Vijay Kumar Gaba: VijayGaba

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Friday, October 4, 2019

Thursday, October 3, 2019

Sentiment watch

Last weekend I had an opportunity to address a gathering of stock market intermediaries. The interface provided some useful insights which I find pertinent to share with the readers.

All the participants deal with small and medium sized household investors and traders, commonly referred to as the Retail Investors. The common refrain was that the recent stock market rally has not benefitted the retail investors. Most of these investors are stuck with the struggling mid and small cap momentum stocks which are down anywhere between 25%-75% from their cost of acquisition and no hope of recovery.

To make the matter worst, many of their active clients are still looking to buy the fallen angels, the stocks where the equity value is negligible or even negative in some cases. Most popular stocks with this segment are stock of JPA group, ADAG Group, Jet Air, DHFL etc.

Tata Motors, SAIL, Nalco, Coal India and Yes Bank are some of the stocks which have perhaps disappointed the largest number of retail investors.

The investors' sentiment has improved marginally post the restructuring of corporate tax rates announced by the government. However, most of them remain skeptic about the sustainability of the current up move. There appears to be a widespread expectation that the budget for FY21 will contain provisions for restructuring of the personal income tax rates also.

The feedback about the business sentiments was scanty. Nonetheless, there appears to be some improvement in business sentiments. Most of the people would however like to wait for supplementary announcements like rate cuts, easier credit terms and government spending etc.

The two key concerns of the participants were:

1. Will the promoter be encouraged by new tax provisions and set up new units as private entities, rather than investing in the growth of the existing listed entities?

2. How the government will manage the fiscal deficit post the rate cuts, especially when the GST shortfall is also going to be much higher than anticipated? Will higher deficit constrain RBI in cutting the rates further? and Will the government investment in infrastructure be pushed back by couple of years due to revenue shortfall?

My take on these concerns is as follows:

Fresh capex

In my view, the first concern may not be valid for the businesses owned by Indian promoters and/or investors. For, many of the Indian businesses (e.g., in cement, power, chemicaal, steel, auto sectors) have either done material capex in recent past or are running at poor capacity utilization and do not need to do invest in fresh capacity in near term.

Insofar as the foreign companies are concerned, many of them like Maruti, Bosch, Siemens, Cummins, and Schneider etc have been investing outside the listed entity for past many years. This trend may continue or even accelerate. The consumer MNCs like Colgate, HUL etc do not need to do much capex in near future at least.

Fiscal deficit

The relationship between the investors and the fiscal deficit is akin to the proverbial Mother in Law and Daughter in Law relationship. No matter what, the investors can never be fully satisfied with the fiscal conditions.

We have seen much worse fiscal conditions in past 3 decades. The point that is often ignored in comparison with global economies is that so far the fiscal deficit in India is still funded by the savers, mostly from middle and lower middle class. In fact, in past 4years the reliance in small savings to fund the fiscal deficit has risen considerably.

Historically, the governments have been managing the fiscal burden through maintaining the interest rates on savings in negative territory (deposit rates being equal to or lower than consumer inflation). In recent times the real rates have become hugely positive and there is lot of leverage there to cut rates and fund the fiscal deficit easily with no critical impact on the overall fiscal conditions.

Moreover, we are likely to see an aggressive disinvestment program in next 12-18months that shall compensate for some of the revenue shortfall. 5G auction in FY21 should also be supportive. However, if the rates are not cut meaningfully (or inflation does not rise meaningfully) in next couple of years, FY22 onwards we may see pressure on the fiscal conditions.

The key monitorable here is the private savings rate that has been declining consistently in past one decade despite very high real rates in recent years. If tax cuts can result in higher corporate savings, it would be good sign for the economy.

Remember the gamble the government has taken is that private investment will accelerate to compensate for the poor growth in public investment. If this bet fails in next 2-3years, we shall have a serious problem at our hand.

Thursday, September 26, 2019

Outlook & Investment strategy review

Since I reviewed my investment strategy three months ago (see here), few things have changed in the economy and market place; the most noteworthy being the following:

(i) The economic slowdown has become more pronounced. Both consumption and investment demand have slowed to multiyear low levels. The government has admitted that this slowdown is unique in nature, since it is for the first time in India that a economic slowdown has been triggered by poor demand growth rather than the usual supply side constraints. Many corporates, especially consumer facing businesses like FMCG and Automobile have echoed similar views. However, the recognition of the unique character of the slowdown within the government has been quite delayed. This has resulted in some misdirected policy actions.

(ii) The government has started the process of restructuring of tax laws, beginning with the announcement of new structure of the corporate tax rates. This has sent a strong message to the business and investor communities about the intent of the government. However, this piecemeal restructuring may not have the desired impact unless followed up by the remaining part, i.e., restructuring of personal income tax. This change may not have any material impact on economy and markets in the near term.

(iii) RBI policy has turned decisively accommodative with focus on ensuring transmission. However, most banks and NBFCs are still grappling with asset quality issues. Besides, the beginning of the process of PSBs consolidation might also slow down the policy transmission to some extent.

(iv) A large oil facility in Saudi Arab has been attacked. The attack was initially likened to the 9/11 attack on the New York twin towers. However, even two weeks after no retaliation of any kind is visible. It is difficult to fathom that the attack of this magnitude and audacity will go without an adequate response. However, since the global leadership is presently preoccupied with their own respective issues (For exsample, UK-Brexit; US-Impeachment, Trade War; China-Slowdown, Trade War) the action may be delayed. This may though remain a overhang in the global financial and energy markets.

(v) The overall corporate earnings may remain poor in 2QFY20 despite tax concessions.

(vi) The global economy is undergoing a slowdown that could be prolonged and more deflationary. The yields may therefore stay lower for longer.

In view of this, my outlook and investment strategy would be as follows:

Outlook

(1) Macroeconomic environment -Stable

(2) Global markets and flows -Volatile

(3) Technical positioning -Marginally negative

(4) Corporate earnings and valuations - Marginally negative

(5) Return profile and prospects for alternative assets like gold, real estate, fixed income tec. -Neutral

(6) Greed and fear equilibrium -Neutral

(7) Perception about the political establishment -Positive

Overall market outlook -Neutral to Marginally negative

Investment strategy

1. Presently, I am fully invested in all asset allocations. If the equity markets rise from here I would be raising 10% tactical cash.

2. Three fourth of my debt allocation is in medium duration gilt. One fourth is in select credit funds.

3. My present equity portfolio mostly comprises of quality mid cap stocks and a few large cap stocks. I shall maintain this mix.

4. I shall increase my overweight on specialty chemical, real estate, and construction. In healthcare, I have pure API manufacturers and CRAM players. I am inclined to add some auto ancillaries and CV manufacturers. I shall continue to avoid industrial commodity producers.

5. I shall continue to trade actively with of one fifth of my equity allocation.

6. I am mindful of the possibility of a significant global market correction and consequent major correction in Indian equities. I would continue to hedge against this possibility through quality of stocks in portfolio rather than buying a put.

I have assumed a relatively stable INR (Average around INR70/USD for 2019), weaker crude prices (Brent crude average below US$62/bbl) and lower rates in investment decisions. Any change in these assumptions may lead to change in outlook and strategy.

What will change my view?

Full blown recession in US.
Total tech melt down in US markets.
Hard landing in China, forced by escalation in trade war.
INR breaking and sustaining over 74/USD.
A full blown war in the Persian Gulf.
A disorderly Brexit

I shall not be bothered at all about the following:

Indo-Pak rhetoric
2QFY20 GDP growth number falling below 5%.
A few more struggling corporates and NBFCs defaulting on their debt payment obligations.
Trump impeachment
Rise in fiscal deficit in India
Results of state assembly elections

Wednesday, September 25, 2019

1HFY20 - Eventful 6months

The first half of the current fiscal (1HFY20) is almost over. On the domestic front, the past six months have been quite eventful for the country in general, and the economy & financial markets in particular.

Politically, the six month period witnessed the PM Modi led NDA returning to power with unexpectedly strong majority. Continuing with the tradition of unpredictable policy responses, the government has rewritten the rules for engagement with Pakistan and China by abrogating the controversial Article 370 of the constitution. Besides, a definitive move has been made towards implementing a uniform civil code by outlawing the practice of triple talaq (The right of men to divorce their wives instantly through oral or text communication) prevalent amongst Indian Muslims. A long standing dispute over the construction of Sri Ram Temple in Ayodhya has been fast tracked and a final Supreme Court Verdict on the dispute is expected in next 2 months.

These developments have removed some splinters that have been hurting the toe of Mother India for many decades. The procedure to remove the splinters is painful and full recovery may take some time. Nonetheless, if proper care is taken to heal the wound without letting the infection to spread, it will be a major relief for the country in medium to long term.

Economically, the growth continued to decelerate to lowest since global financial crisis. More and more sectors joined the class of slowdown. Three noteworthy events have taken place. The inflation is persisting at the lowest levels in a decade and manufacturing growth has almost stalled. Accordingly, tax collections have fallen much short of the budgeted targets weighing on the fiscal balance.

Firstly, the concept of Universal Basic Income (UBI) has been introduced to supplement the rural job guarantee (MNREGA) that was in place for past one decade.

Secondly, the process to restructure the scheme of income tax has been initiated with restructuring of the corporate tax. The process of simplifying and streamlining of GST has also gathered pace with further consolidation of slabs and classifications. A simplified GST and Corporate Tax structure shall provide a strong foundation for reorganization of Indian enterprises. Eventually, we may see large consumer facing businesses adequately supported by a vast network of smaller feed suppliers, contract manufacturers and service providers etc.

Thirdly, the process of bank consolidation has accelerated with on the tap licensing for smaller banks. This shall straighten the structure of Indian financial system that got distorted post demise of development financial institutions two decades ago. Two separate financing verticals one to finance the growth (infrastructure, projects and corporate) and the other to finance consumer and ensure financial inclusion shall get established in due course of time, of course with some overlap.

Financially, 1QFY20 was one of the weakest quarters in past 8yrs insofar as the corporate earnings are concerned. The asset quality remained under pressure with many some new areas of stress emerging. The household debt levels have increased while corporate have deleveraged.

RBI continued to ease monetary policy with rate cuts and liquidity infusion. The policy stance was changed to "accommodative" from "calibrated tightening" earlier.

The logjam between NCLT and Judiciary continued to plague the process of resolution of stressed assets under IBC.

Financial Markets have been volatile. The benchmark stock market indices are little changed from their six month ago levels, thanks mainly to the massive rally in past few day. INR is weaker by couple of percentage points due to 60bps fall in benchmark yields and FPI outflows.

Tomorrow, I shall present my current investment strategy and market outlook.