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

Nifty: Down but not out

Thought for the day

We give advice, but we cannot give the wisdom to profit by it.

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

Word for the day

Overweening (adj)

Exaggerated, Excessive

Malice towards none

The latest Arunachal development reflect best on who:

(a) Supreme Court

(b) Congress

(c) BJP

(d) None of the above

(e) All of the above

 

First random thought this morning

UP Chief Minister has reportedly offered his sulking Uncle whatever ministries, departments and power he likes. This demonstrate that the most populace state in the country has been reduced to a feudal fiefdom of a family, in a total mockery of democratic process and subversion of constitutional proprietary. Surprising the civil society, especially those who shout their throats hoarse on prime time TV shows every evening, are totally apathetic!

Nifty: Down but not out

Despite a sharp gap down opening on Monday, most benchmark indices held well and recovered almost half their losses. Nifty closed the last week with a wow loss of close to 1%. The initial surge in VIX also moderated materially in later part of the week.

The level of institutional activity was poor and volumes were below average. Market breadth does not indicate any panic or moderation in greed of the investors.

Technically, on weekly charts, NIFTY ended the week on the lower edge of the rising and contracting channel that started from end of February 2016. The channel continues to narrow further. However, any breakout (or break down) still appears some time away.

On weekly closing basis, now 8710 appears to be a strong support, however on daily basis 8606-8630 is a strong support zone. A close above 8867 this week shall neutralize the effect of last week's correction and the uptrend shall resume.

Bank Nifty appears to be losing momentum. Watch closely for a weekly close outside 19560-20340 range to decide the next course of action. Near term banks are avoidable for trading.

 

Case of misplaced priorities

Thought for the day

" It is utterly false and cruelly arbitrary to put all the play and learning into childhood, all the work into middle age, and all the regrets into old age."

—Margaret Mead (American, 1901-1978)

Word for the day

Pulverulent (adj)

Covered with dust or powder.

Malice towards none

Every politicians is busy telling us our problems!

No one is suggesting solutions(:

 

First random thought this morning

Visited a government hospital in Delhi yesterday. The condition of poor patient there was really appalling. The medical staff was highly stressed and exasperated. Non-medical staff was mostly unhelpful and exploitive.

This reminded me what I wrote last year at this time. Most of Delhi government & civic administrators, and many of Central leaders residing in Delhi (including PM himself) claim to come from modest socio-economic background. If true they must understand and feel the plight of these poor patients and work proactively to help them. But this does not seem to be the case.

Case of misplaced priorities

The recently released report on Sixth Economic Census (2013) in India is quite revealing in more than one sense. For, it shatters many myths and official claims and depicts the true state of affairs. The report also highlights some of the famous schemes of the incumbent government might be misdirected.

As per the report, there are 58.5mn business establishments (excluding public administration, crop production & plantation, defense and compulsory social service activities) operating in the country. Of these ~96% establishment were privately owned while just ~4% were government owned. These establishments employ 131.29mn people (52% in rural areas and 48% in urban areas).

·         About 60% these establishments are in rural areas while about 40% operate in urban area.

·         About 78% establishment are engaged in non-agriculture activities, while ~22% are engaged in agricultural activities (excluding crop production and plantation).

·         During the 8yr period between 2005-2013, the business establishments have grown by ~42% from ~41mn to ~58mn. In this period agriculture establishment grew ~116% while non-agriculture establishment grew ~29%.

·         Out of total ~58mn establishments about ~72% were Own Account establishment (meaning with no hired worker). These Self Owned Establishments (SOEs) grew 56% during 2005-2013. About 63mn people (48% of total employed people) are employed in these SOEs.

·         About 96% establishment have less than 5 workers. Another 3% have 6-9 people employed.

·         The government or public sector employs only 7% people. 79% people work in proprietary establishments. Organized private and cooperative sector employs 14% people.

·         About 36% of business establishment were operated from the home of the Self Owner, while another ~18% are operated from outside the home without any fixed structure.

·         Livestock accounted for ~87% of the agriculture activity.

·         Retail trade (~35%) and Manufacturing (~23%) were dominant non-agricultural activities.

·         About 74% business establishments are owned by Hindus and ~14% by Muslims.

·         Out of 1.87mn handicraft/handloom establishments, employing 4.2mn people, 79% were family affairs without any hired worker.

...to continue next week.