Gather amunition before the war begins

Thought for the day

"And, after all, what is a lie? 'Tis but the truth in a masquerade."

— Alexander Pope (English, 1688-1744)

Word for the day

Knave (n)

An unprincipled, untrustworthy, or dishonest person.

Malice towards none

Is our fight with Pakistan or Pakistanis?

And have we already defined who is a Pakistani?

First random thought this morning

I have not heard anyone who seriously believed that the latest Indo-Pak standoff could actually escalate into a full-fledged war.

I am therefore totally unable to explain the losses in financial markets on last Thursday.

I suspect it could either be a case of foul play or something serious taking shape in the womb of time that will be revealed in due course.

Gather amunition before the war begins

As the date for RBI's periodic policy review date draws closer the anticipation regarding the likely move on policy rate is rising. Like most preceding policy reviews, the opinion is divided this time also.

The analysts and economists have been arguing against any decision to cut repo rate in today's MPC meet. However, the bond traders and investors appear convinced of a rate cut.

This dichotomy is not unprecedented. Rather it is very common during periods when the monetary policy is expected to play an aggressive role in the overall macroeconomic conditions. Usually it occurs closer to the peak and troughs of the rate and economic cycles.

More often the traders get it right. However, whenever they are wrong, the losses are huge. Whereas economists and analysts usually have not much to lose, should their expectations not materialize.

Though as usual I would avoid speculating what MPC statement to be released later in the day will read like; in the current instance, I would wish that a 25bps cut in repo rate is done in each of next three MPC meetings, beginning today.

This is nothing to do with the FM, industry or traders urging for a rate cut. I intuitively believe that under the current circumstance it would be the right thing to do. For example, consider the following:

(a)   BoJ in its last policy statement has indicated that the current monetary policy direction may have lost its utility and a change would in the order. It is likely that US Fed may hike the key policy rates in next 3-6months, reversing its stance taken since December 2015. Some other key central banks may also be forced to change their current policy stance in 2017.

       The immediate impact of such changes on global economy and market is unpredictable, thus higher volatility is likely, especially in the currency market.

       Under the circumstances it might be desirable for RBI to create some policy cushion for defending INR and attracting higher flows by raising rates. This cushion is almost absent currently, in my view.

(b)   The rate cut today will come at almost no cost as inflation outlook has improved materially; with IDS, disinvestment and spectrum sale the fiscal balance appears supportive of lower rates; economy is far from heated and with real estate market is at bottom no bubble is floating around. To the contrary, a rate cut today will help banks repair their bleeding balance sheets and get prepared for the next credit cycle as well as for any crisis like situation, should the global conditions deteriorate rather precipitately.

(c)    The external account is in balance due to lagging exports. A weaker INR due to rate cut should help.

(d) The demand outlook is improving with government willing to spend more. Lower rates will have the desired multiplier impact

Nifty: tighten your belt

Thought for the day

"Lulled in the countless chambers of the brain, our thoughts are linked by many a hidden chain; awake but one, and in, what myriads rise!"

— Alexander Pope (English, 1688-1744)

Word for the day

Sublime (adj)

Complete; absolute; utter; supreme or outstanding.

Elevated or lofty in thought, language, etc. e.g., Paradise Lost is sublime poetry.

Malice towards none

Have the surgical strikes in PoK by Indian Army taken the government beyond any criticism?

First random thought this morning

The farmers in the border areas of Punjab have been evacuated by the Indian Army for security reasons. Many of them have the crops standing ready for harvest.

I am sure the State will compensate for them adequately for the financial loss. But the loss of precious food grain will not get compensated.

Nifty: tighten your belt

As pointed out last week, in September the divergence between the MoM change in headline Nifty value and the change in MoM average traded value has widened to the largest since March 2016.

There is enough evidence to suggest that this divergence shall get minimized in the month of October. In simple terms it implies that Nifty shall move in a much larger range this month, mostly trading in the upper half of the range and perhaps settling around or below the average.

Given the present chart patterns and placement of momentum indicators, it appears that after a week of consolidation, we may see a sharp jump higher in Nifty, before it settles down little lower to end the month with decent gains.

At the same time, it is critical to note that the intermediate uptrend from the intraday lows of September (8555.20) could be the last such up move in the larger up move that started from February intraday low (6825.80).

I expect Nifty to record an intraday high between 9370-9410 in this up move that may last anywhere between 3-13 weeks. A 8-10% shall likely follow post the tryst with the new peak.

In short technically expect a 8-10% Nifty up move from the current level followed by a 8-10% correction; all in the next 6months.

Last week, Nifty has defended the 8606-8630 range (on closing basis) despite rise in momentum. This morning there is nothing to suggest that this support base will be broken meaningfully this week also.

Bank Nifty though is looking shaky. As suggested last week, I would continue to avoid banks for any short term trading.

 

 

Strategy

Thought for the day

"Gratitude is usually the secret hope of further favors."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Lodestone (n)

Something that attracts strongly.

Malice towards none

Everyone gets to retreat back to barracks.

Indian Army can claim "We did it". Twiterrati can finally rest claiming "we are great". Politicians can submit ATR.

First random thought this morning

None of the members of the family of Mr. Bansal were co-accused in CBI's case.

Why even after 2days no process has been initiated against the CBI officers who allegedly drove them to death. Usually an FIR for abetment to suicide u/s 306 IPC is filed immediately on the basis of suicide note.

Is morality again overriding the legality?

Strategy

Based on the assumptions highlighted yesterday (see here), other strategy inputs that I have been sharing with the readers from time to time through this column, and market performance of the 1HFY17, my strategy for 2HFY17 and FY18 would be as follows.

It is pertinent to note, there are some key changes with respect to currency and rate outlook mentioned in my last strategy outline (see here) shared with readers in April 2016.

The strategy

(a)   In the past one year, the government has shown strong resolve to afford a good deal of autonomy to the public sector enterprises (PSEs) which have been performing well. However, this resolve is yet to be tested in adverse circumstances, e.g., fuel pricing autonomy if crude price rise above US$80/bbl; or autonomy to banks if political considerations require loan waivers or sale of sick units if unions oppose the move etc.

       For now, despite sharp outperformance of many PSEs, I would continue to avoid them. The exceptions could be couple of large banks and couple of other enterprises that may become irresistible due to short term business opportunities. (The change is from complete "no go" to surgical strike.)

(b)   Consumption will remain the dominant theme in my equity investment portfolio. I would continue to focus more on consumable services - especially health, retailing, entertainment, and financing.

       On product side, I would continue to focus on aspirational products like lifestyle drugs, beer, premium liquor, household upgrade (lighting, tiles, plywood), luxury housing, premium automobile, packaged food (non-basic), etc. (No change in this.)

(c)    Technology & pharma will continue to be core theme in the portfolio. Focus will remain on innovators, designers, and engineering services. I would mostly avoid body shops and pure generic plays.

(d)   Will begin to accumulate capital goods players (ex power equipment) and only niche EPC service providers.

(e)    Would like to maintain a 5yr duration in my bond portfolio.

(f)    Prefer USD exposure over EUR and YEN

(g)    Mostly avoid commodity producers except cement.

(h)   Lower return expectation from equity portfolio to 9-10% plus 1% dividend yield from earlier 11-12% plus 1% dividend yield.

(i)    Will continue to avoid SME segment companies a and focus on upper end of the market, mostly BSE200.

Will divulge more in my regular Samvat strategy note later next month.

Assumptions for Strategy

Thought for the day

"We have no patience with other people's vanity because it is offensive to our own."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Eristic (n)

A person who engages in disputation; controversialist.

Malice towards none

How relevant are SAARC, NAM and Commonwealth in the present context?

First random thought this morning

Watched the video of presidential debate between Ms. Clinton and Mr. Trump. Three observations:

(1)   None of the two candidates appear worthy of becoming head of the most powerful state in the world.

(2)   The degeneration in the quality of the leadership might be reflective of the general state of American society itself.

(3)   Whosoever wins, it will not make any difference to my life.

Assumptions for Strategy

I may share with my readers the latest assumptions that would, inter alia, drive my investment strategy for next couple of years; and the key highlights of my investment strategy.

Assumptions

1.    The monetary policy of most developed nations and meaningful emerging markets will continue to be accommodative till at least 2018; though there is no evidence available to suggest that BoJ, ECB, BoE, SNB, US Fed, PoBC and RBI etc. will need to materially tighten their monetary policy even after 2018.

2.    US Fed fund rates may rise quickly and peak in 1.5-1.75% range by end of 2018. The benchmark treasury yields may have already bottomed and may rise to 2 peak in .75-3% range.

3.    US GDP growth might peak ~2.5% by end of 2017 and decelerate thereafter as economic cycle sets in. India & China will continue to grow in 6.5 - 7.5% range supporting the aggregate growth for Asian region. EU, UK and Japan may continue to flirt with recession but may muddle through avoiding any major contraction.

4.    Brexit may actually not materialize by the end of 2018. The uncertainties and delays might impact the business to some extent.

5.    The global consumption of fossil fuels may continue to underperform the supply. Prices of the conventional energy may continue to remain around the current levels, or moderate a little more.

6.    Global demand (both consumption and investment) may not rise materially to cause any inflation scare. However, inflation could surprise on the upside if currency & rate adjustments are not managed well and investors move in a herd away from financial assets and into physical commodities. Precious metals in particular may remain in favor.

7.    Indian bond yields may bottom around 5.5-5.75% and stabilize close to 6.5%.

8.    INR may move between 65-69/per USD. No devaluation either by China or India.

9.    The capex cycle in India may finally begin between 2H2017 and 1H2018. Demand for capital goods, industrial credit and EPC services may see material improvement.

10.  The consumption demand - especially luxury consumption, credit and construction material (cement, paint, tiles, sanitary etc.) - to become stronger. Residential real estate to bottom out and start picking up....to continue

Lower....sooner

Thought for the day

"The surest way to be deceived is to consider oneself cleverer than others."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Bon mot (n)

A witty remark or comment; clever saying; witticism

Malice towards none

War with Pakistan - Seriously!

First random thought this morning

If we go by the media perceptions - US citizens are faced with a dilemma of choosing the best from two worst presidential candidates.

If I have any idea about the psychology of an average American, expect the voters' participation to be extremely low. Yes, avoiding tough decisions to the extent possible is a common American trait.

Lower....sooner

Some of my readers termed my yesterday post rather alarmist. I think, it needs some clarifications.

If the contention is that I am hinting at a major correction (10% or more) in the benchmark indices in near term, I must say, that is not the idea. My simple point is that there are early signs of global flows turning erratic in next few months. This capriciousness of flows may cause market volatility to rise materially, which I do not like.

Nonetheless, intermediate corrections in a larger market trend are normal and desirable. As of this morning, I do see the current trend peaking within 3-5% of the previous Nifty closing high of 8997 and correcting 7-10% from there. Such a correction would be healthy for the market and an opportunity to increase equity allocation for investors. I shall be sharing my strategy for preparing for the volatility, correction, raising equity allocation and leveraging the portfolio in subsequent posts.

Now coming back to where we left yesterday.

In my view, The US Fed would need to hike rates not for any conventional reason, e.g., to tame inflation or cooling down the overheating economy. This would be more to help pensioners and bring down the prices of financial assets (stocks and bonds) in sync with the economic reality.

In past five years, Fed has erred materially in estimating the growth of US economy. The realized growth since 2011 has been almost 50% lower than the forecast. Now, the long term median real GDP growth forecast is below 2% against over 3.5% in 2011.

The corporate earnings have been broadly following the macro growth trend. As per some estimates, S&P500 profit peaked in September 2014 and has fallen 19% since then. However, S&P value has continued to rise through multiple expansion. Currently S&P500 is trading at ~25x or close to bubble territory.

Similarly, the rally in US bonds is also beyond rational explanation. With the shrinking tax revenue, rising fiscal deficit and burgeoning public debt, the yields on US bonds may have some solid reason to move up.

The full employment theory of some Fed members might only be partially correct. An overwhelming majority of new jobs are reportedly part-time and contractual. Besides, the denominator is the 4.9% may not be reflective of the true position of workforce. A large number of people are above 60yrs of age but still offering themselves for work. Secondly, there are many who are out of workforce because their skill sets obsolete.

I therefore believe that while the rate hike may be necessary to prick the bubble in the financial assets, the Fed may not be able realize its dream of 3% federal funds rate and 4-4.5% benchmark 10yr yields.

The normalization may occur at much lower levels and much sooner than most expect....continue

I do not like roller coaster rides

Thought for the day

"A wise man thinks it more advantageous not to join the battle than to win."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Albatross (n)

A seemingly inescapable moral or emotional burden, as of guilt or responsibility.

Malice towards none

Is India rushing too hurriedly into the Paris deal, or NOW is the time to do it?

First random thought this morning

A large majority of Indians seem unable to decide whether Indo-Pak rivalry is about religion (Hindu-Muslim) or about geo-politics. The perception about and the response to the conflict are therefore mostly confused.

An occurrence of violence evokes extreme religious fervor. An initiative for peace evokes even stronger response from the people living on either side of the border!

Let's first decide what we want - (a) Friendship (peaceful co-existence) ; (b) Enmity (perpetual war); (c) Reunion (Unification through agreement or force)

I do not like roller coaster rides

Irrespective of the state of indecision at US Federal Reserve, the market participants appear preparing for a December hike in policy rates.

There is enough evidence to suggest that the market is now finding the rate hike inevitable. It is no longer a matter of "if", but just a question of "when".

The flattening US yield curve suggests that bond holders are now beginning to prefer longer maturities believing that a hike by Fed hike is inevitable and higher rates will keep inflation under check over mid to long term. 

Chinese authorities have approved trading in credit default swaps (CDS) for local debt. This shows that they accept much higher delinquencies in the local bond market as US rates begin to rise, causing pressure on consumer demand (hence Chinese exports).

The central bankers that have been big buyers of US treasuries, believing these to be the safest haven, have been on a selling spree in past few months. Chinese and Japanese central bankers have sold US treasuries consistently for past three quarters, a record selling spree. 

The reasons for such selling could be multiple. For example selling could have been necessary:

(a)   to fund the local fiscal deficit as oil economies and Japan struggle with growth;

(b)   to fund the demand for outflow of capital (e.g., in China) as local economy struggle;

(c)    to defend local currencies as exports slow down and USD supplies contract due to lower US trade deficit; end of QE program of US Fed and easing US fiscal deficit;

(d)   to prepare a war chest, should a currency war is unleashed.

Nonetheless, one major reason is that US bond rally is seen coming to end with the Fed hiking rates.

It is noteworthy that while many Central Banks have lowered their US treasury stock, none has been reported buying gold aggressively. It is clear that central bankers do not anticipate any material rise in inflation in near to midterm as they expect that higher rates will stem any chance of inflation getting out of control.

The question before a tiny investor like me, who does not have any dollar asset, but is invested in equities of Indian companies that may have material exposure to USD assets, liabilities, revenue and/or expenditure, is what should be the strategy under the current circumstances.

In normal course a stronger USD, consequent to Fed hike, should not be a problem for me. However, given that Indian rate cycle may be diverging from the US rate cycle for a year or two, capital flows may become a major challenge. The volatility that may result from a sudden drying up or even reversal of flows would put markets on a roller coaster. I am too scared of such rides....to continue

Another false alarm

Thought for the day

"There are various sorts of curiosity; one is from interest, which makes us desire to know that which may be useful to us; and the other, from pride which comes from the wish to know what others are ignorant of."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Eponym (n)

A person, real or imaginary, from whom something, as a tribe, nation, or place, takes or is said to take.

Malice towards none

Tell me more about Brad Pitt and Angelina.

Fed, BoJ, Uri, Trump-Hillary, Cauvery, RBI et. al. can wait.

First random thought this morning

It feels miserable to hear some of the senior retired Army Generals sitting in TV studios and seeking a jingoistic response from the government to the cowardly terrorist attack on Indian Army.

These officers seem to be suggesting that for decades Indian Army has never retaliated to the unprovoked killing of our soldiers from the elements transgressing from across LoC.

This is totally unbelievable. Anyone who has spend even one hour at a border post would know that the Men posted there do not necessarily seek permission from New Delhi for responding to a fire from across the border.

Another false alarm

In past few years many experts have highlighted that the uncertainty and fear created by US Federal Reserve and its officials through their official and public utterances is causing more harm to the global markets than the eventual policy direction probably would. Through its latest statement also, Fed has left the markets guessing. Giving people on both sides of the line some reasons to be excited.

On the other hand the Bank of Japan (BoJ) and the European Central Bank (ECB) are not leaving anything to the imagination of analysts. They are consistently highlighting that the economic conditions continue to be challenging, requiring continuous monetary support. Both have pledged "whatever it takes" stance on almost every available opportunity.

The fourth large pillar of global markets - China, has never been vocal about its policy stance. However, it is seen that in past few years, the response of the People's Bank of China (PBoC) has mostly been reactionary - adjusting its policy stance to the stance of other global central bankers. Though the de-valuation of CNY has been a matter of concern for competing economies, of late not much noise has been raised over it.

Given the high degree of economic interdependence of US, EU, Japan and China over each other, anyone material divergence in monetary policy stance could cause potentially cause serious disruptions in global markets.

So leaving 25bps here and there, expecting any major divergence in next couple of years at least would not be reasonable, in my view.

The following three point that stand out unambiguously (from the point where I stand) from the latest policy decision of the Bank of Japan and the Federal Reserve of US may be noteworthy:

(a)   The unconventional monetary policy tools being used by various global central bankers have mostly lost their effectiveness. Japan and most part of the Europe continue to struggle with poor economic growth and lack of inflation, despite near Zero interest rates and trillions of dollars worth of money printed and injected in the financial system since the last global financial crisis, popularly symbolized by the collapse of US investment bank Lehman Brothers.

(b)   US economy appear stable, but not growing at desirable pace. In the absence of support from other larger economies like China, Japan and EU - the pace of US economic growth is expected to normalize much below the levels seen in past few decades. The "new normal", as some prefer to call it, is materially moderate than the historical averages. Whatever growth may come, it would be mostly through productivity gains rather than higher demand. The desired trajectory of Inflation therefore could be difficult to attain on sustainable basis.

(c)    The policy rates are likely to normalize much lower than the historical averages, even in case of US.

More on this on Tuesday.

Make growth employment elastic

Thought for the day

"Mediocre minds usually dismiss anything which reaches beyond their own understanding."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Longanimity (n)

Patient endurance of hardship, injuries, or offense; forbearance.

Malice towards none

After Congress now SP hires an election strategist with experience of US elections!

What does this reflect?

First random thought this morning

Would it not be appropriate if someone from this side of the border also takes responsibility for loss of precious life in Uri (Jammu)?

After all some General, Minister, Politician, Bureaucrat must be accountable for the grave security lapse, especially after Pathankot had happened.

Is it too much to ask from those who routinely speak of morality, ethics, accountability and transparency in public life, beside claiming to be brave and potent enough to tackle the enemy?

Make growth employment elastic

Continuing from the last Friday, in my view it is critical to take note the June 2014 working paper on Employment Elasticity in India.

In the said working paper RBI highlighted many interesting facts about the status of employment and its elasticity to the GDP growth.

In particular the change in occupation structure of the economy in past 15years is worth noting; because it helps setting up the agenda for future growth. It is important to note that one of the key promise of incumbent government is to make growth job oriented (hence inclusive) as opposed to jobless growth (therefore exclusive) growth achieved during past few years.

The working paper found that aggregate employment elasticity (change in employment due to economic growth) of Indian growth has fallen considerably in post 1991 period. In this period for every 10 per cent change in real GDP, there had been about 1.8-2 per cent change in employment. The current statistic is even poor.

Moreover, elasticity varies considerably across sectors. While agriculture has witnessed negative elasticity, services including construction have generally been employment intensive. Manufacturing employment elasticity has hovered in the range 0.29-0.33.

Within manufacturing, the employment elasticity for organized manufacturing sector based on various estimates seems to be higher, in the range 0.42-0.57 for 2000s and it has risen over the previous two decades. Given the huge productivity and wage differentials between organized and unorganized sectors, greater employment generation in organized manufacturing is crucial as it has larger multiplier effects.

Subsequent to 2011, India has seen significant moderation in its GDP growth rates. While employment numbers are not yet available for the recent years, Labour Bureau quarterly surveys as well as various private agencies’ information point towards moderation in employment generation. If these data sources are any hint, then one might see some changes in employment elasticity depending upon the relative pace of moderation in employment generation vis-à-vis growth.

The working paper suggests that going forward, it is the relative cost of capital vis-à-vis labour and the nature of investment demand that will determine to what extent growth would be job-creating.

Increased capital to labour ratio in the organised sector for a labour abundant country like India is a concern that has been well-highlighted. I have also been highlighting this rather frequently and to the annoyance of some of my government readers.

If India has to meet the demographic dividend challenge, focus should be on industries where employment elasticity is higher. On a rough basis, about 10 million people would need a job every year for the next 15 years. Finding productive jobs for such huge numbers is a big challenge, and clearly the answer lies in stepping up growth, and importantly, stepping up the employment intensity of growth....to continue tomorrow