Vijay Kumar Gaba

Seven reasons to expect faster disinflation (Nomura Securities)

... driven by softer momentum and not just base effects. Most Asian central banks are

now on a pause, and the window to easing should open up later this year.

By mid-2023, we expect inflation momentum (m-o-m, seasonally adjusted) to be closer to central bank targets in most economies. This means most Asian central banks are now in a policy pause phase and, if underlying inflation moderates durably, as we expect, the window to easing would open up later in 2023.

#1. Asia’s inflation is driven more by supply than demand-side factors Asia’s inflation differs from inflation in the US/Europe, as it is more supply-side driven, and these drivers are gradually abating. Oil prices are around one-third lower than almost a year ago. FAO food prices have fallen for eleven consecutive months, and this has historically transmitted to Asia’s food inflation with a lag of around six months. Pandemic-driven supply-chain disruptions have fully normalised. Currency depreciation pressures have abated. The full impact of these easing supply-side pressures has yet to reflect in Asia’s inflation. That said, risks remain. There are upside risks to food inflation, such as climate change and El Niño (associated with less rainfall in Asia). Geopolitical risks are a threat. Lagged adjustments to utility prices or the removal of subsidies are also risks, although amid slow growth, we expect any such tweaks to be delayed into 2024.

#2. Base effects: The role of base effects in lowering headline inflation is well recognized. For instance, assuming unchanged monthly momentum, base effects alone could moderate percentage year-on-year headline inflation from current levels by 5.9pp by year-end in Singapore, 4.9pp in the Philippines and 2.9pp in Korea.

#3. Easing food/energy prices should lower headline and core inflation: Food and fuel have dominant weights in the consumption basket in EM Asia. They drive headline inflation, play important roles in expectations formation and often spill into core inflation, due to second-round effects. This is a key reason why policymakers pre-emptively use supply-side and fiscal measures to limit the pass-through from high food/energy prices to consumers. Now playing out in the reverse direction, the moderation of food/energy price pressures should lower headline inflation and curtail household inflation expectations, while also easing (sticky) core inflationary pressures.

#4. No wage-price spiral in Asia: Labour markets in Asia are less flexible, so the post-pandemic frictions caused by mass layoffs and early retirements (as seen in the US) are less of an issue. Countries like Singapore and Malaysia that are dependent upon migrant workers have already addressed the supply mismatch. Asia also continues to experience labour market slack, as a more restrained post-pandemic fiscal response has resulted in a more gradual demand recovery.

#5 Goods disinflation: Pipeline price pressures have eased materially across Asia, with falling import prices, lower PPI inflation and a moderation in the PMI input price index. Manufacturing firms used the past two quarters of lower input costs to recoup their margins; however, with weaker goods demand and subdued input cost pressures, we expect faster core goods disinflation.

#6 Services inflation is likely to moderate: Services catchup in Asia is largely complete and as wage growth moderates, this should have a salutary impact on services inflation. In countries where consumption is at a greater risk of slowing due to restrictive domestic monetary policy (e.g., South Korea), we expect services inflation to slow more rapidly. Housing rental inflation remains elevated, but higher interest rates are slowing residential property price growth, which will likely feed through to rental inflation, albeit with a lag. That said, our view is that services inflation in Asia is likely to moderate, rather than collapse, since domestic monetary conditions are broadly neutral.

#7. China is unlikely to be a source of inflation: China’s growth cycle is desynchronized from the rest of the world, but we do not view China as a material source of inflation risk, either to itself or globally. China’s growth rebound since its re-opening has underwhelmed in the cyclical segments like autos and property, and lacklustre export growth remains a challenge. With lower consumer confidence, weak income and job prospects, our China economics team expects the release of China’s pent-up consumption demand to disappoint market expectations, at a time when its policy stance is still one of support, but with restraint. For the rest of Asia, China’s services-led rebound is likely to have limited growth spillover effects on goods demand (which is what matters for Asian exports). Moreover, weak demand from US/Europe amid high uncertainty is likely to more than offset any positive spillovers from China reopening. In our view, the decision by OPEC+ to cut oil production, despite China’s reopening, suggests underlying demand is much weaker than broadly believed.

Q4FY23 Preview (Elara Capital)

We expect Q4FY23E Nifty50 sales to increase ~13% YoY and ~5% QoQ. Sequentially, we see an 81bp expansion in Nifty EBITDA margin (ex-financials) and a 71bp expansion in Nifty PAT margin (ex-Axis Bank due to one-offs following merger of the Citi portfolio), driven by overall lower raw material cost and easing off of commodity prices. We expect Nifty EBITDA (ex-financials) to grow at 9% QoQ and Nifty earnings to grow by ~3% QoQ, owing to margin improvement. If we were to consider one-off effect of Axis Bank-Citi merger, we expect Nifty earnings to post healthy 11% QoQ and 17% YoY growth.

Commodities, led by metals, are expected to post the highest YoY decline in earnings on lower prices and weak realization, while banks (ex-Axis Bank) are likely to grow by 33%, led by improving NIM and lower credit cost. Autos (ex-Tata Motors), fueled by raw material cost moderation, is expected to drive 32% YoY earnings growth.

We expect basic materials, led by metals, to erode 95% of Nifty’s incremental PAT YoY, implying materials will offset half of Nifty’s incremental profit, owing to lower realization and commodity prices. However, improved volume and recovery in steel prices since the past quarter means metals will add 95% to Nifty’s incremental PAT sequentially.

We see banks (ex-Axis Bank) contributing 72% to Nifty incremental YoY PAT, owing to sustained credit growth, improving NIM and lower credit cost, followed by energy, which would contribute 59% on improved marketing margin of oil marketing companies (OMC) and higher GRM of Reliance, due to Russia’s crude discount.

Overall, we expect financials and energy to contribute 131% to Nifty’s incremental YoY PAT. QoQ we see energy and materials contributing 216% to Nifty’s incremental QoQ PAT.

Despite geopolitical tensions, FII outflows, high inflation & interest rates, and the US-Europe banking crises in FY23, India remains resilient, with healthy corporate earnings in the first three quarters. In Q4FY23, financials are expected to dominate with improving net interest margin and lower credit cost. Double-digit growth is expected in consumption-oriented sectors, due to volume growth and softer raw material cost despite subdued demand in rural areas. The metals sector also is likely to recover sequentially, following removal of exports duties and easing off of COVID-19 related curbs in China. As the interest rate cycle peaks, macroeconomic tailwinds are expected to support earnings growth, even as global demand-led growth may falter.

India Autos: Staying Constructive (Jefferies Equity Research)

We remain positive on Indian autos with the sector in midst of strong earnings cycle. We see healthy 11-18% volume CAGR for PVs, 2Ws and trucks over FY23-25E, with 2W growth outpacing 4W. Strong top-line growth and better margins should fuel double-digit EPS CAGR for most OEMs.

2W growth to outpace 4Ws over FY24-25: India's auto demand, after suffering its worst downturn in decades, appears poised for continued double-digit growth in FY24-25. Two-wheelers (2Ws) have lagged in recovery but the abnormal 35% fall over FY19-22 created a very favorable base for the segment that is core to personal mobility; we believe 2Ws are ripe for a replacement cycle too. We see 2Ws outpacing 4Ws with 18% CAGR over FY23-25E (FY23E:+19%). While PVs (passenger vehicles) have witnessed some demand moderation in recent months, we see tailwinds from low penetration, aging vehicles-in-use, and reverse shift from shared to personal mobility, driving 11% CAGR over FY23-25E (FY23E: +26%). Trucks have entered the third year of up-cycle, and we expect 12% CAGR over FY23-25E (FY23E: +39%). Tractors, conversely, are at risk of a downturn, and we expect 15% fall in FY24E (FY23E: +12%).

Improving margin trajectory: Weak demand and a severe metal price rally weighed on auto OEM margins in the last 2-3 years. Steel (Indian HRC flat) and aluminum prices doubled over mid-2020 to Apr-2022, but then corrected 27-32% by Dec-2022, led by weakening China macro and tightening interest rates elsewhere. With China showing signs of cyclical recovery, metal prices are likely to have bottomed out; however, we believe the intensity of any potential price increase is unlikely to be similar to 2020-22. We expect 1-4ppt EBITDA margin expansion for most of our covered auto OEMs over FY23-25E, led by better pricing power amid good demand, and operating leverage benefit.

TVSL and TTMT strengthening EV franchise: The sharp increase in govt incentives, along with new product launches, has resulted in share of EVs in 2Ws rising from just 0.4% in FY21 to 5% in Mar-Q; we expect 10% by FY25. TVS has risen to #2 position in E2Ws in recent months; with its market share in E2Ws approaching that in ICE scooters, TVS is turning the electrification risk into an opportunity. While EV adoption in PVs is slower (2% of industry in Mar-Q), Tata is leading, with EVs forming 15% of its India PV volumes in Mar, and we believe it will benefit from rising EV adoption.

Valuations attractive; still time to Buy: We remain positive on Indian autos, with the sector in a positive demand and margin, and hence earnings, cycle. Most stocks are trading near or below their respective last 10-year average PE on our FY24 estimates; we find this attractive in the context of a strong earning cycle. We have fine-tuned FY24-25E EPS estimates for our coverage within +/-4% range.

Infrastructure: Stable awarding; calibrated aggression (HDFC Securities)

The NHAI had set a target of awarding 6,500 km in FY23, of which it awarded ~3,750 Km (vs. 6,306 Km in FY22) at an NHAI cost of INR 1trn. Ordering seems to have spilt over to FY24 with our checks suggesting ~INR 350bn of bids expected to be awarded during early H1FY24. During the year, HAM continued to be its preferred mode of awarding with 75/31/3 projects awarded on HAM/EPC/another basis. Competitive intensity reduced towards the FY23 end as developers maintained calibrated aggression. Non-road players outperformed their inflow guidance, while road players need to catch up on missed guidance.

Reduction in competition intensity: The competition intensity cooled off with the top-6 listed players placing their bids at an average of 14.3% over and above the NHAI cost vs. a 6.5% discount in FY22. Similarly, the top-6 unlisted players’ bids were at a 4.8% premium over the NHAI cost vs. a 2.9% discount in FY22. Further, HAM projects were bid at an average premium of 6.7/4.4/2.8/5.6% in Q1/Q2/Q3/Q4FY23. However, EPC projects continued to be bid at an average discount of 5.4/22.2/21.4/28.7% in Q1/Q2/Q3/Q4FY23. Out of the total 109 projects awarded during the year, 38 projects worth INR 361bn were awarded at an L1 cost of INR 418bn i.e. an average premium of 16% over the NHAI cost whereas, 71 projects worth INR 683bn were awarded at an L1 cost of INR 573bn i.e. an average discount of 16% over the NHAI cost.

FY23 order inflows; very few companies surpass/meet their FY23 guidance: Out of the coverage universe, companies like LT, Ahlu, ASBL, DBL, HG Infra, KEC, and KPTL have either surpassed or met or marginally missed their FY23 order inflow (OI) guidance. Companies like JKIL, PNC, and KNR have not even achieved 50% of their FY23 OI guidance. This is more a function of broad-based ordering beyond roads and well-diversified companies benefitting from the same.

Power T&D, Railways, Metro, Water, O&G, Hydrocarbon, and Building EPC witnessed robust ordering. Pickup in export orders aided inflows for the EPC companies like LT, KEC and Kalpataru. We expect a pickup in domestic power grid awards for capital goods and railways and private capex pickup shall aid strong inflows.

Valuation remains supportive: Tier-1 infrastructure companies are trading at ~9.5x FY25E EPS. We expect the competitive intensity to reduce further. Infrastructure asset creation is the top priority, which may lead to robust ordering.

Personal Loans Cross Rs 40 L cr in Feb; Industry Growth Moderates (CARE Ratings)

Gross bank credit offtake rose by a robust 15.5% year on year (y-o-y) in February 2023 due to strong growth across all the sectors, especially in the Non-Banking Financial Companies (NBFCs), and unsecured personal loans segments.

Personal loans growth accelerated to 20.4% y-o-y in February 2023 from 12.5% a year-ago period, driven by other personal loans, credit cards, housing and vehicle loans.

Credit growth for the services was robust at 20.7% y-o-y in February 2023 as compared with 6.2% a year-ago period due to growth in NBFCs and retail trade.

Industry credit offtake growth moderated at 7.0% (compared over the last couple of months), registering a lower growth compared to personal loans and services. Infrastructure witnessed a 0.6% growth due to slow growth in the power sector and a decline in the telecom sector and railways.

Housing loans (share of 47.6% within personal loans) grew by 15.0% y-o-y in February 2023 compared with 13.1% in the year-ago period. In spite of reporting healthy growth in the month, the share of housing loans dropped to 47.6% in the personal loans segment as of February 24, 2023, vs. 49.8% over a year ago as unsecured loans grew at a faster pace.

Unsecured loans reported a robust growth of 26.3% y-o-y in February 2023 due to the miniaturization of credit, digitalization of loans (faster loan turnaround and easier process), and preferences for premium consumer products. Its share increased to 32.5% in the personal loans segment as of February 24, 2023, vs. 30.9%% over a year ago. After housing, unsecured loans are the second biggest component in the personal loan segments.

Given the strong demand for different retail loan verticals, we anticipate retail credit growth to remain in the high digit for FY24.

Vehicle loans (a share of 12.4% within personal loans) registered a robust growth of 23.4% y-o-y in February 2023 as compared to 10.0% in the year-ago period. Outstanding for vehicle loans stood at Rs.4.96 lakh crore on February 24, 2022. Nonetheless, it declined by 0.1% over January 2023, witnessing a drop after 20 months. 

The investors are finding themselves standing at a crossroad again. For seasoned investors this is nothing new, but for a large proportion of investors who have started their investment journey in the past 5 years, this is something new.

At this juncture everyone has to choose a path for onward journey. The options are rather simple –

(i)    Continue the journey in the north direction - Stay with the extant strategy and hold on to your investments.

(ii)   Take a right turn towards the East - Review and restructure your portfolio of investments in light of the new evidence.

(iii)  Take a left turn towards the west – Change the strategy and rebalance the portfolio in favor of Safety and Liquidity from Return previously.

(iv)   Turn around and move back in the south direction - Liquidate the whole or a substantial part of your portfolio and wait for an opportune time to begin the journey afresh.

The empirical evidence suggests that the vintage of investors and size of portfolios plays an important role in making this decision. The seasoned investors and/or investors with larger portfolios usually avoid the fourth option and prefer the options listed at (i) and (ii) above; whereas the newer and/or investors chose from the options (iii) and (iv).

In my view, choosing an option is prerogative of the individual investors. I am sure, they make a decision which they consider best as per their investment objectives, risk tolerance, and personal circumstances. The problem however occurs, in most of the cases, when the investors avoid, delay or precipitate a decision. Avoiding a decision makes you jittery portfolio values move beyond your risk tolerance bands; delaying or hastening a decision often leads to wrong decisions.

The question is whether it is an appropriate time to take a decision; or the investors may take some more time to decide the future course of action; or is it already too late to take a decision.

I believe that each investor will have to answer this question individually; and I can speak only for myself. In my view, it is a bit late to make the decision, but not too late.

I would however like to mention a few historical facts that might help my fellow investors in making an appropriate choice.

Prima facie, the market conditions today may appear to be similar to the conditions during dotcom boom, bust and resurrection (1998-2000-2004). Like the dotcom bubble, this time also the market rally was characterized by the new age businesses with undefined business models and negative cash flows for prolonged periods, commanding unsustainable valuations. Like dotcom bubble, the low interest rates in past one decade fueled the bubble and rate hikes caused the burst.

·         For records, Nifty had gained 127% (800 to 1800) in a short span of 15 months (November 1998- February 2000). It gave up all the gains in the next 18 months (September 2001). It took almost three years (November 2004) for Nifty to “sustainably” break past the 1800 level. In the present case Nifty gained 148% (7500 to 18600) in 19 months (March 2020 to October 2021). In the next seven months it has shed about 25% of gains recorded in the preceding 19 months. So, if we assume the present case to be a case of repeat of dotcom

·         It is pertinent to note that while Nifty recovered the losses during the burst in 3years, many market leaders took much longer to recoup their losses. For example, Infosys took 6 years (2006), Wipro took 20 years (2020) and Hindustan Unilever took 10 years (2010) to reach their high levels recorded in the year 2000.

The present economic conditions are substantially different from 2000. The central bankers had sufficient ammunition to support the markets in 2000. The US Federal Reserve cut rates from a high of 6.5% in 2000 to 1% in 2004 to support the economy and markets. The inflation was not a worry and the new growth engines in the form of the emerging markets, especially India and China, were emerging fast to support the global growth. In the instant case, however, the central banks have virtually no ammunition left to stimulate the growth; all the growth engines of the world are stuttering and inflation is a major concern for the entire world. After all, the world perhaps has never seen a recession while the interest rates are still so low.

It is therefore reasonable to assume that the market trajectory may also be different than 2000-2004. Considering that the cycles (rate, Inflation, growth, etc.) are now much more shallow than 2000s. The rates this time may peak at much lower levels. We may not see global growth at 5% in near future and therefore inflation may not last longer either. The markets may not revisit 2020 panic lows and also may not take 3years to breach 2021 highs.

Nonetheless, the valuation readjustment within markets may be material and lasting. The valuations for many new age businesses that have lost significantly from their recent high might continue to correct further. Many of these businesses may fail to sustain and become extinct. On the other hand, some old age businesses that have corrected to “cheap” range may regain some prominence. So it would still be in order to restructure the investment portfolios.

For the record, I chose option (ii) a couple of months ago and took a Right Turn.

 I remind myself of this narration almost every market cycle. I think, it is the time to reiterate once again.

Have you ever been to vegetable market after 9:30PM? The market at 9:30PM is very different from the market at 5:30PM.

At 5:30PM, the market is less crowded. The produce being sold is good and fresh. The customer has larger variety to choose from. The customer is also at a liberty to choose the best from the available stock. The vendors are patient and polite, and willing to negotiate the prices. As the day progresses, the crowd increases. The best of the stuff is already sold. Prices begin to come down slowly. The vendors now become little impatient and less polite and mostly in "take it or leave it" mode.

By 9:30PM, most of the stuff is already sold, and only inferior quality residue is left. The vendors are in a hurry to wind up the shops and go back home. The prices are slashed. There is big discount on buying large quantities. Vendors are aggressive and very persuasive. Customers now are mostly bargain hunters, usually the small & mid-sized restaurant, caterers and food stall owners. They buy the residue at bargain price, cook it using enticing spices and oils, and serve it to the people who prefer to eat out instead of cooking themselves, charging much higher prices.

The cycle is repeated every day, without fail, without much change. No one tries to break the cycle; implying, all participants are mostly satisfied.

A very similar cycle is repeated in the stock markets.

In early cycle, good companies are under-owned and available at reasonable prices. Market is less volatile. No one is in a hurry. Smart investors go out shopping and accumulate all the good stuff.

Mid cycle, with all top class stuff already cornered by smart investors, traders and investors compete with each other to buy the average stuff at non-negotiable prices. Tempers and volatility run high.

End cycle, the smartest operators go for bargain hunting; strike deals with the vendors (mostly promoters and large owners) to buy the sub-standard stuff at bargain prices. Build a mouth-watering spicy story around it. Package it in attractive colours and sell it to the late comers and lethargic, at fancy prices.

The cycle is repeated every day, without fail, without much change. No one tries to break the cycle; implying, all participants are mostly satisfied.

If my message box is reflecting the market trend near correctly, we are in the end cycle phase of the current market cycle. I daily get very persuasively written research reports and messages projecting great returns from stocks which no one would have touched six months ago, even at one third of the present price.

The stories are so persuasive and the packaging so attractive that I am tempted to feel "it's different this time." But in my heart I know for sure, it is not!

In past one month, the set of businesses commonly referred to as “cyclical” in stock market jargon has outperformed remarkably. This one month outperformance has resulted in this set of stocks outperforming the benchmark Nifty on past 12 month performance basis also. Though, on three performance basis these stocks continue to lag substantially.

If I go by the media reports and the messages and report in my inbox, there is still “huge” value left to be realized in these set of stocks. The arguments are varied and quite persuasive.

·         A former CIO of a fund recently tweeted that “Deeply negative rates with excess liquidity getting cleared at zero rates is like cocaine to asset markets. We are in midst of a blow off top rally and if RBI does not mop this liquidity then stock prices in India could rise beyond imagination.

·         Another prominent fund manager, reputed for his stock picking skills, argues that so far the liquidity has gone into financial assets. From here on liquidity may move to real economy and fuel demand for infrastructure building and capacity creation. Components of cost like power, labor and interest rates are favorable for Indian businesses hence profitability should improve. There is strong case for investing in cyclicals which will benefit from capacity building in infrastructure and manufacturing.

·         The global brokerage firm Goldman Sachs (GS), in a recent report, highlighted that global Copper prices are now at highest level in past seven years. GS forecasts that “the world’s most important industrial metal was in the first leg of a bull market that could carry prices to record highs.” The report further emphasizes that-

“Against a backdrop of low inventories and net zero carbon pledges from countries including China, Japan and South Korea, Mr Snowdon believes significantly higher copper prices will be needed to incentivise new supply and balance the market.

We believe it highly probable that by the second half of 2022, copper will test the existing record highs set in 2011 [$10,162],” he said. “Higher prices should ultimately help defer peak supply and ease market tightness, but this first requires a sustained rally through 2021-22.”

·         A report by Motilal Oswal Securities highlights that Indian steel spreads have risen ~25% in 3QFY21 and are at a three-year high. Brokerage expects the spreads to stay strong on the back of a domestic demand recovery and higher regional prices.

It is further noted that Despite domestic iron ore prices rising to a five-year high, spot steel spreads are at a multi-year high due to higher steel prices and subdued coking coal prices. While iron ore prices from NMDC have increased by 30% YTD in FY21, imported coking coal prices have declined by ~35% YTD, keeping total raw material cost in check. As a result, domestic steel spreads are strong at INR33,000/t for flats (HRC) and INR30,000/t for longs (rebar).

·         Nirmal Bang Institutional Equities notes that Automobile sales continued its growth momentum in November’20 amid rise in preference for personal mobility on the back of good festive demand, upcoming wedding season, soft base due to overlapping of Diwali in November this year and continued positive sentiments in rural & semi urban markets. Barring 3Ws, all the segments reported YoY volume growth.

·         Emkay Global highlighted in a recent report that Chemical prices are firming up. The report mentions that In Nov’20, prices for key products such as Phenol, Benzene, Acrylonitrile, Butadiene, Toluene and Styrene jumped over 20% MoM in international markets. Rising container freight costs (~2x) on dedicated Asian routes due to a capacity crunch have pushed prices higher for certain chemicals. Freight costs within Asia are also likely to see an uptick in Dec’20 as carriers are prioritizing long-haul routes over shorter ones as a result of better economics. PVC prices have increased 10% MoM and are likely to swell further next month.

On the other side of the spectrum are people like Peter Chiappinelli of GMO, who are convinced that this liquidity fueled rally is about to end anytime now. In the latest GMO Asset Allocation letter, Peter emphatically advised his clients as follows:

“Currently, we are advising all our clients to invest as differently as they can from the conventional 60% stock/40% bond mix, just as we were advising them in 1999. Back then, we were forecasting a decade-long negative return for U.S. large cap equities. And that is exactly what happened. Today, the warning is actually more dire. U.S. stock valuations are at ridiculous levels against a backdrop of a global pandemic and global recession, and CAPE levels are well above 2007 levels, within shouting distance of the foreboding highs reached in October 1929. But it gets worse. U.S. Treasury bonds – typically a reliable counterweight to risky equities in a market sell-off – are the most expensive they’ve been in U.S. history, and very unlikely to provide the hedge that investors have relied upon. We believe the chances of a lost decade for a traditional asset mix are dangerously high.”

My personal view is that it’s 9:30PM in the stock markets. I believe that in post pandemic era, many of the traditional businesses may even not survive. Besides, in Indian context, the present capacity utilization levels may not warrant any significant capacity addition in next couple of years at least. The so called “Atam Nirbhar” capacity building trade may mostly be limited to soft commodities (like chemicals); electronics and defense production. Unlike 2003-10 infra capacity additions, it may not trigger any life changing opportunity for many engineering and capital goods companies.

The logistic constraints and paranoid inventory building by some economies may cease in next six months as vaccine is made available to more and more people. The Central Banks, especially RBI, may look at containing liquidity in 2021, before it can actually cause an inflationary havoc. The hyperinflation which many analysts, economists and fund managers are secretly praying for since QE1 in 2009 may actually not happen at all. I am also convinced from my own research that stress in unsecured credit segment has increased materially in past few months and banks will have to bear the brunt of this. I shall therefore let this trading opportunity in financials, commodities and cyclicals passé.