Vijay Kumar Gaba: Stock Market

Showing posts with label Stock Market. Show all posts

Friday, April 22, 2022

Let the cows return home before it is too dark

The stock price of the over-the- top (OTT) streaming major Netflix has fallen ~68% from it's all-time high price of US$695/share in November 2021. The current price is lowest since December 2017. At the current price (US$226/share), the stock discounts trailing twelve months earnings by 32x. The company makes a healthy ~31% return on equity and ~11% return on assets. The revenue, operating margins and net profit margins achieved during the past twelve months are higher than the past 5yr average. The company has been generating healthy operating cash flows, but not yet generated free cash flows.

The reason for the latest US$150 fall in Netflix’s share price is the first ever reduction in its subscribers’ base (which may be largely due to Netflix withdrawing its services from Russia).

Six months ago, numerous analysts and portfolio managers were jostling with each other to justify a PE multiple of over 100x for the stock, citing the exciting business model and growth prospects for the company. Most of them are now rejecting the stock with sheer disdain. The following excerpts from a communication of famous portfolio manager to clients aptly demonstrate the change in sentiments:

“Today we sold our investment in Netflix, which we purchased earlier this year. The loss on our investment reduced the Pershing Square Fund’s year-to-date returns by four percentage points. Reflecting this loss, as of today’s close, the Pershing Square Funds are down approximately two percent year-to-date.

While we have a high regard for Netflix’s management and the remarkable company they have built, in light of the enormous operating leverage inherent in the company’s business model, changes in the company’s future subscriber growth can have an outsized impact on our estimate of intrinsic value. In our original analysis, we viewed this operating leverage favorably due to our long-term growth expectations for the company.”

I draw multiple inferences from this latest popular episode of investment learnings. This episode not only reinforces investment learnings that I have gathered over the past three decades; but also provides some key guidance to the current economic environment. Some of the key inferences are as follows:

(a) The current business environment is as dynamic as it was during the industrial revolution in the late 19^th century. Most robust of the business models can become redundant in no time. “Long-Term” investing needs to be defined keeping this factor in mind.

(b) The consumption baskets of consumers are now overwhelmingly aspirational and discretionary. The consumption patterns are therefore susceptible to dramatic change in very short term. Any investment thesis that assumes longevity of the present consumption patterns, without providing for sudden changes, could be ineffective.

(c) Economics and markets eventually converge. Assuming the divergence between economic fundamentals and stock performance to be sustainable over the long term could be fatal to the portfolio returns.

(d) The popularity of a portfolio manager, the size of asset under management and past track record in terms of return generated on portfolio is no guarantee of infallibility. It is important to assess a portfolio manager from the robustness of his investment process; ability to differentiate between “market euphoria” and “investment opportunity”; and most important the strength of conviction in the businesses chosen for investing.

(e) A significant proportion of equity analysts are primarily spread sheet (e.g., MS-Excel) experts. They deftly extrapolate the latest numbers to “long-term” trends and accordingly arrive at their estimates. Their estimates are away from the actual performance in most cases. The investors must learn to distinguish between the “analyst” and “Excelists”.

Netflix is only an example of irrationality in the investment process. There are numerous such stocks in the market that need to return to normalcy. Sooner it happens, better it would be for everyone. Let all the cows return home before it is too dark.

Wednesday, March 2, 2022

Su karva nu? (What to do?)

As I indicated last week (see here) to me markets are not looking good, at least for now. And it is definitely not only due to the latest episode of Russia-Ukraine conflict. This conflict has only added to the caution. My primary problem is the lack of adequate growth drivers for the Indian economy.

There is a virtual stagflation in the domestic economy, constraining private consumption. The exports have helped in the past couple of years to some extent. However, the higher probability of slowing growth in the western countries due to tightening monetary policies and the spectre of a prolonged geopolitical conflict in Europe and probable reorganization of the global order (political realignment, trade blocks, currency preferences, energy mix etc.) clouds the exports’ growth in FY23.

Another key driver of growth in the past few years has been public expenditure. The government made decent cash payments to the poor and farmers to support private consumption. It also accelerated the expenditure on capacity building, to compensate for the slower private investment. From the FY23BE it is clear that the government’s capacity to support the growth is now limited by fiscal constraints.

What does this mean for the equity markets?

In my view, the following ten themes have been the primary drivers of the performance of Indian equities in past five years:

1. Larger well organized businesses gaining market share at the expense of smaller poorly organized businesses. Demonetization, GST and Covid-19 have aided this trend materially. This trend has been seen across sectors and geographies.

2. Import substitution and make for exports. Many sectors like chemicals, pharmaceutical (API), electronics, food processing etc. have built decent capacities to produce locally, the goods that were largely imported. Some global corporations have increased their domestic capacity to address the export markets from India. Many Indian manufacturers have also built material capacity to address the export markets. The government has aided this trend by providing fiscal and monetary incentives.

3. Implementation of Insolvency and Bankruptcy and some ancillary provisions, gave impetus to the resolution of bad assets and material improvement in the asset quality of the financial lenders.

4. Persistently negative real rates, stagflationary environment, business stress for smaller proprietary businesses and significant losses in some debt portfolios, motivated a large section of household investors to invest in equities for augmenting their incomes and even protecting the savings.

5. Increase in rural income due to cash payouts by the government, higher MSP for crops, better access to markets etc.

6. Increasing popularity of digital technology, driving efficiency for traditional businesses and facilitating numerous new businesses (Etailers, FinTech, B2B & B2C platforms, incubators, etc.) that command significantly higher valuation than their traditional counterparts.

7. Overcapacity in infrastructure like Roads & power, where traditionally India has remained deficient, resulting in higher productivity and better cost efficiencies for businesses.

8. Aspirational spending of the Indian middle class outpacing the essential spending, resulting in higher discretionary spending.

9. Climate change efforts prompting higher interest in clean energy and electric mobility.

10. Cut in corporate tax rates leading to higher PAT for numerous companies.

To decide what to next, an investor will have to make assess how the current and evolving economic, financial and geopolitical situation will:

· Impact these drivers of Indian equity markets?

· Impact the earnings forecasts for FY23 and FY24, which basically hinge upon the operation of these drivers?

The assessment will also have to factor whether the impacts as assessed above, will have an endurable impact or it will be just a passing reflection.

In my view, it will just be a passing reflection and these drivers of the Indian equity market shall endure in the medium term (3 to4 years). Therefore, I would mostly be ignoring the near term turbulence and stay put. I would:

· Follow a rather simple investment style to achieve my investment goals. It is highly likely that this path is boring, long and apparently less rewarding, but in my view this is the only way sustainable returns could be obtained over a longer period of time.

· Avoid taking contrarian views.

· Take a straight road, invest in businesses that are likely to do well (sustainable revenue growth and profitability), generate strong cash flows; have sustainable gearing; timely adapt to the emerging technology and market trends, and most important have consistently enhanced shareholder value. These businesses need not necessarily be in the “hot sectors” and these businesses may necessarily not be large enough to find place in benchmark indices.

Of course there is nothing proprietary about these thoughts. Many people have often repeated it. Nonetheless, I feel, like religious rituals and chants, these also need to be practiced and chanted regularly.

Wednesday, February 16, 2022

Time for tortoise to chest the tape

In yesterday’s post I had highlighted that the previous two market cycles had not ended well for the broader markets (see here). By the time the cycle had ended, a large majority of stocks (smallcap and midcap) had given up much more than what they had gained on their way up. Only a couple of hundred stocks ended the cycle with some gains.

This is however not to take away anything from the fact that many stocks like Havells, Escorts, Page Industries, PI Industries, IndiaMart, APL Apollo, L&T Tech, SRF etc. changed their orbit and moved sustainably higher in the previous two market cycles. Also, many stocks either moved to the lower orbit or just vanished as the market cycles were coming to end. JP Associates, ADAG Group stocks, Suzlon, Jet Airways, DHFL, IL&FS, are some of the examples. This is the story of every market cycle and there is nothing unusual about this. This story will inevitably be repeated in the current market cycle also. By the time cows come home, some companies would have transcended to the higher orbits; many would have been relegated to the lower planes; and some would have made an ignominious exit from the markets.

The issue to examine at this point in time however is where do we stand on the current market cycle - Has the cycle peaked and the indices have commenced their descent? Is the market taking a pause and a lot of climb is still left? Have indices already completed their journey downhill and are close to their base camps?

It is of course beyond my sphere of competence to portend where the markets are heading in next few months. Thus I would know the answer to the above only in hindsight.

However, as I hinted in yesterday’s post (see here), the empirical evidence indicates that the current market cycle may be far from over. Therefore, we have either just started the descent and have a long way to go down; or it is just a pause in the climb.

If someone forces me to take a bet, I would bet on the “pause”, for the following five simple reasons:

1. The Indian corporate sector is embarking on a major earnings growth cycle, led by financials, after more than a decade. The valuations are nowhere in the vicinity of the “red line”.

2. The global central banks have already embarked on a major monetary tightening cycle. There is no reason to believe that their united effort would be defeated by inflationary forces. All central banks acting in unison shall be able to defeat inflation in next 6-9 months, as the logistic constraints due to Covid-19 have already started to ease materially. Lower inflation (or deflation) and smooth supply chains shall help both the consumption and manufacturing in India.

3. Higher policy rates and tighter liquidity shall impact the growth more in advanced economies as compared to the emerging markets. This shall reverse the direction of global investment flows towards emerging markets, as has been the case in the past tightening cycles.

4. The inflated (bubble like) valuation like new age businesses are a very small proportion of the Indian public market. A vertical crash in these valuations may not have a crippling impact on Indian markets.

5. In the past 5 years, Indian corporates have deleveraged their balance sheets materially. Most of the “large” bad accounts have been identified and the restructuring process is either completed or is ongoing. The probability of a major shock to the financial system stands significantly reduced.

In other words, for the markets to collapse from here we would need major disappointment in earnings; collective failure of central banks in reigning inflation; a global recession and collapse of some major enterprises. To me these events are less probable.

So how do I see the market moving in FY23?

I believe once the markets assimilate the impact of Fed lifting rates and geopolitical noise subsides in the next couple of months, we are more likely to witness a “bore” market rather than a “bear” market. The exhilarating “hope” trade (new age businesses, macro improvement, China+1, EV, PLI etc.) shall pave the way for the “patient” value trade that shall benefit from controlled inflation, positive flows and sustainable rise in earnings trajectory.

There is nothing to suggest that the existing stock of domestic money in the stock market may fly out in the next couple of years; even if the fresh flows slow down. As the breadth narrows down, the AUM of mutual funds and portfolios of investors may get more concentrated in top 150-250 stocks keeping the benchmark indices high, even though the broader market indices struggle at lower levels. In the past we have seen this kind of market during 1995-96; 2001-03; 2010-12, and 2018-19.

To sum up, FY23 may be the time when the tortoise may chest the tape while the hare lags behind.

Tuesday, May 12, 2020

Nothing looks outside of the realm of possibilities

Thirty years ago, the period between May 1990 and December 1990, was a watershed in global social, political and economic order. In the 7 months, the world changed the most in the post WWII era. For India, in particular that was a defining period in post independence history.

In global context, some of the key events that took place in those seven months included the following:

(a) Apartheid ended in South Africa, marking the end of one of the darkest chapter in world history.

(b) The process of USSR dissolution begins. The Supreme Soviet of the Soviet Union grants Gorbachev special powers to secure the Soviet Union's transition to a market economy.

(c) Soviet Union collapse marked the end of a bipolar world that had divided the world in two camps in post WWII era. In the subsequent two decades, USA would reign over the world as the only super power.

(d) End of cold war between USA and USSR with treaty to destroy chemical weapons and most of the nuclear arsenal.

(e) Iraqi forces invaded Kuwait. This was followed by the invasion of Iraq by 34 nations in a joint operation, first of its kind in post WWII era. This was followed by a long bloody war between the super power USA & its allies on the one side and radical Islamic forces on the other side. The war on terror thus started still continues, but many key supporters like Saddam Hussain, Muammar al-Gaddafi, Osama Bin Laden etc have been eliminated.

(f) Reunification of Germany, ending more than four decades of separation of German people, healing the post war wounds.

(g) LTTE guerillas massacred 600 unarmed Lankan policemen intensifying the long violent conflict in Sri Lanka.

(h) WHO removed Homosexuality from its list of diseases, erasing the centuries old stigma attached to the practice.

(i) The era of Iron Lady Margret Thatcher ends in UK.

In the Indian context also many significant events took place, which changed the course of Indian politics, economics and social milieu forever.

(i) Massacre & exodus of Kashmiri Pundits in January 1990 was followed by firing by CRPF on funeral procession of Mirwaiz Moulana Muhammad Farooq in May 1990. These events triggered a long intense terror war in the valley, nearly destroying the heaven on earth.

(ii) Mandal Commission report was implemented in India, reserving 49% of government jobs for SC/ST and OBC in India. This changed the politics of India forever, marginalizing the Congress Party and strengthening the regional parties who contested elections on social justice slogan not the poverty elimination.

(iii) BJP President L. K. Advani undertakes a road trip (Rath Yatra) to mobilize support for a Ram Temple in Ayodhya. The V. P. Singh Govt falls, after Advani is arrested in Bihar. The BJP rises as the primary challenger in India's national politics. 6 year later Atal Bihari Vajpayee would make the first BJP led coalition government in India that lasted 13 days.

(iv) Chandrasekhar, a socialist leader becomes prime minister and initiates the transition of Indian economy from a controlled economy to free market economy. The job would be carried forward by the Congress government formed in 1991 under leadership of P. V. Narasimha Rao.

This was also the period, when the stock markets globally, including India, did rather well disregarding all the turmoil, uncertainty and concerns.

Three decade later, the circumstances are almost similar to the summer of 1990. The outbreak of novel coronavirus COVID-19 has completely shaken the global economics, politics, geopolitics and social framework. The things look set to change dramatically.

Nothing looks outside of the realm of possibilities. The ways people work, travel, socialize, live, eat, and communicate are all set for major changes. The global strategic and trade relations face the prospects of dramatic paradigm shift.

India will also be a participant in these changes. Marking "anything", yes I repeat "anything", as unlikely or impossible may not be appropriate at this juncture. The more uncertainty we face, more certain we must believe in the change.

The resilience of stock markets in light of this uncertainty has perplexed many market participants. Many readers have asked about my views on the divergence in the stock indices and real economy.

I will share my thoughts on this in next couple of days.

Wednesday, September 11, 2019

You must survive to enjoy the fruits of you labor!

As per the Hindu lunar calendar the ancestors' fortnight (पितृपक्ष), will start from tomorrow. As per the ancient Hindu traditions, all Hindus are obligated to serve Brahmins (Scholars) and feed crows during this fortnight. It is widely believed that serving Brahmins and feeding crows in this fortnight pleases souls of the ancestors and thus redeems the person performing this ritual from the debt of ancestors.

Hindu religious traditions also mandate that a grand feast must be organized by all Hindus within 3weeks of the death of their parents, spouse or children. In this grand feast Brahmins, Dogs, Crows and the poor are served with delicious food. Brahmins and poor are also given cloths, cash and other gifts.

I am not competent enough to comment about the traditions of other religions and cultures, but I am sure similar traditions are practiced by the followers of other religions also.

The anecdotal evidence that I have collected from my interactions with numerous villagers and urban poor, this feast (श्राद्ध) could be one of the top 10 reasons behind perpetual indebtedness, bonded labor and socio-economic distress of numerous rural Indian household.

Regardless of the religious significance and/or relevance of these rituals, I find it pertinent to to highlight that "the feast" will be held regardless of you. In case you want to enjoy the feast, you need to survive till good times arrive; otherwise it will be for the Brahmins, poor, cows and crows to enjoy the feast.

Relating this analogy to the economics, markets and politics—

In past two decades corporate India has invested huge amount of money in creating capacities. Many of these capacities, especially in infrastructure and real estate sector, have been created without bothering about the prevailing demand conditions. Consequently, a significant amount of these capacities became economically unviable. Promoters who created these capacities, bank managers who funded these capacities, and investors who provided equity to these promoters and lenders - are all in distress.

There is no argument against the need for these capacities. The demand will also come in next few years. But the question is who will enjoy the feast. The bank managers would have retired, sacked or shunted out for his poor performance. The promoters would have diluted his equity substantially at distress price or forced out by IBC. The equity investors would have booked the loss.

The Brahmins and Crows - the new bank manager in whose tenure these capacities will become viable adding to bank's profitability, investors who will buy equity at distressed prices and acquirers who would then be managing the show - will feast on the misery of others.

The traders in stock markets usually have this tendency to protract recognizing their losses. These losses could be due to wrong choice of stock, sudden change in external environment, or any other reason. But the first reflex of most traders is to average the cost by buying into the fall in prices. More often than not the traders end up losing more money than they would have lost had they booked the loss at first hint of trouble. The pain of loss rises exponentially when they see the whole market recovering, except the stocks they own.
It must be understood that to benefit from whatever good a government does, the political parties running that government will benefit from that good only if they survive to see the result of their good deeds. Otherwise, the party that will form the successive government will enjoy the benefit.

The moral of the story is simple - You must survive to enjoy the fruits of you labor!

Tuesday, August 20, 2019

Suggestions for stimulating the economy

Suggestions for stimulating the economy

The number of people cautioning about a deeper and longer economic slowdown in India is rising by the hour. Tata Motor's management has guided for double digit fall in automobile sales in FY20 (see here). Most auto companies have announced shut downs; some have also announced significant reduction in the employed workforce. SBI chairman is insisting on urgent need for some stimulus in almost each of his public presentations (see here). Most other senior banks and industrialists have also sounded the caution begul (see here)

The stock markets have corrected sharply in past one year; though the benchmark indices may not be reflecting the correction as yet. The wealth erosion for investors has been material. The market participants are clamoring hard for a stimulus package to bring the economy and market back on path of high growth.

Whereas, most businessmen and market participants have echoed the demand for stimulus, I have not seen many actionable solutions being suggested. Generally the solutions suggested are limited to lending rate cut, GST rate cut, and roll back of tax provision relating to surcharge and long term capital gains.

In my view, roll back of the tax provisions relating to long term capital gains and surcharge on high income non corporate entities may not add to the economic growth in any significant measure, though it might be a short term sentiment booster.

As per the available data, SBI has already cut MCLR by about 30bps post recent repo rate cut of 35bps. Current SBI MCLR (8.25%) is now ~100bps lower than the highest rate seen in early 2016. However, the current interest rate is still 300bps higher than the lowest rates we saw in 2003. Given the persistent low inflation, low money multiplier and global strong deflationary trends, there is scope for meaningful rate cut. To be effective immediately this rate cut must have some shock value. Small doses of 10-20bps cut in lending rate may take much longer to reflect in higher demand and therefore may not qualify as "stimulus".

A material cut in GST rates for automobile etc may stimulate demand. However, the impact may be somewhat neutralized as lower GST revenue shall constrict government's spending ability. In case the government chooses the path of fiscal expansion through additional market borrowing, the private investment may get crowded out. GST rate cut therefore may not be an easy option for the government to exercise.

I believe the government needs to take these conventional stimulating measures steps in adequate quantity. However, to enhance the impact of these measures, a number of additional measure aimed at boosting sentiments and stimulating higher trade volumes and activity level would be needed simultaneously.

The following are some of the illustrative measures that could be considered by the government for immediate implementation:

(a) In most parts of the country, the Ready Reckoner or Circle Rates (minimum property rates considered for levying stamp duty) are much higher than the prevailing rates of property. The government must consider bringing this minimum threshold to 10% below the prevailing market rate to stimulate transactions in property market.

(b) Capital gains of upto Rs25lacs on all constructed properties may be exempted from income tax for two years, i.e., AY21 and AY22.

(c) Capital gains on sale of gold may be exempted, provided the entire sales proceed is invested in buying one or more constructed property (residential or commercial).

(d) Concessional Housing advance by companies to their employees in next 2years may not be treated as perquisites during the term of the advance.

(e) Trading in agri commodities may be exempted from cash transaction limits completely for 2yrs, i.e, till March 2021. Post that restrictions may be applied in graded manners over next 5yrs.

(f) GST input credit for automobile purchase may be allowed for six months, i.e., October 2019 to March 2020.

(g) Upto 50% discount may be offered on power tariffs to all green field industrial units that are approved before March 2020 and begin commercial operation before March 2022.

(h) The payment time for all government contracts and supplies may be cut to 15days from the present 60-180days. All outstanding payments to contractors and suppliers may be released immediately. The arbitration and legal awards in favor of the contractors and suppliers may be honored immediately.

(i) PSU banks may be adequately recapitalized immediately.

(j) Long term corporate bonds (10yrs or more original maturity) may be treated at par with equity for capital gains taxation purposes. Periodic Interest on such bonds may be taxed @10% without any limit.

(k) CSR spend in setting up rural schools and health centers may be made tax deductible at 125% of the amount spend. The operating and maintenance expenses on such schools and health centers may also be made tax deductible.

(l) 25% capital subsidy may be provided to agri produce processing units set up in the rural areas, provided the farmers who would supply agri produce for processing to such industrial unit form a cooperative society; and such cooperative society is allotted 25% equity in such unit free of cost. Gram Sabha land may be leased to such industrial units at nominal rent.

(m) The government may make a solemn promise that the effective rate of direct taxation for any assessee shall not rise for next 3yrs

Wednesday, August 14, 2019

What do we really want?

What do we really want?

To accelerate the economic growth in order to generate more employment and improve the quality of life of Indian populace, the country indubitably needs huge amount of fresh capital.

Various economists, government agencies and expert committees have suggested that to attain optimum level of employment Indian economy would need to grow 8-10% CAGR for next decade or so.

The capital investment required by private sector to create critical infrastructure to support 8-10% GDP growth is pegged in the range of US$10-12trn over next 10yrs. Energy sector alone may need investment of more than US$1trn over next one decade.

It is well recognized fact that such kind of long term risk capital may not be available internally. Foreign investment is therefore a pre-requisite for the process of economic planning, development and growth. Any debate on path, trajectory and sustainability of growth should therefore begin with this assumption that adequate foreign capital would be available.

A pragmatic economic development and growth plan under the current circumstances should therefore acknowledge the following in the preamble itself:

(a) India needs huge amount of long term risk capital to achieve the goal of fast, equitable and sustainable economic growth and development.

(b) Meeting of this goal is materially contingent upon flow of foreign capital.

(c) Despite unprecedented liquidity sloshing the global financial system, the risk capital that could be invested for long term in an emerging market like India is scarce and circumspect.

(d) The long term risk foreign capital will come to India at its own terms and not at the whims and fancy of the politicians and myopic bureaucracy.

...do we want to follow the herd?

However, what is true for long term risk capital (commonly known as FDI) may not be true for the short term arbitrage money (commonly known as Foreign Portfolio Investment or FPI).

This is the money that usually is not invested by the owner of the money. Instead professional investors, who are paid to maximize the returns for owners of the money, exercise the control over such money. Mostly, their interest in the investment is limited to the remuneration they would get. The remuneration is usually based on the relative performance of the money invested over a small period of time (usually 12 to 24months).

In order to maximize their remuneration, these fund managers would chase the relative outperforming assets in a most secular fashion - with no regional, racial or systemic bias. They would go to communist China, chaotic Russia, democratic but unpredictable India, war torn Africa, vulnerable Chile & Columbia, or struggling Venezuela and Argentina.

As most of them usually move in a herd, they are able to cheer the target market by driving up the asset prices with huge collective inflows in a short span of time. They invariably inflict severe pain and cause huge volatility by their ruthless collective exit.

There is little evidence to establish their long term positive impact on the investee market or economy. However, there is enough anecdotal evidence to show the damaging impact of the excessive volatility caused by their collective actions.

The South East Asian economies suffered tremendously at their hands during 1990's. Emerging markets crashed during subprime led global crisis, when some many of them were growing at 8% to 10% annual rate.

India too had have few instances of irrational boom and bust cycle driven by collective withdrawal of FPI money. 1998 post nuclear blast exodus, 1999-2001 dotcom bubble and bust, 2006-2009 easy credit driven boom and bust, and 2011-12 Grexit paranoia led selling are some major instances.

Besides, we have also seen frequent collective actions to pressurize the government and regulators over issues such as taxation (MAT, DTAA, GAAR) and transparency (P. Note disclosures), etc.

On most occasions the government and the regulators have given in to the pressure, deciding to maintain the status quo. Consequently—

(a) Many nagging issues got accumulated to keep the FPIs and agencies at confrontational path for many years.

(b) The message that goes to FPIs is that Indian government and agencies accord significant importance to the stock market indices and are willing to walk extra mile for a few billion dollars of FPI flows.

Currently Indian markets are witnessing yet another instance pressure tactics. This time most of the domestic participants are also pleading with the government to yield to the FPI demands. The indications are that the government will give in yet again.

The question that may still remain unanswered is "what do we really want?"

Do we want long term risk capital that would support out economy in achieving sustainable high growth? Or do we only care for the fleeting arbitrage money that would stay in India only until a better opportunity arises in some other corner of the world.

I am certainly not denigrating the importance and need of FPI flows to Indian securities markets. But I strongly believe that unlike the long term risk capital (FDI) these flows must be on our terms and within the regulatory framework designed to ensure orderly development of securities market.

Also read Modi Says Surplus Global Liquidity An Opportunity To Access Cheaper Funds

Wednesday, August 7, 2019

Keeping it simple

Some food for thought

"When my cats aren't happy, I'm not happy. Not because I care about their mood but because I know they're just sitting there thinking up ways to get even."

—Percy Bysshe Shelley (English Poet, 1792-1822)

Word for the day

Intellection

The action or process of understanding; the exercise of the intellect; reasoning.

First thought this morning

Home Minister Shri Amit Shah made an emphatic speech in the Parliament in support of government's decision to change the constitutional status of the state of Jammu & Kashmir. It sure is a historic and very brave step. The government, especially the prime minister and the home minister must be commended for this unconditionally.

I am sure with this determination, the government will be able to execute this decision as planned paving the way for overall development and growth the region.

The reply of the home minister to the debate in Rajya Sabha highlighted two things - (a) Article 370 and 35A of the constitution were temporary and transient provisions and have outlived their purpose; and (b) depriving the state of J&K from investment by outsiders has resulted in grave injustice to the state.

I mostly agree with him, and request the following:

(a) Article 341 provided that after 15yr of implementation of the Constitution, he official language of the Union shall be Hindi in Devanagari script The form of numerals to be used for the official purposes of the Union shall be the international form of Indian numerals. We all know that this could not be achieved in spirit, even though In 1976, Official Language Rules were framed under the provisions of section 8(1) of the Official Languages Act, 1963. The government at least should ensure that the Supreme Court allows the cases to be filed and heard in Hindi.

(b) There are number of other states that restrict or prohibit investment in property by people not domiciled in the respective states in pursuance of various provisions of Article 371. Many of these states are presently ruled by BJP, e.g., Himachal Pradesh, Uttrakhand, Arunachal Pradesh, Goa etc. It needs to be examined whether the people of these states are also being deprived because of these provisions.

(c) Indians visiting the States of Nagaland, Mizoram and Arunchal Pradesh require to take permit from respective states. The government may consider reviewing these provisions also.

Chart of the day

Keeping it simple

It was summer of 2014. The citizen of the country had just elected a new government with overwhelming mandate. The general mood in Mumbai, the financial capital of the country, was ebullient. It reminded me of the following lines of famous Hindi poet Baba Nagarjuna:

"कई दिनों तक चूल्हा रोया, चक्की रही उदास
कई दिनों तक कानी कुतिया सोई उनके पास
कई दिनों तक लगी भीत पर छिपकलियों की गश्त
कई दिनों तक चूहों की भी हालत रही शिकस्त।

दाने आए घर के अंदर कई दिनों के बाद
धुआँ उठा आँगन से ऊपर कई दिनों के बाद
चमक उठी घर भर की आँखें कई दिनों के बाद
कौए ने खुजलाई पाँखें कई दिनों के बाद।"

In this hope filled environment, I happen to meet CEO and CIO of a large asset management company, managing funds of about rupees one trillion. The CEO asked me how do I see Indian equity markets and where would I be investing my money?

From their public statements I knew that both of them were very bullish about public sector banks (PSBs) and had huge overweight in most of their schemes. I plainly told the guys, "I have not yet decided yet where to put my money, but I am very sure where not to put my money, and that is the funds managed by your AMC".

Not expecting such a direct reply, both were stunned and immediately exclaimed "why?"

I explained my rather simple logic to them as follows:

"One of the reasons for businesses and markets not doing well is the hugely stressed corporate balance sheets. Till the time these balance sheets are deleveraged and destressed, the wheels of the economy could not be put into motion.

Destressing the corporate balance sheets may inter alia involve one or more of the following:

(i) Writing off existing equity and Infusion of further equity by existing equity owners;

(ii) Conversion of debt into equity by lenders;

(iii) Writing off debt in full or part;

(iv) Sale of assets and repayment of lenders;

(v) Nationalization of firms.

Historically PSBs have always played a major role in destressing exercise by taking over a large part of the stress through loan write off, loan conversion into equity and/or asset take over. So this time also there is a significant probability that PSBs will be made to swallow the bitter pill to put the wheels of economy in motion, i.e., take over most of the stress from corporate balance sheets so that corporate may begin to borrow again.

This essentially means that PSBs and some private corporate lenders cannot do well, if the economy and market has to do well."

Nifty PSU Bank rose further 10% from ~4000 to 4400 in the next following 8 months (January 2015), before correcting 55% to ~1900 level in subsequent 12months (February 2016).

Last week, I heard the same couple, and a few more, voicing serious concerns about the future of PSBs and advising major underweight on state lenders. I feel it is time to be overweight on PSBs, again for the simple logic.

Corporate balance sheets have been destressed materially in past 5years. We hear new cases of stressed emerging every day. But these are regular cases which are part and parcel of banking business. Whatever latest cases of stress we are aware of may not account for 2qtr equivalent of profits of banking sector.

PSBs have obviously consumed the bitter pill. The wheels of the economy shall put in motion as the government begins its massive infrastructure building drive, besides affording material cash in the hands of consumers. A material rate cut may just be the catalyst consumers are waiting to begin spending.

Recapitalized and cleaned up PSBs would be at front foot in financing the investment and consumption growth as the rivals (NBFC and MFs) have been cut to size. Any recovery from stressed assets acquired during cleanup process would just be a bonus.

Important to note that unlike the 1990s credit cycle, PSBs have materially strengthened their systems and processes, rationalized their costs, attained a fair degree of autonomy (freedom from undue political pressure), improved their business model and enhanced their understanding of business dynamics in the process of learning from latest debacle.

To me, the top 4-5 PSBs offer best trading opportunity for next 2years. But remember, there could be some pain before any big gain accrues. And for god sake, please do not drag me into technical jargon like capital dilution, significant watch list, NBFC stress, IBC delays etc. I am not interested in bothering about these small chips in the big picture.