Vijay Kumar Gaba

 Once upon a time a sparrow couple made their nest in a wheat farm. In few days, lady sparrow laid four eggs. In two weeks eggs were fully hatched and four chicks were born. In the meantime, the wheat stems had started growing tall. In another two weeks, the chicks started to fledge and the wheat kernels began to turn golden. This was the day when parent sparrows first discussed about leaving their nest and move somewhere else.

“The crop will be soon ready for the harvest. Our nest shall be exposed and trampled by the harvesters”, the lady sparrow feared. Her companion however was not worried as yet. “Nothing to worry as yet”, he assured her.

In another three weeks, the farm turned completely golden with wheat completely ripe to harvest. The lady sparrow was terribly worried now. “We must fly out now. The chicks have also grown up now and can easily fly to the woods behind the hill”, she argued with her companion. “Nothing to worry as yet. We have plenty of food here. Let chicks eat god and become strong”, the companion remained nonchalant.

In couple of days, the farmer came to the farm with his wife. He looked at the ripe crop with pride and said, “we shall now call my brothers and begin harvesting the crop from tomorrow”. They soon left the farm. The lady sparrow was terribly frightened now. ‘We must fly out right now”, she coaxed his companion and chicks. “Nothing to worry for now”, the companion quipped playing with the chicks.

After couple of days, the farmer again came to the farm with his wife. “My brothers are all thankless and selfish”, he said annoyingly. I would help them whenever they need, but they have refused to help me in harvesting. I shall now call all my neighbors and begin harvesting from tomorrow. “I beg you please let’s fly out now”, the lady sparrow pleaded with the family. The children had become strong and comfortable in the farm by now. “Not yet”. The companion reiterated. The children agreed.

One week passed, nothing happened. One day the farmer and his wife again came to the farm. He saw that the wheat kernels were beginning to wither now. The golden crop had developed many black spots. “We live in a world full of selfish and thankless people. We cannot count on anyone for help”, he said furiously to his wife. “Let’s buy our own tools and begin harvesting ourselves from tomorrow”, the farmer said resolutely. “Hey guys let’s get ready, it’s time to fly out”, the sparrow told his companion and children, with a sense of urgency. “What happened now” the lady asked. “Farmer has realized that no one helps those who do not help themselves”. He will definitely come tomorrow and begin harvesting, the companion bird explained.

From my exposure to ground realities, I can confidently say, “common people have now realized that government and administration can help them only if they are willing to help themselves”. I believe that the anguish and annoyance of people is fast turning into self-help enterprise. Numerous community enterprise have sprung up everywhere to help those suffering from pandemic. Help has started to pour from every corner of the world. Indubitably, there is cynicism towards apathy of the politicians and administration. However, one can see signs of this cynicism abating slowly or transforming into resolve to fight it out.

For politicians and administrators it may the time to join the fighting enterprise of common people or fly out as soon as possible.

After almost 5300years, the human civilization may again be entering a copper age. In the Copper Age 1.0 (which mostly occurred between 4500BC to 3300BC) the human transited from stone age to metal age. Copper age was just before we learned to mix tin with copper to make bronze, a stronger metal to be used for hunting tools. A variety of research shows that the invention of first proper round wheel may have happened in this period. The wheel was initially used primarily for pottery and children toys, before it was used in vehicles to transport man and material. Copper age therefore is considered to be an important watershed in evolution of human civilization.

A strong consensus is evolving amongst global expert that acceleration of climate change efforts mean that human may be entering Copper Age 2.0, as the “Red Metal” shall play a critical role in decarbonisation of global economy.

As per a recent research note of Goldman Sachs, “The critical role copper will play in achieving the Paris climate goals cannot be understated. Without serious advancements in carbon capture and storage technology in the coming years, the entire path to net zero emissions will have to come from abatement - electrification and renewable energy. As the most cost-effective conductive material, copper sits at the heart of capturing, storing and transporting these new sources of energy. In fact, discussions of peak oil demand overlook the fact that without a surge in the use of copper and other key metals, the substitution of renewables for oil will not happen.” The report further notes that “At the core of copper’s carbonomics is the need for the world to shift away from a production system based on the chemical energy of hydrocarbons (oil and gas), to one based on a range of sustainable sources – electromagnetic (solar), kinetic (wind) and geothermal. Copper has the necessary physical properties to transform and transmit these sources of energy to their useful final state, such as moving a vehicle or heating a home.”

ING’s research team noted that “Copper seems to be marching towards the peak from its previous cycle thanks to risk-taking and inflation fears. The red metal’s constructive fundamentals, and green narrative on the demand side, seem to be reinforcing the bull run. Given that policymakers seem to be allowing the economy and markets to run hotter, we see further upside for prices near-term.”

ING research further highlighted that “Macro tailwinds, combined with copper's constructive fundamentals and a 'green' narrative in medium- to longer-term demand, could see upside risks dominate for copper…suggesting the red metal could be on a parabolic run, testing previous highs.”

A senior executive at BHP, one of the largest copper producers in the world, was quoted as saying that surging demand for green renewable energy implies that “To keep pace with these mega trends, copper production will have to double over the next 30 years.”

No surprises that copper prices in global markets have risen more than 85% in past one year.

The Goldman Sachs’ note cited above notes that “Crucially, the copper market as it currently stands is not prepared for this demand environment. The market is already tight as pandemic stimulus (particularly in China) have supported a resurgence in demand, set against stagnant supply conditions. Moreover, a decade of poor returns and ESG concerns have curtailed investment in future supply growth, bringing the market the closest it’s ever been to peak supply.”

Are we prepared

Insofar as India is concerned, we mine about ~0.2% of global copper concentrate and contribute about ~4% to the total global copper production. The three major players Sterlite Copper, Hindalco Industries and Hindustan Copper dominate the copper industry in India. The copper production in India has been declining for past years, mainly on account of legal issues; whereas the consumption is rising. The reliance on imports therefore is rising.

The moot point is how do we prepare for Copper Age 2.0? At present it seems that Copper and Natural Gas imports will replace the Crude Oil imports. We might therefore continue to remain vulnerable on trade account and energy security.

The stock price of few top IT services companies in the country recently corrected sharply after declaration of 4QFY21 results. The explanation commonly offered and widely accepted for the fall in stock prices was that “the results were not as per the street expectations”. I find this little intriguing, especially in the current market environment.

It is well acknowledged that in recent times, the non-institutional investors (“retail investors” in common parlance) have been the dominant players in equity markets world over. In my past 30years of interacting frequently with this category of investors in India, I know that a large majority of these non-institutional investors are not well versed with financial analysis, especially related to the forecasting of financial performance and deriving fair price based on such forecasts.

Moreover, there is an insignificant minority in this category of investors which actually relies on the target prices forecasted for a security by “fundamental analysts”. This simply because they invest in a stock for much larger gains than an average analyst can possibly forecast.

Therefore, I find it little hard to accept the explanation that not meeting consensus forecast disappointed the “market”, even though the results are good and the forward guidance provided by the company is even better.

Another disturbing fact is the level of discussion on TV channels and social media about the future performance of reputable company. For example, I heard some young enthusiastic analysts having 6-8years of post qualification experience in equity analysis, questioning the guidance of the managements of companies like Tata Steel, Infosys, TCS, etc. I saw an analyst, who has spent just 5hours in a cement plant; has never purchased a bag of cement for himself; has always been a commerce student; learned the chemistry of cement from St Google, rejecting the demand forecast made by the management largest cement company in India.

Obviously, these analysts’ forecasts will eventually prove to be way of the mark. However, that is none of my problems. My problem is whether an investor should be relying on the forecast and guidance of the management, which has consistently delivered on its guidance; or go by the “street expectations”; particularly, when few are aware about the constituents of this “street”. It may be pertinent to note that in case of many mid and small cap stocks only 2-3 nondescript brokerages release their estimates. Thus the “street” in these cases may be extremely narrow, dark and stinking.

In this context, the following findings of a recent study by UBS Securities are also interesting to note:

(a)   In past one decade, the market consensus has overestimated one year forward Nifty EPS by an average of 20%, at the beginning of the relevant financial year. E.g., the earnings of FY22 are likely to be overestimated by 20% on 1 April 2021.

(b)   The analysts were so off the mark that even on the last day of the relevant financial year when only one quarter of earning was remaining to be declared, there was usually an overestimation by ~9%. In past year this error has ranged between 10% to 15%. Implying that even on 31 March 2021, the consensus Nifty EPS for FY21 could be overestimated by ~9%.

So before you call your broker to execute a trade based on what the anchor or analyst on TV is telling you about the earnings forecast, street expectations, forward guidance etc, please hold for a second and think “do you actually want the TV anchor or a random analyst to drive your investment decisions?”

India's trade gap widened to $13.93 billion in March of 2021 from $9.98 billion a year earlier. The trade gap was however lower than the preliminary estimates of a higher $14.11bn. The key highlights of trade data were as follows:

·         In March 2021 exports soared 60.3% to a record high of $34.5bn (up from $27.5bn in Feb’21), marginally higher than the preliminary estimate of $34bn.

·         The exports surged ~60% yoy in March, driven mainly by $6bn rise in non-petroleum products’ export.

·         Imports in March 2021 were $48.4bn ($40.5bn in Feb’21), led by non-petroleum imports of $38.5bn ($31.5bn in Feb’21). Imports surged 54% yoy

·         Overall exports contracted by ~7.2% yoy in FY21, a reasonable figure given the difficult period for trade due to global lockdowns.

·         Imports were down 17% yoy in FY21, mainly on account of 37% lower petroleum import due to lockdown and mobility restrictions.

·         Trade deficit widened in March 2021 to $13.9bn ($12.6bn in February and $9.98bn in March 2020)

·         Pharma exports maintained high growth in March, growing 49% yoy to $2.3bn, an all-time high.

·         For FY21, India recorded current account surplus equal to 1% of GDP, due to lower imports and higher FPI flows. Overall BoP surplus in FY21 was $84bn.

I usually do not like to read too much into monthly macro data, unless there is a sustainable trend that could be reasonable extrapolated to future periods. However, I find that any decision based on headline trade data might be erroneous. It is important to factor in the details. For example, consider the following:

(a)   While almost all items recorded positive growth, majority of the growth in imports and exports was driven by abnormal growth in a handful of items.

Out of ~$17bn yoy increase in exports, gold imports alone accounted for 50% delta or $8.3bn. Reportedly, gold imports touched 98.6 tons in Mar 2021 from 13 tons a year ago.

(b)   Export’s growth was led by the growth Engineering products’ export, which accounted for almost one third of the export growth. It is estimated that large stimulus spending in trade partner countries led to higher engineering product growth. However largest export growth was recorded in Iron Ore, led by sharp rise in prices.

(c)    With fresh mobility restrictions the trade momentum may slow down again. FPI flows may also taper this year reducing the CAD and BoP surplus. The consensus appears a CAD deficit of ~1% for FY22. INR may therefore

On the positive side, the advance economies are outpacing the emerging economies in growth recovery. This trend augurs well for Indian exports, especially engineering goods. A weaker INR (my view 74-74.50/USD average for FY22) might be an added advantage.

India is presently passing through the worst phase of the pandemic. The scenes at hospitals, crematoriums, pathological labs, and in homes are heart-wrenching. Many young lives are being lost for want of basic facilities like medical oxygen and ventilators. Distressed and anguished citizens are begging for help, but to little avail.

It is distressing to find that there is no dearth of people who are trying to take advantage of this calamity by hoarding and black marketing essential drugs and medical equipment. The worst part is to find that many highly educated and influential people, who have developed symptoms of the disease, not getting themselves tested or not disclosing it to their contacts; and thereby accelerating the spread. Many people with symptoms have traveled in public transport risking the lives of co-passengers and adding to the alacrity of spread.

Last year we all had seen disturbing visuals of pandemic aftermath from developed countries like US, UK, Spain, Italy, etc. We had seen how the pandemic had exposed the fault lines of the healthcare system in those countries.

The most unfortunate part is that despite getting more than nine months of lead time (since the second intense wave hit the developed world) we failed to develop inadequate basic health infrastructure to handle the emergency. Rather, at many places the infrastructure already built last year to manage the crisis was either diluted or completely dismantled. Citizens had also lowered their guard. Norms were being flouted with impunity.

Anyways, we have this situation to survive and learn our lessons. In my view, the following could be the key learnings for this crisis:

(a)   First of all, we need to introduce Ethics as a main subject at primary and secondary level. The ease with which educated, uneducated, rich and poor break compliance rules, endanger others’ lives with selfish motives, is despicable. No society or country can expect to develop with this tendency.

Recently, I had an opportunity to look at the language books of primary and higher secondary classes. I was aghast to note that none of the books contained any story from Panchtantra or Jataka tales, indubitably amongst the best treasures in ethics and wisdom. In my view, Panchtantra alone may suffice as literature book for primary classes (standard 1 to 5).

(b)   We need to build a robust healthcare infrastructure in private public partnership. The CSR spending of corporate sector must exclusively dedicated to health and education at least for next one decade.

(c)    Physical activity (NCC, Sports, Yoga) must be actually made a compulsory subject till graduation level. Many young people are struggling with weak lungs, respiratory issues, weak immunity etc. It is extremely important to inculcate healthy life style and develop strong immunity from very young age. This must be strictly implemented, unlike the present system, where physical education period is usually free time for students.

(d)    The graduation program must include at least 500hrs of compulsory social service (CSS) for all streams. Each college must affiliate at least five recognized NGOs and students must be assigned to these NGOs for completion of CSS. Any cheating in this must result is total disqualification of the student.

 A Newsweek story couple of weeks ago (see here) highlighted that Americans may not be splurging the $1400 stimulus checks given by the Biden administration. As per the story, a survey has found that “Americans are generally saving about 42.6% of the third federal stimulus payments, up from 37.2% and 36.4% of the second and first stimulus checks respectively”. It is pertinent to note that the latest stimulus payment of $1400 is larger than the first two, which were $1,200 and $600 respectively. The Survey also finds out that little over one third of the latest payment has been used to repay debt, as compared to 37.4% and 34.5% respectively for the previous two stimulus checks.

This data could be interpreted in different ways. The most common interpretation is that the recipients may be saving the money to get some more clarity on the Covid-19 conditions and come out in hoards to spend in next couple of years (2022-2023). Few are interpreting it as harbinger of a structural change in the US consumer behavior. It is suggested that the shock of global financial crisis (GFC, 2008-09) and Covid-19 may result in curtailment of overspending habits of average American.

(The following is with inputs from www.zerohedge.com)

In its latest earnings report, JP Morgan drew attention towards another dimension of this phenomenon. The bank highlighted that “in Q1 its total deposits rose by a whopping 24% yoy and up 6% qoq to $2.278 trillion, while the total amount of loans issued by the bank was virtually flat sequentially at $1.011trnn (down 4% yoy). This implies that for the first time in history, loans to deposit (LTD) ratio of largest bank in USA is below 50% for the third consecutive quarter. Similarly, at Bank of America, the second largest American Bank after JPM, the amount of total outstanding loans is below GFC levels, implying NIL loan growth for 12years. In fact, the aggregates at the top four US Banks indicate, no loan growth for past 12years while deposits have doubled in this period.

Prima facie, this divergence is unprecedented. Traditionally, loans and deposits have not diverged to this large extent. However, if we juxtapose this divergence to the unprecedented amount of money printed by US Federal Reserve (QE) in post Lehman era (2008), this divergence may not appear too blatant; for the amount of excess deposits accumulated over past 12years is approximately equal to the amount of excess reserves injected by the Federal Reserve in that period.

This obviously has changed the traditional paradigm that banks create money through extending loans and in the process fractional banking builds the reserves at Federal Reserve. This time Federal Reserve has created money and that money is lying in banks as deposits. The velocity of money has crashed to lowest levels. This is the primary reason why trillions of dollars in new money printing have not resulted in any inflationary pressure so far; even though the equity markets have been factoring in bouts of hyperinflation for more than a year now.

The question now is “how this situation shall get corrected?”

Many analysts expect the situation to revert to the traditional paradigm as Fed begins to taper in 2022. It is estimated that tightening of liquidity from Fed would force banks to lend aggressively, at a time when the deposits may be shrinking. A couple of years of aggressive lending and withdrawal of deposits will restore the balance in financial markets. The collateral would be higher interest rates and higher inflation.

I am neither an economist nor a research analyst. I am therefore not eligible to make an intelligent comment on this situation. Nonetheless, my naïve view is that this saving glut has only allowed QE to persist for so long; which means, QE has been nothing but a book entry to sooth the nerves of markets. The collateral of QE has been massive reverse transfer of wealth, from poor to the rich by way of wealth erosion for poor (joblessness, negative rates, asset price erosion) and disproportionate rise in wealth of top 10%.

In my view, this tiger ride (QE) will end only when the rider (excess saving deposits) perish. I am however not yet inclined to believe that this will happen the way it is popularly believed, i.e., Fed tapering, higher rates, inflation, aggressive lending and higher investment & consumption demand. I have a feeling it will happen through currency redundancy. The USD and EUR deposits may just become irrelevant over years, as new independent currencies become popular establishing a parallel global monetary system. The small savers will carry this cross, as has been the case always.

 Over past couple of weeks, I had exciting interactions with some professionals from the IT capital (Bengaluru), Pharma Capital (Hyderabad), Engineering capital (Chennai), Financial Capital (Mumbai) and political capital (Delhi) of India. From these interactions I learned that a definite new paradigm is emerging in Indian commercial space. The following are some key take away from my interactions:

1.    Traditionally, a majority of Indian entrepreneurs have not aimed for global scale in their businesses. Despite a rich history in the areas like culinary and textile, few businesses of global recognitions and scale could be created in these areas. However, now the first generation entrepreneurs have materially widened their vision. Many of them are now working on business ideas with global markets and scale in sight. No eye now widens on the mention billion dollar figures.

2.    The skills in Artificial Intelligence are becoming common place. In late 1990s Indian youth acquired skills in basic programing and coding of computer programs. This helped them crossing ocean in hoards and make a good career. A similar phenomenon is developing in artificial intelligence skills. The difference however is that unlike 1990s, now a large proportion of the young professionals want to become entrepreneur of independent professionals. They are not looking just good salary. I am sure a few of them would certainly be able to repeat the fables of Bill Gates, Jack Ma, Jeff Bezos et. al.

3.    The best part is that there is a strong start up ecosystem already in place. There are numerous investors who are willing to risk money on a good idea. Not many are looking at government for support. In fact, if I were to take my sample as representative, the only support neo entrepreneurs are seeking from the government is (i) less interference; and (ii) supportive tax structure.

4.    A lot of people of Indian origin, who are settled abroad are positive on Indian skills and entrepreneurship. They are helping the new ideas with financial and technical support. Many of them appear to be keen to have substantial exposure to Indian startup ecosystem.

5.    Though, the visibility of startups in technology enabled financial services (FinTech), retail, food delivery, and gaming is highest, some amazing developments are happening in the area of agriculture technologies, space technology, engineering design, water management, logistics management, pharmaceutical research and healthcare.

After this round of discussions, I am even more convinced that we have already entered into a business and economic paradigm. I believe that over next couple of decades, maximum value creation shall happen in businesses with technology leadership. Intellectual property shall derive significantly higher premium over conventional property. “Services” will continue to be key driver of economy rather than “Goods”; notwithstanding the government’s focus on manufacturing and construction.

On the negative side, the pace of elimination of smaller businesses, which cannot invest in technology and are not equipped to become ancillary of a large business, will continue to accelerate. The inequalities shall rise on multiple levels – economic, skills, access and opportunity.

 Prices of industrial metals and base metals have risen rather sharply in past few months. Most prices are now ruling at multiyear high levels. Though it is not clear whether this trend continues to be driven by the “supply shock” or a “demand shock” is driving the prices of higher.

Actually, it could be a mix of both the factors. For example, growth of electric mobility and accelerated adoption of reviewable (solar & wind) energy could be driving the demand of copper faster than the supply; where China’s curbs on steel production to control emission levels may have extended a supply shock to global trade. Similarly, the massive Covid stimulus by developed countries (e.g., US announcing massive stimulus for infra building) may have added to demand acceleration for steel and aluminum etc. while renewed mobility restrictions in many jurisdictions, Suez logjam, container shortages etc. may have added to supply restrictions.

There are some conspiracy theories also in the works. Couple of which I heard go like this:

(i)    Fearing further intensification of trade war with US, EU, Quad etc., China may be building strategic reserves of many commodities, causing an artificial scarcity in global markets.

(ii)   The global currencies face the prospects of getting materially debased after trillions of dollars in fresh printing, over and above the global financial crisis (GFC 2009-10) printing. Traders may therefore prefer to invest in physical commodities and independent (digital) currencies rather than fiat currencies.

Famous economist Nouriel Roubini, in his latest blog wrote, “Make no mistake: inflation’s return would have severe economic and financial consequences. We would have gone from the “Great Moderation” to a new period of macro instability. The secular bull market in bonds would finally end, and rising nominal and real bond yields would make today’s debts unsustainable, crashing global equity markets. In due time, we could even witness the return of 1970s-style malaise.”

A fund manager friend, who has been resisting investing in commodity stocks because he believed that it is purely a supply shock driven phenomenon and cannot be sustainable, is not finding the rally irresistible. His reaction yesterday was not entirely unexpected, when he said, “Inflation will kill this market. Till then buy commodities. Exactly opposite of what I have been believing for a year now. I am finally succumbing and buying xyz @$$$.”

It is part of my investment strategy not to invest in commodity stocks, except for short term trading purposes. To that extent, I am not too concerned about the price action in commodity stocks. Nonetheless, I continue to believe that most of the current forecasts for commodity inflation may not be fully factoring in the impact of some emerging trends like:

(a)   United global action on climate change may result in some dramatic change in consumption patterns across the world. This shall definitely impact the demand supply equilibrium of many commodities.

(b)   Acceleration in trends digitization of transactions, remote working, consumption of services (robots for housemaids, digital games for actual games, animation over normal entertainment, AI generated customizable digital books for physical books etc.)

(c)    Wider changes in food preferences, especially sugar, animal protein, simple carbs etc.

(d)   The rising inequalities of income, wealth and access to technology, may result in sever contraction in discretionary consumption.

(e)    One of the prolonged side effects of the pandemic could be acceleration in demographic degeneration of global population. As per some thoughts it could have impact of fertility and it could also impact the will to procreate.

It may be pertinent to note the following in this context:

·         US President Joe Biden has invited 40 world leaders to the Leaders’ Summit on Climate on 22-23 April, 2021. The agenda apparently is “to underscore the urgency – and the economic benefits – of stronger climate action.  It will be a key milestone on the road to the United Nations Climate Change Conference (COP26) this November in Glasgow.”

·         Reportedly, the summit will be preceded by United States announcing “an ambitious 2030 emissions target as its new Nationally Determined Contribution under the Paris Agreement.

·         “South Korea is developing the world’s largest offshore wind farm, generating up to 8.2 GW of power. The $42.8 billion project is part of the country's aim to become carbon neutral by 2050.”

·         A few months ago, Chinese premier Xi Jinping also surprised the global markets by announcing that “China will aim to hit peak emissions before 2030 and for carbon neutrality by 2060.”

·         India has also made commitment reduce greenhouse gas emission intensity of its GDP by 33-35 per cent below 2005 levels by 2030.

·         Many global companies have decided to include “Work From Home” and ‘Work From Anywhere” in their regular business plans.

Obviously, none of it impacts the portfolio today and I plan to hold on to my present metal and sugar sector stocks’ for few more weeks. Also, I am not planning to add duration to my debt portfolio anytime soon. Nonetheless, I do not subscribe the hypothesis of a sustained bout of high inflation over next few years. I believe that technology and climate change efforts will consume most of the money floating around in the world and in 15-20years the world will become a much better, cleaner and safer place to live and work.

In the context of India stock markets, I found the following two things worth noting on Tuesday:

(i)    A number of brokerages wrote strategy notes urging the clients to use the recent “lockdown fear” led correction in stock prices as a good opportunity to buy stocks. Apparently, the strategy appeared to be driven by (a) deep fall followed by a sharp recovery in 2020; and (b) belief that the abundant global and local liquidity and low interest artes will continue to support equity markets for couple of more years at least.

(ii)   The IT sector stocks corrected rather sharply after the bellwether TCS announced a decent set of number for 4QFY21 and encouraging commentary for FY22. This highlights, in my view, that markets expectations may be running rather high in terms of corporate performance and payouts. There is virtually no margin for any disappointment on earnings or payout front.

Some research reports have taken note of the intensifying second wave of Covid-19 infection cases, and cautioned against the likely adverse impact of the incremental restrictions on mobility due to this. For example-

“The Economic data released yesterday showed that the restrictions & sporadic lockdowns in response to the fresh wave of coronavirus infections started impacting the overall demand & growth. The IIP contracted 3.6% for February 2021, mainly on account of a steep contraction in the manufacturing output. Meanwhile, India's retail inflation rose to a 4 month high of 5.52% in Mar (5.03% in Feb & 5.91% in Mar 2020) as food prices soared.” (Aditya Birla Capital)

“The sporadic lockdowns/mobility curbs & night curfews put in place across key economic hubs in India in the past few days are likely to cost the nation $1.25 bn/wk. Taking into account rolling COVID curbs, if the current restrictions remain in place until the end of May, estimate is that the cumulative loss of activity could amount to around $10.5 bn, or ~0.34% of annual nominal GDP. However, the impact on the Q1FY22 nominal GDP is likely to be higher, shaving ~1.4% from the same.” (Barclays Bank)

The Nomura India Business Resumption Index (NIBRI) dropped sharply to 90.7 for the week ending 4 April from 94.6 the prior week, ~9.3pp below the pre-pandemic normal. This is its steepest weekly decline since mid-April last year. Accordingly, Nomura has cut the 2021 GDP forecast for India to 11.5% from the earlier 12.4%.” (Nomura Securities)

It is pertinent to note that currently, Nifty valuations (one year forward PER) are at 15% premium to the long term (10yr) average; and the market consensus is expecting ~32% earnings growth in FY22 followed by ~18% growth in FY23. Obviously, the expectations are running high, leaving little room for any disappointment.

Even after the recent episodes of sporadic mobility restrictions impacting the business and consumer sentiments, and downgrade of overall GDP growth for FY22, the consensus earnings estimates have been cut by less than 2% for FY22.

In my view, we may see further downgrades in both macroeconomic growth and earnings growth estimates for FY22. I am not sure if market may be forced to de-rate the equities’ valuation by these downgrades, but any rerating would certainly be difficult.

Currently, market consensus appears to be working with Nifty EPS of Rs640-650 for FY22 and Rs750-770 for FY23. I would prefer to be somewhat conservative and work with Rs590-610 for FY22 and 680-700 for FY23.

This means, I may be mostly ignoring the benchmark indices and focusing on businesses which I found (i) reasonably valued; and/or (ii) having very high visibility of growth, in spite of Covid-19 related obstructions. Because the Lord has commanded that “Blessed are the meek: for they shall inherit the earth” (Bible, Mathew 5:5)

Just when everything appeared to be settling nicely, the volatility in Indian equity markets has increased materially. The sharp corrections at any hint of adverse event highlights the jitteriness (and to some extent lack of conviction) of market participants. Considering that household investors (and traders) have increased their participation in the market significantly in past 6-8 weeks, the pain quotient of any sharp correction from here could be significantly higher.

Evidently, while the benchmark indices are now mostly flat for past 8-9 weeks, the sectoral shifts have been meaningful. Investors have adopted inflation (commodities) and cyclical recovery (mid and small cap) as a primary investment theme. Financials, discretionary consumption and realty sectors have witnessed a major “move out”.

The investors positioning seems to be, inter alia, based upon the following premise:

(a)        The earnings recovery witnessed in 4QFY21 shall continue for most of the FY22 and FY23.

(b)   The inflation which has been mostly a “supply shock” phenomenon in past three quarters will become a “demand shock” as cyclical recovery continues to gather pace and supply response lags the demand surge.

(c)    End of forbearance period for loans may lead to accelerated delinquencies, especially from MSME sector.

(d)   RBI shall continue to pursue accommodative monetary policy, regardless of the fiscal conditions, inflationary pressures and pace of cyclical recovery.

(e)    The companies may further improve on the multiyear high margins achieved in 2HFY21 and justify PE rerating of mid and small cap stocks.

The investors’ positioning is mostly based on promise of higher fiscal spending and incentives for setting up new manufacturing capacities. Obviously the assumptions suffer from a certain degree of dissonance.

Stress in MSME sector that is driving financials down is not reflected in sharp outperformance of mid and small cap stocks. Fears of lockdown, poor income growth etc. are reflecting in underperformance of discretionary spending (auto, media, realty etc.) but the “demand shock” expectations in metals etc. contradict this positioning. Service sector underperformance also mostly belies the cyclical recovery thesis.

The participants’ positioning also does not fully factors, in my view, the recently added high risk dimension to the RBI’s monetary policy. So far the quantitative easing (money printing) has been the domain of the jurisdiction having a universally acceptable currencies (US, EU, Japan, UK). RBI has ventured into this with a partially convertible currency. This could be a two edged sword. Could make INR highly volatile and impact the CAD.

The following excerpts from some recent global research are worth noting:

“US producer price inflation has jumped to a 10-year high. Business surveys suggest pipeline price pressures continue to build with some surveys suggesting a greater ability to pass higher costs onto consumers. This will add to the upside risks for CPI in coming months and increasingly points to earlier Federal Reserve policy action.” (ING Bank NV)

“China’s renewed focus on de-carbonisation leading to steel capacity cuts, strong domestic demand and muted global coking coal costs are likely to sustain high steel margins globally over FY22-23E. Lower Chinese export rebate as suggested (for months now) in media articles can discourage Chinese steel exports further. India domestic HRC price ex- Mumbai stands at c. INR 60k/t , significantly higher than JM/street assumption of INR 48k/t, while the landed China price at c. INR 68.7k/t leaves significant room for further price hikes in the domestic steel circuit.” (JM Financial Research)

“After two consecutive quarters of solid earnings beats and upgrades, we expect another strong quarter, aided by a deflated base of 4QFY20 and healthy demand recovery for the large part of 4QFY21 – as attested by high-frequency indicators. Performance is expected to be healthy despite headwinds of commodity cost inflation in various sectors. The key drivers of the 4QFY21 performance include: a) Metals – on the back of a strong pricing environment and higher volumes; b) Private Banks and NBFCs – on moderation in slippages and improved disbursements / collection efficiency; c) a continued strong performance from IT – as deal wins translate into higher revenues; d) Autos – as operating leverage benefits offset commodity cost pressures; and e) Consumer Staples and Durables – on strong demand recovery despite commodity price inflation. MOFSL and the Nifty are expected to post a healthy two-year profit CAGR of 16% and 14%, respectively, over 4QFY19–4QFY21” (Motilal Oswal Securities)

“If our growth projections were to come to fruition, India’s economy would pass the US$6.4 trillion mark by 2030, with per capita income at US$4,279 – reaching the upper middle income country threshold. This implies a real GDP growth of 6% and nominal growth of 10-10.5%. A key ingredient to our forecast is our estimate that manufacturing as a share of GDP will rise from approximately 15% of GDP currently to 20% by F2030, implying that its goes from US$400bn to US$1175bn. We believe that the thrust toward a manufacturing-led growth will set in motion the virtuous cycle of productive growth of higher investment - job creation - income growth – higher saving - higher investment and India would be one of the few large economies offering high nominal productive growth.” (Morgan Stanley)

I shared my investment strategy with readers in December 2020. I expected 2021 to be one of the most difficult years for investors in terms of high volatility, poor expected returns from diversified portfolios and continued low return expectations from cash and debt. After 3months into the year, I am even more confident about my view.

I continue to believe that to generate normal return on the financial asset portfolio one would need to maintain a certain degree of flexibility in portfolio. A part of the portfolio may be dedicated to active trading, at least in 1HFY22. I am therefore not changing my investment strategy for next 6months at least.

I may share my current investment strategy as follows:

Asset allocation

I shall continue to maintain high flexibility in my portfolio, by keeping 30% of my portfolio as floating, while maintaining an UW stance of equity and debt.

Large floating allocation implies that I shall be trading actively in equity.

(a)   The fixed equity allocation would be 40% against 60% standard.

(b)   The fixed debt investment would be 20% against 30% standard.

(c)    I would park 10% in cash/money market funds.

(d)   30% of portfolio would be used for active trading in equities and debt instruments.

My target return for overall financial asset portfolio for FY22 would be ~7 to 7.5%.

Equity investment strategy

I would continue to focus on a mix of large and mid cap stocks. The criteria for large cap stocks would be growth in earnings; while for midcaps it will be mix of solvency & profitability ratios and operating leverage.

(a)   Target 6% price appreciation from my equity portfolio;

(b)   I shall be overweight on IT, Insurance, Healthcare, Agri input and large Realty stocks. I shall maintain my underweight stance on lenders for at least 1HFY22.

(c)    For trading I will focus on large cap liquid stocks.

Miscellaneous

I have assumed a relatively stable INR (Average around INR74/USD) and slightly higher short term rates in investment decisions. Any change in these assumptions may lead to change in strategy midway.

I would have preferred to invest in Bitcoin, but I am not considering it in my investment strategy due to inconvenience and unease of investing.

Factor that may require urgent change in strategy

·       Material rise in inflation

·       Material change in lending rates

FY21 in retrospect