders aspiring to emulate Lewis’s conviction in his analysis and make big money. Michael is reportedly short in the stock of Tesla, Inc. after the stock bent ballistic, gaining 800% in past one year. He has reportedly stated that the stock price of tesla will “collapse”.

I am not sure how many young aspirants are emulating Burry on Tesla, but one thing I know for sure – if Burry is right then Tesla will not fall in isolation. It will bring the entire market down, like the Lehman bros did in 2008.

Too good to be true

Not long ago, social media and TV channels were hyper busy analyzing the potential beneficiaries of the Covid-19 vaccine and its logistics. Few large pharma companies, a logistic company, couple of glass manufacturers, air conditioning companies, an airlines etc were widely discussed as likely beneficiaries of this once in a century opportunity.

Well, two unlisted Indian entities have started to ship the vaccine this week. They do not require -80°C temperature to store and transport the vaccine. The vaccine is being procured exclusively by the government at controlled rate and apparently being provided free for now.

In the investing world, usually, the things that sound too good to be true are actually not true!

Alibaba getting nationalized?

As per media reports, Jack Ma, the founder of online retailer Alibaba, is missing for past two months, after he had highlighted some problems with the Chinese financial system. Many observers who keep a watch on Chinese developments have suspected that he might have been in custody of Chinese authorities. There are reports that the Chinese government may be planning to nationalize Jack Ma's Alibaba and the Ant Group.

The Chinese government has been reported to say, "Based on tip-offs received by the State Administration for Market Regulation in recent days, the administration will be investigating Alibaba for suspected monopolistic activities." (see here)

The truth may be known only few months (if at all). However, since there is no official word about the whereabouts of the legendary entrepreneur, the doubts are getting stronger. This is a strong reflection on the true colours of the Chinese model of free enterprise.

It may sound little sadistic, but I see this as an opportunity to aggressively push India as an alternative investment avenue; though some radical steps to promote ease of doing business would be a prerequisite.

Governments are pro reforms, regardless of party in power

The incumbent government led by BJP has implemented (or attempted to implement) many legislative, administrative and policy reforms, which the party had opposed vehemently when it was in opposition. GST, higher FDI limits in trade and industry, disinvestment of strategic and profit making public sector undertakings, and labour laws etc., are some of the examples.

This highlights that the “governments” in India are usually pro reforms, regardless of the party in power. This needs to be remembered in next elections.

 RBI released the 22^nd edition of its biannual Financial Stability Report (FSR) on Monday, January 11, 2021. The report highlights some key trends that could influence the financial markets in months to come. I note the following red flags raised in the report, which in my view could be relevant to my investment strategy:

Uneven and hesitant recovery, with disconnect in real activity and asset price

Economic activity has begun making a hesitant and uneven recovery from the unprecedented steep decline in the wake of the COVID-19 pandemic. Active intervention by central banks and fiscal authorities has been able to stabilize financial markets but there are risks of spillovers, with macrofinancial implications from disconnect between certain segments of financial markets and real sector activity. In a period of continued uncertainty, this has implications for the banking sector as its balance sheet is linked with corporate and household sector vulnerabilities.

COVID-19 pandemic-induced economic disruptions have exposed some fault lines in global economy. Increased public spending (stimulus) and sharply lower revenue receipts have enlarged the fiscal deficits across geographies, aggravating global debt vulnerabilities.

The credit risk of firms and households has accentuated. This could impact corporate earnings in short term. However, the equity prices continue to reflect strong earnings growth expectations. Developments that lead to re-evaluation of corporate earnings prospects will have significant implications for global flows, going forward.

Capital flows and exchange rate volatility

A hesitant recovery in capital flows to emerging markets (EMs) began in June 2020 and picked up strongly following positive news on COVID-19 vaccines. The response of foreign investors to primary issuances from EMs has been ebullient. Anticipating the COVID-19 vaccine induced economic boost, US yields of intermediate tenors (2– and 5-year) have started edging higher. This could have implications for future portfolio flows to EMs.

EM local currency bond portfolio returns in US$ terms have been lower than local currency as well as hedged returns since early 2020 as emerging market currencies have softened against the US$. This has led to sluggishness in EM local currency bond flows even as global bond markets have been pricing in a prolonged economic slowdown and benign inflationary conditions in Europe and US. In this scenario, any significant reassessment of either growth or inflation prospects, particularly for the US, can be potentially destabilising for EM local currency bond flows and exchange rates.

Improvement in bank asset quality might be misleading

By September 2020, the banking stability indicator (BSI) showed improvement in all its five dimensions (viz., asset quality; profitability; liquidity; efficiency; and soundness) that are considered for assessing the changes in underlying financial conditions and risks relative to their position in March 2020. This improvement reflects the regulatory reliefs and standstills in asset classification mentioned earlier and hence may not reflect the true underlying configuration of risks in various dimensions.

Banks risk losing better quality customers

A sharp decline in money market rates specifically since April 2020, has opened up a significant wedge between the marginal cost of fund based lending rate (MCLR) benchmark of banks and money market rates of corresponding tenor. Expensive bank finance may lead to more credit worthy borrowers with access to money markets shifting away from bank based working capital finance. Such disintermediation of better quality borrowers from banking channels could have implications for banking sector interest income and credit risk.

Banking sector prospects to see marginal changes in 2021

In the latest systemic risk survey (SRS) of October/November 2020 about one third of the respondents opined that the prospects of the Indian banking sector are going to ‘deteriorate marginally’ in the next one year as earnings of the banking industry may be negatively impacted due to slow recovery post lockdown, lower net interest margins, elevated asset quality concerns and a possible increase in provisioning requirements. On the other hand, about one fourth of the respondents felt that the prospects are going to improve marginally.

…stress to come with a lag

Domestically, corporate funding has been cushioned by policy measures and the loan moratorium announced in the face of the pandemic, but stresses would be visible with a lag. This has implications for the banking sector as corporate and banking sector vulnerabilities are interlinked.

Macro stress tests indicate a deterioration in SCBs’ asset quality and capital buffers as regulatory forbearances get wound down.

NPA ratio of banks may see sharp rise

The stress tests indicate that the GNPA ratio of all SCBs may increase from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 under the baseline scenario. If the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8 per cent. Among the bank groups, PSBs’ GNPA ratio of 9.7 per cent in September 2020 may increase to 16.2 per cent by September 2021 under the baseline scenario; the GNPA ratio of PVBs and FBs may increase from 4.6 per cent and 2.5 per cent to 7.9 per cent and 5.4 per cent, respectively, over the same period.

These GNPA projections are indicative of the possible economic impairment latent in banks’ portfolios, with implications for capital planning. A caveat is in order, though: considering the uncertainty regarding the unfolding economic outlook, and the extent to which regulatory dispensation under restructuring is utilised, the projected ratios are susceptible to change in a nonlinear fashion.

In light of the findings of FSR, the governor of RBI, Shaktikanta Das has cautioned the investors and financial institutions that “The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India” and “Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.

I take note of the above red flags and continue with my “underweight financials” strategy for 2021.

 Ricky Ponting, the former captain of the Australian cricket team, commented during a TV show on Sunday that Indian team may not be able to score 200 runs in the fourth inning of the third test match played in Sydney. Ponting was obviously trolled badly on unforgiving social media for his “prejudiced” and “audacious” forecast. India went on to score more than 300 runs and even managed to draw the test. Ponting later clarified that his “view” was based on the condition of the pitch on fourth day. The pitch did not deteriorate on fifth day as expected. Nothing much should be read into his statement. He need not have presented his defense. The social media would have forgotten his statement in couple of days, anyways.

The stock market experts (strategists, analysts, fund managers and seasoned investors etc.) who stick their neck out and make forecast about the market trends and likely levels of benchmark indices often face the situation like Ponting; especially for past 2 months those who are cautious on the market and warning a sharp correction are consistently at the receiving end. Regardless, the markets will keep rewarding investors and keep having corrections.

Moving on to business, I found the following five points worth noting from media reports in past couple of days. In my view, these five points aptly highlight the internal conflicts and challenges within the policymaking framework, and pose potential risk for the seemingly unstoppable stock rally.

1.    The road transport and highways minister Nitin Gadkari, highlighted that probably steel and cement manufacturers have made cartels to keep the prices artificially higher. The two being the key inputs for physical infrastructure development, may lead to material rise in the cost of development and even hamper the viability of projects. He even proposed a regulator for monitoring process of steel and cement (see here).

In UPA-1 tenure, the then finance minister tried to hit the cement cartel by introducing differential tariff structure based on price per bag, Rs190 being the differential point. Should the market expect something similar in weeks to come? In 2007-2008 the differential pricing and price regulation only helped the government in raking higher revenue. The industry and private consumers did not benefit much. (see here)

Besides, the suggestion for a pricing regulator also highlights the tendency of the government to impose deeper and wider regulation to control various segments of the economy. This is obviously contrary to the commitment of “less government more governance.” It also confirms the rising policy unpredictability.

2.    WPI inflation has now risen for seventh consecutive month led by food (see here). Energy prices have also been rising steadily over past few months. This may require a rethink on the RBI premise that food inflation may be mostly a seasonal phenomenon and wane in few months due to base effect. If the food & energy inflation persists, the second round effect may begin to become pronounced from the next quarter. The hopes of a meaningful monetary easing may be belied; and even fears of a rate hike might begin to bother markets.

3.    Many analysts are interpreting higher food inflation as good for rural income (and hence consumption demand); and higher energy prices as good for languishing energy sector stocks. “Cyclical” is projected to be the mood of this spring (see here). Higher energy prices shall reduce at least some of the cost advantage of cement and steel producers that has led to sharp earnings upgrades.

4.    The finance minister has earnestly committed a historic budget 2021. She went on to say that this shall be a budget unlike any presented in past 100yrs (see here).

There is no empirical evidence to support the finance ministers’ inclination to think radically or take risks. During the course of 2020, she made many attempts to enthuse the markets with a series of “historic” stimulus packages; but was hardly found inspiring by the markets.

The good thing is that markets may not be placing much high hopes from the budget; and the finance minister has a chance to surprise the markets this time. The bad thing is that no one is expecting higher taxes; even though the reports are indicating a serious discussion within the government about a Covid cess (see here). The ugly thing is that LTCG is again in the agenda of various budget discussions.

5.    TCS has reported an excellent set of numbers. Most other IT companies are expected to follow the suit. The Nifty IT has yielded a return of ~66% in past 12 months; ~89% in past 24 months; and 122% in past 36 months. In past 1 month, the IT sector has yielded a return of ~18% vs (~17% for Nifty in past 12 months). In past couple of months, most brokerages have published uber bullish reports on the sector, forecasting strong returns over next 2-3years. IT sector along with pharma, has been a massive outperformer for past 3yrs, over all other sectors.

The question is whether risk reward in the sector is still as attractive as it was a year ago?

In my view, the market is now running like a Formula One car. It can see the challenges and obstructions but cannot afford to stop or slow down. So far it has negotiated the sharp turns and obstructions brilliantly. But at least I cannot say with confidence that about the next mile. I am therefore happy watching the race sitting at the fringes, till it lasts. I have no intention of entering the track with my Alto K10 to compete with Ferrari SF90.

 Besides digital transformation of global economy, sustainability is the other theme that had dominated the investment strategies in past three years. The global energies have remained focused on enhancing the role of digital capabilities in our day to day life, and making the growth sustainable in terms of the pressure on natural resources and dispersal of harmful waste in the environment.

Scrolling through my social media timelines, I gathered some interesting instances of “sustainability” theme dominating the investment discourse.

·         Market capitalization of Tesla Inc., the US company making electric cars, among other things, has topped market of top 10 global auto makers; even though it’s annual revenue is about US$28bn (vs. Toyota revenue of US$572bn).

·         The stock price of Orsted A/S, a Danish largest energy company in Denmark and world's largest developer of offshore wind power, has risen by 275% (vs S&P500 growth of 36%)

·        Zhong Shanshan, the Chinese promoter of Nongfu Spring (water bottling and selling) and Wantai Biological (vaccine manufacturing) surpassed Oil Refining Moghul Mukesh Ambani and Oil retailer Jack Ma, to become the richest person in Asia.

·         Markets celebrated the victory of “climate change hawk” Joe Biden with London Stock Exchange’s FTSE making an all-time high, despite the country (UK) facing serious healthcare emergency and fresh lockdown.

In Indian context, stocks of companies like Borosil Renewable (PE 203x, Market Cap 3x Revenue); Suzlon Energy (Loss per share -2.95, Market Cap 2.6x Revenue) and Adani Greens (PE 9956x and Market Cap 67x Revenue) have been prominent amongst the most poplar shares in past one year.

It is evident that the stock markets, as usual, have embraced the trend enthusiastically, just like a toddler would embrace a new toy. It is very difficult to separate the toddler from his new acquisition. He/she would eat, sleep, play and do everything else with the new toy in his/her hand. Invariably, the alienation would occur only when a new toy is presented to the child or the old toy gets broken very badly.

Remember, the toddlers who fell in love with Suzlon & Inox Wind (wind energy)’ JP Power (Hydro Power); Himadri Chemical (Lithium Batteries) etc. are still nursing their wounds (emotional and financial).

Just to set the record straight, personally I am a huge supporter of the sustainability effort. I strongly believe that these efforts will create tremendous investment opportunities in next one decade. These opportunities need not come necessarily from the clean energy or producers of natural products. Many of these opportunities shall come from the existing businesses adopting sustainable methods, and thus improving their productivity and acceptability. As a tiny investor, I do not have resources to analyze the risk involved with businesses focused on new technologies and products. I would therefore focus on established businesses adopting new technologies and methods to become sustainable.

Some examples of such opportunities include – large FMCG companies becoming water and carbon neutral; large IT companies adopting solar energy and work from home as normal business practice; textile companies using natural colors.