A midway diversion to nowhere

A midway diversion to nowhere

The desperation shown by the government functionaries especially by PM and FM in past 7-8months is exemplary. The “whatever it takes” façade presented by the duo did indeed enthused everyone for a while.

However, a conspicuous lack of vision, leadership and commitment that had in fact been the key weakness of most Indian governments since mid 1980’s has exposed the reality quite early in the day. The enthusiasm has given way to frustration and dejection all over once again.

In our view, the current socio-economic mess in the country is outcome of total adhocism in policy and program formulation & implementation, non compliance with the comprehensive socio-economic structure conceived in the Constitution, and lack of committed leadership, especially in past three decades.

The political establishment has so far mostly failed in justifying the midway diversion from the prescribed socialist framework taken in mid 1980’s. The obduracy shown by successive governments in relinquishing enormous amount of discretions enjoyed by political establishment has been a consistent obstruction in the way to evolve the intended quasi capitalist or neo-socialist policy framework that would lead to sustainable and faster growth.

A brief spell of high growth, which many may find accidental in hindsight, has probably misplaced the popular aspirations and thus added to the complexity of the problem.

The following are some of the glaring examples of lack of vision leading to ad hoc policy and program formulation leading to faulty implementation and avoidable strain on the fiscal balance.

(a)   Lack of vision and commitment on public sector investment policy, especially public sector enterprises.

(b)   Completely adhoc policy framework on foreign capital, through FDI, portfolio investment in equity and debt.

(c)   Failure in implementing an integrated energy policy.

(d)   Misdirected sustainability program – reflected in incongruent environment protection norms, inequitable resource allocation, imbalanced agri pricing, marketing and input subsidy policies.

(e)   Attempt to implement massive social security and inclusion programs, like MNREGA, PDS, RTE, no-frill banking etc., without developing a conceptual framework and adequate delivery mechanism.

We shall be discussing these in some details in coming days.

We feel that the country needs to comprehensively review the constitutional framework for evolving a wider consensus on the policy direction for sustainable socio-economic development in the current context. Leaving many things to the discretion of the government of day may not serve much purpose.

To be continued…

Get, set…wait!

Get, set…wait!

Dwindling car and home sales, slower air traffic despite sharp cut in fares, first negative reading on core sector growth in a decade, virtual collapse in capex announcement, slower project credit growth, and persistently low stock market volumes and volatility – all indicate the present state of confidence in the economy. The investors, consumer and businessmen all seem to have lost confidence. Pessimism is the only graph that seems to be moving up sharply.

Historically speaking this is a valid sign of imminent economy and therefore market bottoming out. However, in our view, the markets are yet not reading these signs and therefore not yet close to bottom.

We feel the concerns like depleted order books, rising NPAs, fast eroding margins, collapsing revenue etc. are well recognized and documented but not yet truly reflected in analysts’ earnings forecast. This might occur once 4QFY13 result are announced

Similarly, investors have been very vocal in their expression of concerns over worsening fiscal and current account deficits. The market volatility, volumes and flows are indicating that they are however not walking the talk.

The market tops and bottoms are usually associated with rise in volatility. During 2007-10 the market witnessed 121 daily moves of over 3%. Out of this 33 daily moves were greater than 5%. In past 2years we have seen just 6 moves of over 3% (none over 5%). No such move has occurred in past 15months. This suggests that the panic usually associated with market bottoming has yet not set in.

Post conclusion of budget session in May 2013, we expect the politics to completely dominate the economics. Monsoon and winter sessions may not see much activity given a heavy election calendar and minority status of the government.

Nonetheless, we continue to believe that the economic downturn that started 

Q2007 shall bottom out in next 3-4 quarters. The market downtrend that started in early 2008 shall bottom a little earlier.

Watch out for the following signs before you set off the block:

(a)   RBI panicking – watch for couple of unscheduled announcement.

(b)   Collapse in G-Sec yields below 7%. This could be preceded by a sharply lower reading on core inflation chart, sharp cuts by RBI, and a sharp rise in NPA provisioning by banks.

(c)   Real estate and crude prices fall sharply.

(d)   Nifty trading 10% or more below 200EDMA, and RSI is below 30.

(e)   Nobody talks about stocks at social gatherings you attend, and you get a strong urge to sell the stock you have been holding for more than 5years.

(f)     There are few large daily moves, ideally over 3% on closing basis, in Nifty.

(g)   S&P500 in USA falls below 1275 and US 10yr yields breach 1.5%.

Why this kolaveri over current account deficit

Why this kolaveri over current account deficit

Current account has conspicuously emerged as one of the primary concerns in past couple of months. Everyone – Government, RBI, investors, analysts, economists and financial institutions – seems extremely concerned about the current account deficit. The other deficits – fiscal, governance, trust, energy, infrastructure et. al. have taken a back seat for the time being.

In our view, the concern over high current account deficit, though not completely unwarranted, may be slightly misplaced. We worry that more than due emphasis on the problem may lead to desperate solutions leading to introduction of some structural imbalances in the economy, e.g., RBI postponing the replenishing of forex reserves, unwillingly liberalizing FII debt investment rules, enhancing export subsidies, etc.

Following the oil price shocks in the 1970s, there have been large swings in the current account balances of most countries. Australia, New Zealand, Portugal and the US have been running large current account deficits for the most part of the 1990s. At the end of 2000, the US current account deficit had reached to $415.5 billion, equivalent to 4.5 percent of US GDP. There is enough empirical evidence to suggest that while some countries such as Ireland, Australia, Israel, Malaysia and South Korea were able to sustain large current account deficits for many years, other countries such as Chile and Mexico suffered severe losses. Excessive current account deficits in crisis countries were also a prevalent feature of the 1997 Asian crisis.

Current account measures trade, international income, direct transfers of capital, and investment income made on assets. A current account deficit is when a country's government, businesses and individuals import more goods, services and capital than hey export.

The current account by definition should correct itself in due course. For example - the fall in currency value, a natural outcome of high CAD, should normally result in rise in the value of foreign and gold reserves of the country; it should make the exports competitive and destroy the demand for inflated imports if CAD persists for longer period; the high yield on currency should attract more capital resulting in higher investment, employment and savings rate resulting in creation of additional local capacities leading to import substitution.

However, artificial curbs like capital controls, managing the currency value at artificially higher level, and forced import substitution and subsidization, may introduce structural imbalances in the economy that may take longer to correct.

Given that the Indian currency is mostly convertible on trade account now (this was not the case during Asian crisis of 1990s) we need to be little more cautious. But interfering with market forces will only exacerbate the problem.

We continue to suggest a short trade on INR, with the expectation of a 7-10% fall in next 6-9 months.

It ain’t over till the fat lady sings

It ain’t over till the fat lady sings

When the cows come home, the world might realize that the QE was nothing more than a scare crow assigned to protect the wounded and feeble global economy.

The money printed itself does not create inflation. It has to reach the hands of consumers who are willing to spend it at a time when supply of goods and services is constrained. None of these conditions exist or are likely to exist in foreseeable future.

Moreover, the liquidity created by Central Bankers does not automatically become capital. Somebody needs to take risk of losing it, to give it the color of capital. The liquidity chases 20-30bps arbitrage without taking additional risk. It is neither spent nor invested.

The Black Swan, if any, might come flying from the commodities’ world. By definition it will be visible only on the day it is visible. Bothering too much about that will not help.

The series of financial crisis that started in summer of 2007 has definitely taken an interesting twist with the latest episode (Cyprus). The script that was becoming boring and predictable has turned interesting again.

When the whole world thought that with the quantitative easing (QE) now effectively open ended in US and EU, and “committed to do whatever it takes” approach of BoJ and BoE, the Central Bankers might have run out of options, Cyprus solution has opened up many new vistas.

US had successfully experimented with a similar solution through IRS going after Swiss deposits of “tax evaders”. But this is much more direct and effective.

In our view this should make three things reasonably clear:

(a)   The global financial system and investors are significantly better positioned and prepared for a Lehman like event and therefore chances of a 2008-09 like collapse in the global markets are substantially lower, irrespective of what the prophets of doom may wish.

(b)   Incessant QE is proving to be a blessing despite all its criticism. The trends in global commodity prices in past one year clearly show that QE has not and will not result in the kind of hyper inflation many are expecting. In fact it may end up regulating inflation whenever the next super economic cycle begins (may be a decade or two down the line).

Inflation usually occurs when the amount of money available is more than the goods available. QE has just created cyber money to take care of volatility in financial markets. So far there is little to suggest that it has any impact on the real market for goods and services.

The commodity prices are down despite lower supplies (due to capacity shut down), largely in line with the trends in consumption demand. Banks and corporates have accumulated huge reserves to handle any black swan event and households are saving more. The business consolidation process is gathering momentum to complete the bottoming process.

(c)   The USA will once again emerge a winner out of this crisis. Historically, most large European crises have been settled through a war. However, this will not be the case this time. You need truck loads of young people and trunk load of gold to fight a war. The struggling Europe may have none this time.

The emerging nations, including so called BRIC, have demonstrated that they are yet not prepared to move above their “developing” status. China may be the biggest short term loser of this economic down cycle.

So, we need to watch only the USA. So far its global leadership is not seriously challenged; the world is not coming to an end.

Focusing back home, India once again becomes a domestic story that would soon be pregnant again with hope of a better government post next election. Any investment strategy that assumes a higher than 7% sustainable growth is bound to fail, in our view.

We are accordingly restructuring our model portfolio – based on the USA and Hope.

The retail conundrum - IV

The retail conundrum - IV

In past three days we have highlighted that the debate on indifference of household investors towards the publicly traded equity is not only inadequate but perhaps misdirected also. Our informal survey of some brokerages who primarily deal with household clients and many of their clients highlighted many structural and systemic reasons for their disenchantment with the listed equities.

In fact regulator and the government authorities took cognizance of some of these reasons in recent past, and we do have yet seen a few steps being taken. But we are still some distance from finding a sustainable cure the malice. Some of the reasons that we found are worth noting and act upon are listed below:

(a)   In past two decade, since the capital controls were removed, listed equities have not been able to match the returns provided by traditional sources of investment like real estate and gold. A deeper study would reveal that the rise in market capitalization during these two decades is mostly due to rise in quantum of publicly traded equity rather than rise in earnings or PE re-rating.

(b)   The mutual fund and insurance industry has grossly and consistently failed the investors in these two decades. Except for 2-3 fund houses, most fund managers have performed briefly and only during the bubble like conditions.

(c)   Regulatory framework has evolved over past couple of decades and is robust enough to prevent any systemic collapse in the trade settlement. However, it has still not been able to effectively break the malevolent promoter-operator nexus, causing frequent cases of price manipulation.

(Source: InvesTrekk Research, BSE, World Gold Council, Value Research)

The retail conundrum - III

The retail conundrum - III

We find a strong equity culture amongst Indian households. However, factors like fewer employment opportunities, better business opportunities and dismal performance of publicly traded equity have led them to invest more in their own business and/or home equity rather than listed equity.

The need therefore is to reinvent the Gandhian model of socio-economic development by focusing on small household enterprise, rather than relying on Nehruvian model of unbalanced growth and development of large enterprise, that has mostly failed in promoting inclusive growth.

The debate on the household investors’ indifference to the listed equity would be incomplete and totally misdirected if we ignore the structural changes in Indian economy in past two decades.

In our view, post liberalization of trade and commerce in 1990’s, the number of self entrepreneurs has certainly increased in the country. This has coincided with the sharp fall in public sector employment. The aggregate private sector employment level has not been able to compensate for fewer opportunities available in public and unincorporated private sector. Consequently, the total number of employees on live payrolls has fallen sharply since early 2000’s.

The combination of two – lower employment opportunities and liberal business rules – has perhaps forced people towards entrepreneurship. The number of self owned enterprise has swelled in past one decade, implying people are investing in more in equity, but not in listed equity.

(a)   As per 67^th round of NSSO survey (June 2011), there were 58million unincorporated enterprises in India (excluding agriculture, construction and those registered under Factories Act). Over 85% of these enterprises are run by the owner himself, without any hired worker. 44% of these were run from the residence of the owner. These enterprises employed 108mn people against just 39mn on the live payroll in organized sectors, including 11mn in private sector. (Source: RBI, NSSO)

(b)   These self owned enterprises generated annual gross profit of Rs6283.56bn; whereas all listed companies in India generated gross profit of Rs610.44bn in FY12. 1/3^rd of this profit was earned by top 36 PSUs. Top 100 listed companies accounted for over 76% of this value addition.

The point we are making is that there is a strong equity culture amongst Indian households. However, factors like fewer employment opportunities, better business opportunities and dismal performance of publically traded equity have led them to invest more in their own business and/or home equity rather than listed equity. With most of your net worth in your business’s equity, you obviously need protection of gold.

(Source: RBI, NSSO)

The retail conundrum - II

The retail conundrum - II

We find that household investors had began meaningful investment in listed equity in late 70’s at the time of FERA dilution of MNCs. Reliance in 80’s and PSU disinvestment and capital market reforms in early 90’s drew the 2^nd lot of household investors. IT boom of late 90’s drew the 3^rd set to listed equity. In these 3decades households invested 8-17% of their financial savings in capital market related products.

Though the household financial savings started declining from mid 1990’s, 2000 was the key inflection point. Since then household have invested more in physical asserts than financial instruments.

Our informal survey of some broker and household investors highlights multiple reasons for this trend. Some key reasons suggested were:

(a)   Fall in average age of house ownership. Higher income levels in urban areas, rise in nuclear families and rise in real estate prices has prompted people to buy houses earlier in their life cycle.

(b)   Rise in personal automobile ownership.

(c)   Rise in self owned enterprises has also apparently led to diversion of savings to physical assets.

(d)   Rise in gold prices in 2000’s has definitely contributed to the trend.

With rise in urbanization and affordability, the trend is likely to exacerbate only.

The retail conundrum

The retail conundrum

Our study suggests that the disenchantment of household investors with publically traded equity has substantial implications for near and mid-term investment strategy.

The small informal survey conducted by us prima facie validates our belief. We however feel a larger study is needed to fully substantiate the findings and evolve a workable strategy for further development of capital markets in the country.

In past couple of years the government and regulators have been consistent in their concern about indifference of “retail investors” towards capital markets. Some part of this concern might be flowing from the de facto failure of almost all disinvestment floats since Coal India. The finance minister has initiated some nominal and mostly unsuccessful schemes to lure them back.

The background for this concern mainly is (a) rising investment in real estate, leading to overheating in some markets (b) persistent high investment in gold leading to rise in current account deficit, (c) failure of infrastructure companies in raising equity leading to lower participation in project bidding and (d) persistent redemption pressure in equity mutual funds and equity linked insurance schemes.

In order to make a factual assessment of the situation and assess the mood of the “retail investors” we carried out a small informal survey involving 32 brokerage firms and many of their clients.

It is important to note that we make a distinction between household investors and small day traders, traders, and speculators.

The key findings of our informal survey are as follows:

(a)   We find that household investors had began meaningful investment in listed equity in late 70’s at the time of FERA dilution of MNCs. Reliance in 80’s and PSU disinvestment and capital market reforms in early 90’s drew the 2^nd lot of household investors. IT boom of late 90’s drew the 3^rd set to listed equity. In these 3decades households invested 8-17% of their financial savings in capital market related products.

(b)   Post IT bubble burst, the household investors’ participation had been gradually diminishing and has become negative post 2009 for a variety of reasons. What we now have is mostly an assortment of small traders and speculators actively participating in daily market activity.

(c)   In past three years the small traders and speculators have moved away from trading in listed stocks, especially small and midcap stocks. Some part of their activity has moved to commodities market where volatility is higher, and cost & margin requirements are lower. A large part of their activity has moved to option segment, mainly Index options. The option segment volumes now constitute over 80% of daily volumes at NSE, against 10% or less prior to 2009.

(d)   Many people also cited rampant malpractices and gross underperformance of mutual fund and insurance fund managers as their disenchantment from listed equities.

(e)   Surprisingly, most people we spoke to were completely indifferent to the tax incentive available for investing in listed equity and equity mutual funds. Also Contrary to the popular belief, the change in MF load structure had little impact on householders’ preference for equity mutual funds.

On digging a bit deeper, however we find a number of structural reasons that could be attributed to this shift in preference of household investors. In the coming days we shall be discussing some of these factors in detail.

The bugle sounded, but elections only in 2014

The bugle sounded, but elections only in 2014

It had been our consistent view in past many months that the Congress is completely in election mode. They have a strategy and executing that well, so far.

The Congress strategy appears to be focused primarily on:

(a)   Diverting the popular debate away from corruption and non-governance to economic (price rise) and social (food and women security) issues.

(b)   Weakening NDA and work on reconstitution of UPA.

(c)   Present a transformed youth looking party image to people.

(d)   Keep the government alive till May 2014, and demonstrate Congress’s ability to run governments in adverse conditions and wait for inflation situation to improve a little.

By completely ignoring the concerns of DMK on A. Raja, Kanimozhi and Sri Lanka, the Congress has endeavored to show distance from DMK and thus 2G scam. The other side of this coin could be an attempt to come closer to AIDMK whose leader has appreciated Narendra Modi but has remained non-committal on issue of joining NDA. Similarly, it has distanced itself from Jagan Reddy in Andhra Pradesh, but got promise of support from his mother.

Knowing well that Congress will have to choose between Mulayam Singh Yadav (MSY) and Mayawati before next election, they have been systematically increasing distance from MSY. Steel Minister’s recent statement should be seen in this context. The pictorial proximity to Nitish Kumar is also an attempt to create confusion in NDA’s rank.

There had been a concerted effort led by the finance minister in past 6months to present a reform oriented, progressive, and business friendly image to the media and the world. Sudden influx of youth leaders like Pilot, Scindhia on TV channels and media events, in conjunction with anointment of Rahul Gandhi as crown prince is aimed at conveying the message that the Congress has transformed and should not be judged by the governance record of past 10years.

Promise of support from Nitish Kumar, in lieu of Special Status would make sure that the government completes its full term. DMK withdrawal is inconsequential in that sense. Anyways, even if the government falls tomorrow, it might take 6months to complete the elections and form a new government.

Developments in 2G scam trial took an interesting turn with summoning of CEOs of some telecom companies in NDA period spectrum allocation case. The political ramifications of this will be known in next few weeks.

Insofar as the economic situation is concerned, we can expect it to worsen only, as the priorities of the government would be different in next 12months.

On a side note, RBI did what was most expected and said what is widely known. We regard this as another opportunity missed and see little impact on market or corporate bottom lines in near term.

It’s 3AM – too late to sleep and little early to wake up

It’s 3AM – too late to sleep and little early to wake up

While we are confident that next 6-9months will provide a great opportunity to build an equity portfolio that will outperform most asset classes in next five years, we continue to suggest investors should not lower their guards as yet.

The way the events in Cyprus (population 1.1mn and GDP USD28bn) have caused panic in global markets, shaving billions of dollar in asset value in matter of couple of days, it is clear that at the moment the global economy is nothing but “fragile”. The fabled economic recovery at best is shallow and confined to pockets.

Moody’s Investor Services yesterday said that China’s local-government financing vehicles face greater risk of default, as regulators warn 20 percent of their loans are risky. Australian and Russian governments are also facing serious fiscal challenges.

US Fed in the FOMC meeting beginning today is also likely to emphasize that the economic recovery is much weaker than anticipated and therefore stimulus needs to continue till the recovery shows some strength.

Indian government also appears to have resigned to the next general election. The almost threatening advertisement blitz by IT department indicates that the government is bothered least about business confidence as of now. Any businessman will tell you that no income tax refund has been processed in past four months and many of them have been arm twisted to pay higher advance tax.

NTPC and Coal India dispute is worsening, suggesting a summer of discontent ahead for power consumers. The discordant notes coming out from UP, Bihar, West Bengal, Tamil Nadu, Andhra Pradesh, Maharashtra et. al. are suggesting that not much efforts is being put in to building political consensus on critical economic issues.

The feeling we get rather points to an active effort by Congress Party to encourage the supporting parties to cause the government to fall so that they can claim the status of martyr and thus become eligible for a sympathy vote in next election.

The market is looking up to RBI governor for a rescue act. He may oblige by 25-50bps repo and even 25bps CRR cut. But at this point in would help only the struggling infra players and stressed SMEs to sail through the rough weather. It would not be a catalyst for igniting an investment cycle in the short term. Historically, a pre-election year does not see many large private sector projects getting initiated. Everyone likes to see the new government and their priorities before making large commitments.

On a satisfactory note, InvesTrekk model portfolio has significantly outperformed the markets in past two months. Our underweight equity, OW cash call has done really well. Even the big bet on gold seems to be turning positive. We are not proposing any change as yet. However, as suggested early this month we plan to restructure portfolio in next couple of months to factor in our macroeconomic and strategy view.