Adjusting to new normal

सभी पाठकों को नव विक्रम संवत्सर एवं चैत्र नवरात्र उत्सव की बहुत शुभकामनाएं.

The next post of Morning Trekk will be published on 3 April 2017.

 

Thought for the day

"All the ills from which America suffers can be traced to the teaching of evolution."

—William Jennings (American, 1860-1925)

Word for the day

Comportment (n)

Personal bearing or conduct; demeanor; behavior.

Malice towards none

Now that SC has effectively admitted that Ayodhya land dispute may not be decided through legal route, what are the options left?

First random thought this morning

Once a group of people comprising statesman, entrepreneurs, economists, bureaucrats, business managers, and financial analysts were asked a question – “What would you do if you get a INR100bn lottery? The replies were as follows:

Economist: “The proposition is purely hypothetical. I cannot answer this.”

Bureaucrat: “Will take early retirement, buy a bungalow on a hill station and enjoy”.

Business Manager: “Will put 75% in fixed deposit and start a business with the rest.”

Financial analyst: “Buy a good house, make a world tour, put 75% of money in fixed deposit and take a high risk bet with the balance.”

Entrepreneur: “Will leverage the money 3x and begin a new business venture.”

Statesman:  “Will investment money in projects that makes 1mn people capable of earning INR100k every year.”

You decide who from this group is fit to govern the country like India.

Adjusting to new normal

It is almost five years since the markets started discussing about the "New Normal" in global economics. The jargon essentially means that we should get used to a lower level of economic growth for a longer period of time.

The recent data, policy statements and policy actions suggests that the thought has begun to gain wider official acceptance.

Most global agencies like World Bank, IMF, ADB, OECD etc. have lowered the levels of global growth, which they would consider good or satisfactory. Even China sounds happy with 6.5% growth projection.

Central bankers like US Federal Reserve have already started to reverse the loose monetary policy, accepting that 3% GDP growth and 2% inflation would good targets to achieve. The others like BoE, BoJ, ECB, RBI, RBA etc. are also talking about the same.

In my view, as we adjust to a lower pedestal, new horizons would emerge. We are already witnessing the adjustment phase of the economic cycle shifting to a lower orbit. For example consider the following:

Corporate: Companies are selling core assets, acquired in past few years with great hopes; airlines are competing with railways; hotels are competing with home stay; automobile manufactures, realtors are offering humongous discounts to get rid of inventory; IT companies are delaying calling the new hires; instead of jumping over each other to capture airwaves, telecom operators are merging operations to spare existing airwaves; road projects that were awarded with exuberant premiums are getting cancelled; sports and entertainment events are finding it difficult to get sponsors; managements are working overtime in cutting corners to save margins, as topline are no longer priorities; many fancy startups have stated to wind up to cut losses.

Consumers: Consumers are not crowding the red sales; household budgets have reconciled to higher energy prices, rail fares, vegetable prices, service tax on every rupee spent and lower return on savings; savings are settling at lower level, and credit outstanding is rising.

Government: The government has become austere; has taken many unpopular decisions even during crucial elections

Financial institutions: Usually, the financial institutions, especially those in public sector, bear a substantial part of the cost of adjustment. We have seen in past 3years that the “restructured” assets of PSU banks have risen significantly. The credit growth is lagging even the GDP growth. The banks appear to have adjusted to the reality of “restructuring” and hence are conserving capital (by lending less and selectively).

New horizons

Historically, the adjustment phase has always resulted in durable cost efficiencies, higher productivity, smarter consumption patterns, stricter lending norms, better compliance levels and reformed policy framework.

Material (esp. cement and metal) companies, large banks, consumer (both durable and staple) companies and IT companies have come out much leaner and stronger out of this phase.....shall discuss it in more detail later

Where INR is headed

Thought for the day

"Burn down your cities and leave our farms, and your cities will spring up again as if by magic; but destroy our farms and the grass will grow in the streets of every city in the country."

—William Jennings (American, 1860-1925)

Word for the day

Anthophilous (adj)

Attracted by or living among flowers.

Malice towards none

Why a sudden rush in media to highlight the secular credential of the Yogi?

First random thought this morning

The common market area of Europe (European Union) is looking distinctly similar to the Congress Party of India.

The people outside it are not very sure if it will survive. The people currently inside are divided. Some, primarily who have lost their niche and suffer from a relatively stronger Euro, want to leave. Some, primarily who have gained from market access and relatively weaker Euro, hope that it is a sustainable arrangement, and therefore want it to stay.

Few appear confident about its relevance or otherwise in the current context.

Where INR is headed

A lot of people have expressed their surprise as well as concerns over sharp appreciation in INR value versus its global peers, especially USD, in past few months. Many have sought my views on the likely path for INR in near future.

I want to make it clear that I am no expert in the matters of macroeconomics, foreign trade or currency trades. While I do assign a small weight to the currency impact in my investment decisions; the consideration is mostly limited to avoiding companies that are unduly impacted by currency volatility.

I also strongly believe that Portfolio investment of few billion dollars may not have any lasting impact on the exchange rate of INR. However, sustained FDI inflows do support the case for some currency appreciation.

In my view, like any other tradable commodity, the exchange values of a currency vis-à-vis other currencies depends on the relative demand and supply of these currencies at any given point in time.

In simple terms, the recent sharp appreciation of INR vs. USD in recent months indicates that the demand for INR vs. USD has sharply outpaced the supply. There could be several reasons for this higher INR demand versus USD. For simplicity, I classify these reasons in three categories (a) structural, (b) cyclical and (c) speculative. Some examples are as follows:

Structural reasons

(a)   There have been some significant changes in the composition of foreign trade of India in past one decade or so leading to structurally higher demand for USD.

The structure of our imports has changed in favor of consumer goods as the domestic supply has failed to meet the burgeoning consumption demand. A large part of this demand has in fact been generated through massive government social sector spending and managed Chinese currency. The imports and therefore demand for USD is mostly inelastic to economic growth.

On the other hand the composition of exports has changed in favor of engineering goods, from dominantly consumer goods (tea, tobacco, leather, spices, textile, jewelry etc.). This has increased the correlation of exports to global growth, which is likely to remain below par in at least for next few years.

(b)   The change in political regime in 2014 has restored the confidence of global community in Indian political establishment and therefore markets & economy. This confidence was seriously impacted by a spate of scams, scandals and policy flip flops in the preceding 5-7yrs. This has certainly led to reduction in risk premium for INR denominated assets. Besides this has also prompted higher inbound FDI. There is nothing to suggest that this trend will reverse in near future.

(c)    The efforts to improve infrastructure and remove procedural constraints are likely to help improving India’s export competitiveness and result in higher exports growth.

The structural reasons are therefore mostly in balance at this point in time.

Cyclical reason

(d)   The success of RBI's measures in reigning the runaway inflation, strict fiscal discipline and improvements in trade balance have helped lowering rates in the economy to a limited extent.

As of now, both the inflation and fiscal deficit seems to have bottomed out and accordingly RBI has changed its policy stance to Neutral from the earlier Accommodative. The interest rates are therefore not seen changing materially from the current level in very near term.

This stability has made INR assets attractive to foreign investors.

(e)    The protectionist measure taken by the government in past one year to curb imports and promote exports through various tariff and non-tariff measures have also helped the trade balance to some extent. For example, from a large steel importer, India may have turned into a net steel exporter in past one year.

(f)    The outlook of EUR is clouded by the political calendar of Europe, especially schedule for Brexit, French and German elections. This is also seen helping Indian currency that is being perceived as safe haven by many under the current circumstances.

Speculative reason

(g)    The Fed Chairman’s recent remark about the gradual trajectory of rate hikes, against the widely speculated steep hikes, has led to recovery in US bond yields and weaker outlook for USD. This has made emerging market local currency assets attractive on relative basis.

(h)   The move to abolish 86% of Indian currency in circulation is speculated to have resulted in material reduction in informal market for USD, known as hawala trade in common parlance. This is speculated to have resulted in significantly lower demand for physical dollars in Indian market, resulting in stronger INR.

On balance, I feel the current strength in INR is mostly cyclical and to some extent speculative. It may not last beyond few months, in my view. Presently, I am working with 67/USD as average exchange rate for my FY18 earnings.

If they fail, well...they fail

Thought for the day

"Couples are wholes and not wholes, what agrees disagrees, the concordant is discordant. From all things one and from one all things."

—– Heraclitus (Greek, 544-483BC)

Word for the day

Portmanteau (n)

A word made by putting together parts of other words, as motel, made from motor and hotel, brunch, from breakfast and lunch, or guesstimate, from guess and estimate.

Malice towards none

The blame of loss lies on whose shoulders?--------

(a) If BJP losses

(b) If SP-Cong alliance losses.

(c) If BSP's vote shares falls below 18%.

First random thought this morning

What is the role of media of in the business of elections.

Is it an influencer, trying to mold public opinion in favor of or against a particular party or candidate?

Is it a reporter, just reporting the events occurring on the ground?

Is it a mediator trying to bring parties together or creating rift in them?

Is it an agent that brings political parties closer to people and their issues?

Then the question remains - what should ideally be media's role in the business of election, if at all there should be one?

If they fail, well...they fail

A very senior government official, who retired recently, argued that it is time to invest in public sector stocks. His argument was rather simple - the level of corruption is diminishing fast, level of professionalism is improving and transparency is much better now to provide comfort to investors.

He strongly felt that these changes are remarkable, sustainable and should lead to much better growth in these mostly large companies, with huge asset base.

I am somehow not convinced. I continue to believe that owning a miniscule stake in the businesses in which majority stake is owned by the president of India does not make much business sense.

My argument is simple. Like any other corporate house, the businesses of PSUs could be divided into two categories - (a) core businesses and (b) non-core businesses.

The core business of government of a democratic welfare state could only be the socio-economic welfare of the people. Making profit is usually incidental and mostly undesirable in these businesses. Running these businesses in an professional, efficient, and transparent way should ideally not add to the profitability of these businesses.

The non-core businesses of a democratic welfare state is an anomaly. The government has no business in doing such businesses. Why would an investors, who obviously invests for making money, should be investing in non-core business of a confused entrepreneur.

With 5% teledensity, Department of Telecommunication was a social venture. With close to 100% teledensity, BSNL, MTNL are non-core businesses for the Government. They should be looking for a closure to this business, with satisfaction that its objectives have been fully achieved. Trying to perpetuate this business and compete with private enterprises is not a good idea for the government.

Same is true with banking, civil aviation, power, capital equipment, and roads etc.

The Rail Minister wants us to buy minority stake in a company that runs business of railway ticket booking and catering food to rail passengers. He should answer, why government should at all be doing this business.

No matter how much transparent, non-corrupt and professional the manager of a PSU be, the fact is, and it would remain, that the majority owner does not care a dime for the minority shareholders. The regulator has so far not shown any teeth, insofar as the protection of minority shareholders' interest in PSUs is concerned.

For example, PSU banks have been burdened with the cost of servicing the Jan Dhan accounts. Could you raise a voice against it in the AGM. The most inefficient employees of PSUs are automatically entitled to the benefits of 7th pay commission award.

In my view, for investment the PSUs should be evaluated like any other private enterprises. If they fail corporate governance criteria, well they fail.

While I do not hold any brief for the momentum traders, to investors, PSUs have rarely made money.

And for those who are excited about the superlative performance of PSUs in the current market context, the following data point could be useful.

The current bull market started from last week of August 2013, with the government taking definitive steps to correct the problems of twin deficits and inflation.

In the last 42months period, Nifty has gained 47% and PSUs have gained around 22% (PSU Nifty, data available from march 2014). The worst underperformer IT sector has also registered similar gains. Metals and infrastructure have done only marginally better.

The current bull market had been about inflation and interest rates.

Auto and banks have clearly led the rally, and appear tired.

 

An Elephant and six blind men

Thought for the day

"To God everything is beautiful, good, and just; humans, however, think some things are unjust and others just."

—– Heraclitus (Greek, 544-483BC)

Word for the day

Fusillade (n)

A general discharge or outpouring of anything, e.g., a fusillade of questions.

Malice towards none

Karan Johar, one could appreciate.

But why Abu Azmi is a news?

First random thought this morning

What would be a good development strategy for Indians:

(a)   Be proud about their ancient past, and attempt to recreate it.

(b)   Be proud about their ancient past, and continue to live a life a complacent life.

(c)    Be proud of their ancient past; but begin the development process afresh, keeping in view the present day realties.

(d)   Forget about past, begin the development process from where we stand today.

(e)    Let it be, we are doing just fine.

 

An Elephant and six blind men

Once upon a time, there lived six blind men in a village. One day the villagers told them, "Hey, there is an elephant in the village today."

They had no idea what an elephant is. They decided, "Even though we would not be able to see it, let us go and feel it anyway." All of them went where the elephant was. Every one of them touched the elephant.

"Hey, the elephant is a pillar," said the first man who touched his leg.

"Oh, no! it is like a rope," said the second man who touched the tail.

"Oh, no! it is like a thick branch of a tree," said the third man who touched the trunk of the elephant.

"It is like a big hand fan" said the fourth man who touched the ear of the elephant.

"It is like a huge wall," said the fifth man who touched the belly of the elephant.

"It is like a solid pipe," Said the sixth man who touched the tusk of the elephant.

They began to argue about the elephant and every one of them insisted that he was right. A wise man was passing by and he saw this. He stopped and asked them, "What is the matter?" They said, "We cannot agree to what the elephant is like." Each one of them told what he thought the elephant was like. The wise man calmly explained to them, "All of you are right. The reason every one of you is telling it differently because each one of you touched the different part of the elephant. So, actually the elephant has all those features what you all said."

"Oh!" everyone said. There was no more fight. They felt happy that they were all right.

The moral of the story is that there may be some truth to what someone says. Sometimes we can see that truth and sometimes not because they may have different perspective which we may not agree too. So, rather than arguing like the blind men, we should say, "Maybe you have your reasons." This way we don’t get in arguments. (Source:Jain World)

A similar situation has arisen in Indian equity markets in past few months. There is strong disagreement amongst analysts, commentators, investors and observers with respect to valuations and therefore sustainability of current price level.

The disagreement, in our view, is a consequence of limited view each of us seems to be taking.

In my view, under the present circumstances, it would be more appropriate to take a holistic macro view of the market. Views based purely on earnings multiple or assets using extrapolation of near term historical data may probably not lead to accurate conclusions.

A non-linear view considering wider historical perspective and socio-political context may be necessary to make a valid argument for staying invested in Indian equity markets.

"Kya Lagta hai?" (Whats the outlook?)

Thought for the day

"Hide our ignorance as we will, an evening of wine soon reveals it."

—– Heraclitus (Greek, 544-483BC)

Word for the day

Salaam (n)

A salutation meaning “peace,” used especially in Islamic countries.

Malice towards none

Democracy in India is a farce. Politicians swear by democratic traditions only until they are elected to a public office. As soon as they assume the office, they become feudal lords, irrespective of their socio-economic backgrounds and political ideologies.

They need servants to carry their mobile phones, bags and briefcases; to open doors of cars for them; to open doors of elevators for them.

They seek privileges even in temples and hospitals.

 

First random thought this morning

Life of suitable boys in smaller cities and town is really tough. No girl from larger towns and cities wants to relocate there for marrying them; and most eligible girls from their towns want to relocate to larger towns after marriage.

A very rich boy from a town in UP aptly put it like this  - "Money can certainly not get you everything. For few things you need to slug out in Mumbai/Delhi".

"Kya Lagta hai?" (Whats the outlook?)

Nowadays, I am getting numerous calls every day, asking invariably the same couple of questions, i.e., "Kya Lagta hai?" (Whats the outlook?); and "Kya karna chayiye?" (what should be the strategy?)

The first questions seeks opinion on both -the political situation as well as financial markets. The second question is limited to the financial markets.

Insofar as the political situation is concerned, my view has been consistent that BJP is well on its way to become the Congress of 1950s and 1960s. In few years, it will have competition only from within.

In near term, the party is most likely to win the assembly elections in UP and Uttrakhand. In Punjab BJP and SAD alliance is losing, and In Goa and Manipur they are very much in the race.

Regarding investment, I may reiterate what I have been saying for past three decades.

Investors must be well versed with their socio-economic environment. They should be aware about the events and circumstances that may impact their investment portfolio. But it is not necessary to react to each and every event and data point that comes to their knowledge. In fact most events and data points may actually not need any action on their part.

Investors may better follow a rather simple investment style to achieve their investment goals. It is highly likely that most find this path boringly long and apparently less rewarding, but in my view this is the only way sustainable returns could be obtained over a longer period of time.

I believe, taking contrarian views, speculating policy changes and implications of election outcome, anticipating short term performance (e.g., monthly sales, quarterly profits etc.) and reacting to that, or arbitrage on information/rumor of a corporate action are examples of circuitous roads or short cuts that usually lead us nowhere.

Taking straight road means investing in businesses that are likely to do well (sustainable revenue growth and profitability), generating strong cash flows; have sustainable gearing; timely adapt to the emerging technology and market trends, and most important have consistently enhanced shareholder value.

These businesses need necessarily not be in the “hot sectors” like commodities in early 1990’s, ITeS in late 1999s, or infrastructure and financials in 2004-07. These businesses may necessarily not be large enough to find place in benchmark indices.

I have discussed it many times in past. However, given that the market may be entering a prolonged period of high volatility and low returns, making investors jittery and indecisive, in next few days I shall present my thoughts as to why contrarianism or lottery seeking attitude to investing might not be the right one and may expose investors to greater losses.

Of course there is nothing proprietary about these thoughts. Many people have often repeated it. Nonetheless, I feel, like religious rituals and chants, these also need to be practiced and chanted regularly.

Markets not in equilibrium

Thought for the day

"The downtrodden are the great creators of slang.'

‑Anthony Burgess (English, 1917-1993)

Word for the day

Malfeasance (n)

The performance by a public official of an act that is legally unjustified, harmful, or contrary to law; wrongdoing

Malice towards none

Many "intellectuals" who are frequently visible on TV and social media, do not appear to be much intelligent.

Wisdom is something, that has not even touched them.

First random thought this morning

The government has shown remarkable resolve in sustaining the dismantling of control of transportation fuel and cooking gas. The highest ever single rise in LPG prices, when the UP elections are in critical phase, clearly demonstrate this.

Why economists like former Prime Minister Manmohan Singh and Amartya Sen; and politicians like P Chidambaram fail to mention it when they criticize the government on economic failure. This prejudice and partisanship is making even their valid criticism incredulous.

Markets not in equilibrium

In my view, a combination of following six factors determines the movement of stock markets, under any given circumstance.

1.    Macro outlook

2.    Earnings outlook

3.    The quality and quantum of flows (liquidity)

4.    Valuations

5.    Positioning vis-à-vis alternatives like debt, real estate, gold etc.

6.    Market technical (demand and supply equilibrium)

In the state of equilibrium of these six factors, the markets are calm; and average returns are closure to nominal GDP growth, usually higher than the risk free rate.

In this state usually the premium for alpha generation (outperformance of individual stock return over average return) is not great, as stable macro conditions, adequate liquidity, steady flows, reasonable valuations, and balanced market technical allow most businesses to grow in tandem and there is little case for unusually premium valuations of some businesses over most others.

On the contrary, when these key factors are not in equilibrium, i.e., one or more factors are far away from the mean position, the divergence in stock performance is significant and thus the premium for alpha generation is much higher.

From this viewpoint, if I analyze the market performance of past couple of years, it is clear that the divergence in performance of stocks is unusually high. Especially, many small and midsized companies have outperformed their large size peers massively. The premium for alpha generation has been accordingly significant.

Historically, whenever, the key factors impacting the stock markets have remained in the state of inequilibrium for longer period, the corrections needed to revert to the state of equilibrium have been sharper, deeper and painful.

If the correction occurs from bottom to mean, the pain occurs from missing the move. If the correction occurs from the top to mean, the severe erosion in prices causes the pain.

This makes me conclude two things:

(a)   The phenomenal rise in the assets under management of institutional investors like mutual funds, pension funds and portfolio managers may be related to the premium for alpha generation. This becomes even more clear, if we consider the stupendous rise in the asset under management of portfolio managers who invest in broader markets.

(b)   The key factors that impact the market are not in equilibrium. This essentially implies that we shall soon see the correction - this time top to mean, via bottom.