Take shelter as the tornado passes by

Many equity markets world over (with the notable exception of China) have mostly recouped their losses of past five years. The same however cannot be said about the macroeconomic data. In fact there are little signs, despite near zero interest rates and persistently low inflation in developed economies, of economic growth stabilizing even at lowest levels or employment conditions improving in any helpful measure.

This is leading many, including InvesTrekk, to believe that the extant equity rally may be purely technical and hence should not be considered as beginning of a secular bull market. In exclusive Indian context, the rally has certainly outpaced macroeconomic and corporate fundamentals and valuations in select pockets are already flirting with bubble like conditions.

A normal monsoon, complete government post next general elections (hopefully!), lower rate, benign consumer prices and massive election spend may support higher consumption demand and hence justify expensive consumer sector valuations. Passenger vehicle may also gain. But many pharma, banking and metal companies would need to correct over 25% to deserve an investment consideration.

Second tier IT could be one suitable shelter given their strong balance sheets, stable businesses and cheaper valuations. Though growth there may still remain muted for another year or so, favorable resolution of US VISA uncertainties may cause a rally there.

Similarly, the valuation gap between top 3 cement companies and the rest is probably at historic high. A revival in infrastructure spending next year post election aided by lower rates could be trigger there.

There is a strong buzz around PSU oil marketing companies (OMCs). The cheap valuations relative to their replacement value is the primary investment argument, duly supported by recent fuel pricing reforms. In our view, these companies are worst examples of corporate governance. The majority shareholder (government) has consistently and blatantly oppressed the minority shareholders in these companies – by not allowing them to fix the prices of their products, raise capital when required, make investments where and when desirable and disallowing the managements to restructure their costs (especially employee cost) during downturns. Moreover, there is no legal guarantee that the current fuel pricing mechanism will continue for, say next 5years.

Insofar as the global rally is concerned, consider the following three data points are worth considering:

1.       The most-indebted U.S. companies are rallying more than any time in almost four years compared with the rest of the stock market.

2.       China’s trade surplus is contested to be one-tenth the official $61 billion reported so far this year after accounting for fake transactions used to disguise hot-money inflows.

3.   Imports of refined copper by China, the biggest user, declined in April to the lowest level since June 2011, while exports fell for the first time in 8months.

Bulls caged in Wall Street

We have been accused of being excessively and obdurately pessimistic on market in past one month. We strongly deny the charge. We are of the view that the present bullishness on Wall/Dalal street is like a cart without horse slithering down the hill. The following two charts (via Zero Hedge) aptly demonstrates that bulls are mostly confined to “the street’ and have not yet reached the real economy. We shall wait for the cart to get behind a healthy horse before riding it.

Changes in core portfolio FY14

InvesTrekk core portfolio for FY14 has returned 11% since its launch on 1 April 2013. This compares to 9% return on Nifty.

As two components Lupin and Yes Bank have returned over 25% in 6 weeks, we book profit there and invest the proceeds in TCS (8% weight) and keep 2% cash.

To see the updated portfolio please click here.

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It is important to note that InvesTrekk is a purely research oriented firm and does not offer any portfolio management , brokerage, money management or investment advisory services of any kind. The model portfolios are only for illustrative purposes. Please take advise of a qualified and registered investment advisor before taking any investment decision.

InvesTrekk Research Reports provide generalized macro investment strategy to its subscribers.. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). InvesTrekk reports are not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in the reports and should understand that statements regarding future prospects may not be realized.

Mandate 2014 – Rajasthan: Dying traditions and sweating dreams

Continuing with our second phase of discovering India, we travelled to Rajasthan in past one week. We drove through 15 districts of the state, namely, Udaipur, Sirohi, Jalore, Barmer, Pali, Bhilwara, Tonk, Jaipur, Sikar, Alwar, Bundi, Kota, Jhalawar and Rajsamund.

The most critical learning of this trip was that in a land that supposedly takes pride in its traditions and history, these things find little relevance in peoples’ life. People are concerned with their roots (history, culture, tradition) only to the extent it could be sold to “tourists”. Our efforts to find people who would wish to keep the traditions alive because they take pride in this, were totally futile. If we speak in words of famous American author Mason Cooley “Preserving tradition has become a nice hobby, like stamp collecting.” It is no longer a way of life.

The key take away of our Rajasthan trip were as follows:

(a)   After speaking with over 800 people across 15 districts, we feel that the generational abyss in this supposedly traditional state is widening at fastest pace in the history. The young and middle aged who cannot adopt “history and culture” as viable occupation are totally disinterested in carrying out their tradition, whereas old still swear by them. Consequently, the rich tradition and culture is dying fast. The few rich people however would like to promote traditions with their young ones as a hobby and mark of distinction.

In our view, this will further increase the income disparities, which are already very high, as the poor lose their source of income from traditional arts and handicraft.

(b)   Unlike the neighboring Gujarat, the religious divide is not very conspicuous in Rajasthan. However, the society remains deeply divided on caste lines. The politics remains art of managing caste balance rather than focusing on development. The consequences are there for everybody to see. The gender bias was also strong.

(c)   Most of the development is consequence of central schemes like highways, rural roads, water canal, oil 7 gas exploration etc.

(d)   The employment deficit created by diminishing illegal mining businesses and automation in textile and agro processing (mainly edible oil) is being met by booming real estate sector and MNREGA.

(e)   The “self enterprise” is on the decline and traditional Marwari kids are taking to “professions” rather than businesses.

(f)     The city of Kota (day temperature above 45C) was buzzing at midnight. The city’s economy, that once depended on mining, textile, cement, chemical and agriculture and related industries, is now centered around numerous “coaching centers”. Numerous aspiring IITans weather extreme heat and cold conditions to pursue their dreams. We wondered why many other places with good weather and better connectivity could not do this! On qualitative side, one respected “coach” told us that most aspirants are victims of their parents’ dream and are likely to grow into “frustrated useless unproductive reluctant workers”. Not a great commentary for ‘Bharat rising’.

Read our special series Mandate 2014

 Anxiously Indifferent

Karnataka & Delhi

Goa, Punjab and Haryana

Corruption Matters, Alas! Not the way it should

 Reforms ain’t mean the same for Delhi and Sangli

Gujarat

20 Program: Agenda for 2014 election

 Modi Vs. Rahul

Hopes and fears coming true

The markets movement in India in past couple of weeks confirms that our hopes and fears are both coming true.

We had hoped that Indian markets will benefit from the global risk-on mood and participate in the rally that is conspicuously reminiscent of 1999-2001 global rally. The benchmark equity indices appear set to rise another 5% in this melee.

We had feared that the corporate fundamentals may not improve in any substantial measure and hence would only lend a feeble support to the rising valuations; much like 1999-2001.

It is important to note that whenever the long term market returns have significantly outperformed the earnings growth we have seen sharp corrections in the market.

(Source: BSE, InvesTrekk Global Research)

In our view, if the fall in commodity prices and cost of capital does not result in improved profitability over next 2-3 quarters and Nifty continues to trade above 6000 level, we shall see a substantial correction of 20-25% in equity prices.

The YTD weakness in commodities and AUD could be an early indicator of the coming pain in commodities’ world. We have heard some distress calls from Indonesia, Mexico, Australia, Russia, Brazil, and South Africa. Deepening recession in EU area and slowing demand in China indicate that this distress may only rise in the coming months.

So as we said a few days ago, do not be a party pooper, enjoy your dinner, but make sure you are not too late to return home. (Also read: Enjoy your dinner, but don’t get too late and …and save my fears!)

QE a matter of fact, not going anywhere

It is important to note that “money” is different from “currency”.

Consider it like this:

For a theater that can seat 1200 people, if the owner prints 5000 tickets for one show – the “excess” 3800 tickets will have no value.

Similarly, if the central bankers print “currency” that is more than the amount required for transacting the real goods and services produced in the economy, the “excess” currency will have no value and hence it is not “money”.

The unprecedented bond purchase program of global central bankers, under various schemes and programs, collectively referred to as quantitative easing or QE, has been subject of intense debate in past four years. QE in instant case has two primary objective - (a) lend stability to global financial system which witnessed a complete collapse post Lehman Bros. bankruptcy in 2008; and (b) bring the global economy back to a sustainable higher growth path.

The stability witnessed in the global financial market in the wake of recent crisis in Cyprus does indicate to the success of QE program in bringing a reasonable degree of stability to the global financial system. However, the critics find it worth little use in promoting economic growth and hence call for its withdrawal. Any suggestion of withdrawal of QE usually evokes nervous response from investors.

In our view, QE is now a matter of fact and will remain so till it completely outlives its utility – not likely in next 3yrs at the least, most likely till the time EU economy shows definite signs of revival, Japan achieves its objective of creating nominal inflation in the economy and gets out of decades of stagnation, and global trade rebalancing especially in relation to China makes steady progress.

Insofar as the extent and impact of QE is concerned, there are many sensational reports doing the rounds. We would like to take a rather simplistic view of the situation.

We all know that currency is nothing but an “unsecured zero interest bond” that usually loses its value with the passage of time. Under various QE programs, central bankers in the developed world, especially US Federal Reserve (Fed), European Central Bank (ECB), Bank of Japan (BoJ) and Bank of England (BoE), have been exchanging interest bearing sovereign and corporate bonds with virtual currency – thereby augmenting the state income at the expense of fearful savers. If they are successful in creating acceptable level of inflation in the global economy, they will also make capital gains as the “currency” in the hands of savers depreciates in its value. Moreover, this has created artificial scarcity in the global debt market and hence allowing the governments to borrow at lower cost. (see here)

Those who fear “withdrawal” need to understand that QE is a goose that is laying diamond eggs (gold is not a good analogy these days) every day. Why would someone kill it?

For records, Cumulative bond buying since 2008 by four major central banks alone - the Fed, Bank of Japan, European Central Bank and Bank of England - reached more than $4 trillion this year. Added to existing holdings, that brings their total to $5.2 trillion.

With new Fed purchases of Treasury bonds set to top $1 trillion in 2013 and Bank of Japan bond buying more than half that amount, the year-end total will be about $6.5 trillion.

And as both the Fed's and the Bank of Japan's bond buying will exceed new bond sales by their governments by at least $100 billion this year, there will be fewer bonds around this year than last despite all the new debt sales.

Market comfortable with politics

Conventionally one would have expected higher volatility, jitteriness and weakness in the market given the political impropriety leading to legislative impasse and administrative inaction. However, the market has brushed aside most concerns and moved on.

We are however not surprised by the market’s reaction to the political events. We firmly believe that market is not indifferent to the political event and the collective wisdom has assimilated the political environment well. We believe that market is finding the political events constructive and medium to long term positive.

Insofar as the up move is concerned, it has two major drivers – (a) global positive sentiment towards risk assets, especially equity, and consequent larger FII participation and (b) bottoming of macroeconomic fundamentals, in particular inflation, rates and investment demand.

Domestic politics has little influence on global markets and flows. Macro fundamentals do get impacted by the efficacy or otherwise of the political establishment; and here in our view the market is deriving comfort from the recent events. In our view, the Congress party has strengthened its position in past few months and market is comfortable with that. For example consider the following:

(a)   We had highlighted in one of our earlier reports that in our view the Congress party has well defined strategy and it is executing it well (see margin note). The recent instance of two ministers resigning on impropriety charges is yet another instance of impeccable execution of this strategy. The Congress party has emerged stronger after each such episode in past one year.

The Congress Party strategy, in our view:

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

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

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

(4)    Distance itself from the current government and all the impropriety charges it is facing.

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

(b)   By electing Karnataka CM through secret ballot, the party has given a strong message of its readiness to accept greater intra party democracy, thus debunking a key plank of opposition.

(c)   The party has successfully created a projection in media that incumbent FM Chidambaram is a likely PM candidate, thus diverting the focus from Rahul Gandhi. Our discussion with many businessmen and industrialist suggest that at this point in time many would prefer PC over Modi since they believe PC will try to improve the current system and hence execution will improve faster; whereas Modi would like to first change the system and that might adversely impact the execution part in the short term.

In view of this we suggest the following strategy:

(i)      Avoid shorting the market. Though continue reducing/rationalizing equity positions at every rise. Global liquidity will likely remain comfortable, and PC will do better things to strengthen his position – do not position for a collapse in market.

(ii)    The deterrent to corruption has also risen. Post Coalgate bashing, CBI would certainly try to redeem its pride. In our view, we might see many Bansal/Singla like episodes in next six months. That might create large bouts of volatility and provide better entry points – buy on days when sky appears falling apart.

No pain, relief or regret?

The cold response of household investors to the ~8% rally in Indian equities in past six weeks has apparently intrigued many pundits. The rally is characterized by persistently low volumes, poor market breadth, low volatility, implying total lack of greed or fear.

On the positive side, it implies that this rally may continue much further than most of us anticipate as so called weaker hands are not participating. On the negative side, it lacks any foundation and is always susceptible to a sudden crash like January 2008.

In traditional sense, we may neither call it “Pain Rally” – since no one was interested in investing even at lower level; nor it is a relief rally – since the mid and small cap stocks or laggard mutual funds with which household investors are still saddled have not participated much in the rally. Our discussion with some investors suggests that it is not even a regret rally – for those who sold stocks or redeemed their MF investments a few weeks earlier.

The so called retail investors have obdurately refused to participate in publically traded equities’ market in past few years. In particular, post 2010 the household participation in listed equities has declined sharply.

We had highlighted in our four part series on household investors’(see I, II, III, IV) the reason for participation of household investors (or lack of it) in stock markets. We do still not see them coming back in a hurry.

The surprising part is that this is not true only for a emerging market like India with all its imperfections and scams. Only 52% of American households now have money invested in the stock market, down from 53% a year ago and 62% five years ago. This is historically quite low.

(Source: Zero Hedge)

Read our special four part series on household investors “Retail Conundrum”

Part I

Part II

Part III

Part IV

Enjoy your dinner, but don’t get too late

The feel good factor in global equity markets is going strong since past few months. India has also joined the party in past few weeks. Obviously no one would like to see a party pooper at this point in time. Nonetheless, there are some and investors would ignore them only at their risk.

The perennial party pooper Nouriel Roubini said on Tuesday that Stocks aren't in bubble territory as yet, but a "huge rally in risk assets" over the next two years puts markets in danger of a big crash.

But more notable is Michael Snyder of The Economic Collapse Blog, who is flashing the following dozen warning signals:

1.       The price of copper has traditionally been one of the very best indicators of the future performance of the U.S. economy. It is down nearly 20 percent so far this year.

2.       Home renovation spending has fallen back to depressingly-low 2010 levels.

3.       U.S. retail spending is repeating a pattern that we have not seen since the last recession.

4.       Manufacturing activity all over the country is showing signs of slowing down. In fact, Chicago PMI has dipped below 50 (indicating contraction) for the first time since the last recession.

5.       In April, consumer confidence unexpectedly fell to a nine-month low.

6.       NYSE margin debt peaked right before the recession that began in 2002, it peaked right before the financial crisis of 2008, and it is peaking again.

7.       The S&P 500 usually mirrors the performance of Chinese stocks very closely. That is why it is so alarming that Chinese stocks peaked months ago. Will the S&P 500 soon follow?

8.       The economic data coming out of the Chinese economy lately has been mostly terrible.

9.       Things just continue to get even worse over in Europe. Unemployment in both Greece and Spain is now about 27 percent, and the unemployment rate in the eurozone as a whole has just set a brand new all-time record high.

10.   Crude inventories have soared to a record high as demand for energy continues to decline. As I have written about previously, this is a clear sign that economic activity is slowing down.

11.   Casino spending is usually a strong indicator of the overall health of the U.S. economy.  That is why it is so noteworthy that casino spending is now back to levels that we have not seen since the last recession.

12.   The impact of the sequester cuts is starting to kick in. According to the Congressional Budget Office, the sequester cuts will cost the U.S. economy about 750,000 jobs this year.

In our view, investors may enjoy their dinner, listen to party poopers and decide when to return home. Make sure it’s not too late.

Read our special series Mandate 2014

Anxiously Indifferent

Karnataka & Delhi

Goa, Punjab and Haryana

Corruption Matters, Alas! Not the way it should

Reforms ain’t mean the same for Delhi and Sangli

Gujarat

20 Program: Agenda for 2014 election

Modi Vs. Rahul

A Wednesday

Thi khabar garm ke Ghalib ke urenge purze, Dekhne hum bhi gaye the per tamasha na hua. – Mirza Ghalib

(The buzz was that I will be publically thrashed today; I also went to see the drama; but nothing happened.)

Wednesday 08^th May 2013 was widely touted by media as super Wednesday. Karnataka assembly poll results and Supreme Court’s hearing on CBI’s affidavit in Coal Block allotment case were widely seen as critical for the political establishment of the country.

However, as it turned out, nothing happened. Karnataka poll results were exactly on the lines we expected. BJP lost. Congress did not make it big. B. S. Yeddyurappa made ignominious exit. Supreme Court censured CBI but spared the political bosses.

Stock markets ignored both the events and moved on. Companies with good results (e.g., HDFC, Lupin) gained; and those giving bad numbers (e.g., Ranbaxy) were punished. A normal day, prima facie.

At least five disturbing trends continued unabated, namely-

(a)   As we highlighted in our earlier report, corruption was absolutely a non-issue in the Karnataka election. Despite serious allegation on Law and Rail ministers just days before the elections, Congress won comfortably; especially the urban voters backed the party. Kumaraswamy of JDS who was ousted last time on serious corruption charges gained the most in terms of seats. BSY got sufficient votes to ensure BJP’s rout.

(b)   Media vigorously debated the SC order the whole day with many “intellectuals” generously contributing their wisdom to the debate. No one, yes no one, not even once mentioned the name of Anna Hazare, who in his Jan Lokpal Bill had suggested an effective solution for the malaise SC is trying to fix in Coalgate.

(c)   SC did come down heavily on CBI in the extant case. But this situation could have been avoided if it had taken suo moto cognizance of the allegations made publically (in and outside the Parliament) by the SP and BSP leaders about misuse of CBI to pressurize these parties to support the UPA II government.

(d)   The government showed total disdain for people; refusing to react to the SC observations and concluding the Lok Sabha session ahead of schedule.

(e)   The opposition has no plan to request a special session of the Parliament to bring “no-confidence vote” or “impeachment” motion against the government/PM/Law minister.

In our view, the market would be happy if early elections are called, as this government would not be able to transact any legislative business in remaining term and bureaucracy will not cooperate in carrying out the administrative business also.

As for today, expect the market to largely remain unaffected by what happens in Delhi.

Read our special series Mandate 2014

Anxiously Indifferent

Karnataka & Delhi

Goa, Punjab and Haryana

Corruption Matters, Alas! Not the way it should

Reforms ain’t mean the same for Delhi and Sangli

Gujarat

20 Program: Agenda for 2014 election

Modi Vs. Rahul