Bulls’ resolve tested

Thought for the day

“You have to take risks. We will only understand the miracle of life fully when we allow the unexpected to happen.”

-          Paulo Coelho (Brazilian, 1947 - )

Word for the day

Ambulant (adj)

Moving from place to place. Itinerant.

(Source: Dictionary.com)

Teaser for the day

With US assiduously avoiding any direct intervention in international conflicts in past couple of years, and Russia gaining tremendously from spike in energy prices – who will lead the joint action in Iraq, should a need arise?

Bulls’ resolve tested

The raging bulls in Indian equity and currency markets faced their first serious test last week. Various local and global events tested the resolve of bulls who are having a free run for past one month.

Globally, strife in Iraq sent energy prices soaring, as global leadership continued to dither over a clear stance on military intervention. The situation in Ukraine remained fragile.

Back home, IMD forecasted a 7% deficient monsoon. Heat wave across north and northwest India led to serious power crisis. Reports suggest that the crisis may worsen as coal inventory at many plants is below critical level. Unusual rains and hailstorm damaged the onion crop in Maharashtra again, threatening the consumer price inflation. Mumbai coast was deluged by a high tide making people nostalgic about July 2005 flash floods.

On supporting side, IIP data for April brought some cheers to the market. Morale of the bulls was also supported by the government’s effort to accelerate the decision making process by removing many redundancies. The vision statement of the government as articulated in the President’s address to the joint session of the Parliament and subsequent very assuring reply of the Prime Minister to the debate on that address were largely accepted as harbingers of the good times.

The first round has apparently gone to the bulls, as the sharp falls in prices has largely been lapped as opportunity. So far there are no signs of panic in bull camps. Over weekend, the Finance Secretary Arvind Mayaram has also attempted to reassure markets that as yet there is no need to panic over Iraq. The markets ended the week with about half a percent loss over past week; though the losses were about 2percent from intraweek highs.

I also believe that Iraq situation has the potential to evolve into a larger conflict in the region, if the militant forces are not curbed immediately. The success of Islamic militia in Iraq could encourage the defeated militant groups in the Middle East Asia, South Asia and North Africa region.

The attitude of US administration and many western European nations towards the events in Syria, Ukraine and Iraq, in my view, has exposed the weakest part of the global economy, viz., lack of credible strategic leadership that has been the hallmark of global economy in past 150years. Britain and US have invariably taken lead in resolution of most global conflicts since later half of the 19^th century. This assumption of strategic leadership has made their economic and financial acceptable to the other relevant forces in the world.

Britain has been losing their leadership status since Tony Blair era. The economic decline of UK has coincided with it. London has lost substantial share in global financial business to new centers like Dubai and Singapore. The argument that only favorable taxation regime is responsible for this shift is not acceptable to me. I would give first priority to the perceived safety when it comes to my wealth.

I would watch keenly for next decade how US losses or retains its strategic leadership over the world. For now, Barack Obama is not making much effort.

Morning dream

Thought for the day

“Reality is wrong. Dreams are for real.”

-          Tupac Shakur (American, 1971-1996)

Word for the day

Schmaltz (n)

Informal, exaggerated sentimentalism, as in music or soap operas.

(Source: Dictionary.com)

Teaser for the day

Pride of triumphant is fine, but it should not cross the line of hauteur.

Morning dream

In order to diminish deflationary pressures and weaken the common currency Euro and thereby stimulate economic growth, ECB announced some measures a few days ago. The most discussed of these was reducing the interest on ECB deposit facility to below zero percent.

Though at face value 1/10^th of a percent is not much below zero percent and should not be a matter of additional concern for savers who are now used to earning negative return on their savings, the signals are worth taking note of.

It is conspicuous that like Fed, ECB is also past the trauma of financial crisis that repeatedly threatened the global financial system since 2008. The regulators now want participants to take risk. They want banks to lend more, businesses and household to borrow & spend more and save less.

The sharp decline in long term yields, despite US Fed tightening the policy stance, across Europe, USA and Japan is contrary to popular expectations. It could be a matter of concern for markets.

Conventionally, compression in yields is a negative growth signal. However, there is little evidence to suggest that economy is the USA, Japanese or European economies are likely to fare poorly in next couple of years at the least.

The lower yields therefore could be logically defined by shift in demand-supply curve of government bonds. With many governments simultaneously endeavoring to put their fiscal conditions in order, the supply of bonds is falling at a time when crisis struck households’ propensity to save is rising at fastest pace in recent decades. Consequently, the demand is outstripping the supply at much faster clip.

ECB might therefore be right in signaling its support for risk taking, lest the economy slips again into recession, this time led by higher savings and risk averseness, unlike 2008-10 a period which saw unsustainably high leverage and excessive risk taking materially damaging the financial markets.

There are many who believe that it is not long when Fed may also follow ECB below the ground Zero on deposit rates, despite continuing with moderation in bond buying program. This may be necessary to keep US exporters competitive against sharp decline in Euro.

Back home, we have heard some voices pleading the regulators and government to stimulate risk appetite of investors through a series of measure, including tax concessions, lower interest rates etc.

It would be interesting to see how RBI reacts to likely deluge of FII flows due to higher risk appetite fueled by fall in global yields and weaker USD and EUR.

In my view, a dramatic cut in rates to keep INR around 60/USD level would be in order. It is with this premonition I suggest a duration play on long bonds, after spending almost 4years exclusively in accrual products.

Gold may also warrant a re-look if my suspicion comes true.

Make a beginning

Thought for the day

“We shall not cease from exploration, and the end of all our exploring will be to arrive where we started and know the place for the first time.”

-          T. S. Eliot (American, 1888-1965)

Word for the day

Prevaricator (n)

A person who speaks falsely; liar.

(Source: Dictionary.com)

Teaser for the day

The government need to choose between 6,50,000 smart villages and 100 smart cities.

If you say we need both – tell me what should happen first?

If you say both should happen together – show me the money.

Make a beginning

The political events in couple of weeks and subsequent up move in equity stock prices have reignited interest of many savers. Many people who drastically reduced weight of listed equities in their wealth portfolio are also showing keen interest in rebalancing of their risk profile by increasing weight of listed equities. I have received many requests for suggestions as to what should be the approach for rebalancing the portfolios.

While I have been replying to individual queries, I find it appropriate to present a general approach for the benefit of broader readership of this column.

The most common question I get is “What would you do if you have to invest fresh Rs___ in equity market?”

To this, my answer is usually as follows.

Make a diversified portfolio, which captures the current environment and likely trend in economic hence business cycle. The portfolio should be focused and not too diversified. It should largely contain leaders in terms of market, product, technology, and pricing power. It would however not be completely inappropriate to include couple of new kids on the block who are clearly demonstrating the potential to become leaders in their respective spheres.

The basis of diversification could be as follows:

Basket 1 - Broader economic growth (25%): This will be a basket of leading corporates of India which would lead and equally participate in the revival of economic growth in India and than elsewhere. A focused large cap fund that picks up from top 100-150 stocks will be optimal for this purpose. A passive index fund can also serve the purpose, but I would prefer an actively managed fund at this stage, given that the economy is still not likely to get out of woods in next 2-3 quarters at the least and currency could be a major play impacting the performance of a large number of Nifty constituents.

Basket 2 - Cycle leaders (25%): As the economy revives, some sectors will do better than the others. Companies in sectors will obviously give more return than benchmark indices. In my view, early cycle plays (large operating leverage, faster demand pick up) with market leadership should be considered for this. A sectoral fund (banking and power for domestic and IT and Pharma for global) could be a good way to participate in this segment.

Basket 3 - Growth vs. value (20%): Being convinced that we are embarking on a long journey of faster and sustainable growth we need to identify and invest in few high growth potential companies that have demonstrated strong potential to become market leaders in future. We could consider a basket (specialized funds) or not more than 5 direct stocks.

Basket 4 - Secular growth (30%): About two fifth of our portfolio must be secured in secular non-cyclical growth stories like consumption and generic pharma. Assuming that other three buckets will capture some exposure in this segment, I suggest 30% direct exposure to this segment through quality stocks.

Based on the latest socio-economic vision statement of the government, as enunciated in the President’s address to the Parliament on Monday, I find the following investment themes that may be relevant in the next few years.

Investment themes

Professionalization of PSU. Select PSU’s that are doing well and are least affected by policy decisions. Nevertheless, the current positive policy cycle may favor energy and banking.

Railways could be to 2015-2020 what roads were to 2003-2007. Focus on technology leaders rather than generic stock (wagons and wheels) suppliers.

Agri productivity as an economic activity will likely enjoy highest priority for the incumbent administration. Focus should again be on technology innovators and market leaders rather than generic fertilizer producers.

Cyclicals. Buy cyclicals and industrials with god balance sheet and decent operating leverage (cement, capital goods, auto and construction).

Commodities: Buy global commodities which are on the cusp of reversing demand-supply cycle (Aluminum, Zinc and Lead).

Global businesses (IT, pharma, auto ancillaries) as INR completes its correction over next 2-3months

Consumers (FMCG, 2wheelers, telecom, pharma, textile, finance, media) for demand pick up on fiscal and monetary stimulus.

Illustrative list of stocks (Not be considered as recommendations)

1.       Bharat Forge (Undisputed global leadership, strong B/S, operating leverage, CV cycle upturn, higher railway and defence demand)

2.       Bosch (Technology leadership, operating leverage, CV cycle upturn)

3.       HCL Tech (Cheaper valuation, better margins, new business traction, management transition to high degree of professionalism, large size)

4.       HDFC Bank (Undisputed market leadership in retail banking)

5.       HUL (Undisputed leadership, strong product profile, margin bottoming)

6.       Idea (Strong growth in data business, best cost management)

7.       Kaveri Seeds (Strong market leadership in hybrid seeds, strong B/S)

8.       L&T (Undisputed market leadership, operating leverage, cyclical upturn)

9.       Mahindra and Mahindra (Cyclical upturn, diversified)

10.   Motherson Sumi (Technology & product leadership, operating leverage)

11.   PVR (Strong market and brand leadership, high growth, operating leverage, top play on consumer discretionary, early stage business)

12.   Reliance Industries (Cyclical upturn, strong product leadership and B/S)

13.   Sun Pharma (Strong leadership, consistent premium valuation, high growth and margins)

14.   Tata Motors (Cyclical upturn, Global leadership (JLR)

15.   Ultra Tech Cement (Market leadership, cyclical upturn, operating leverage )

I’m lovin’ it

Thought for the day

“Once we have a war there is only one thing to do. It must be won. For defeat brings worse things than any that can ever happen in war.”

-          Earnest Hemingway (American, 1899-1961)

Word for the day

Prate (v)

To talk excessively and pointlessly.

(Source: Dictionary.com)

Teaser for the day

If Narendra Modi is successful in his endeavor to bring good governance – do we need an alternative like AAP?

I’m lovin’ it

Since past couple of days the new government had been giving signals regarding its priorities, style of functioning, targets and above all their vision of India’s future. However, the broader view was fragmented and critics’ opinions divided. A section of society still had misgivings about the intentions and agenda.

The President’s address to the joint session of the Parliament, in my view, has defined the intentions, vision, mission and agenda of the government unambiguously. I am particularly delighted as the government’s agenda incorporates most of my suggestions presented through this column.

I know that by now the readers of this column must have been overwhelmed by the threadbare, between the lines and behind the hand analysis of the vision statement of the government. However, I would still take risk of offering my two paisa. In my view, the key highlights of the vision statement of the government made through President of India are as follows:

Strong and firm leadership

The best way to find out if you can trust somebody is to trust them. (Ernest Hemingway)

From the address it is clear beyond doubt that the country has a strong and firm leadership. The prime minister is in full control of the situation. The conventional wisdom suggests absolute power in one hand is worrisome. But so far we do not have evidence to suggest that the present leadership is corruptible. The statement goes a long way in addressing the fears of the traditional detractors of the Prime Minister, by remaining strictly within the contours of constitution.

Conceptual clarity

The best part of the statement is the conceptual clarity on various issues, especially structural imbalances faced by the economy and imperative to correct these imbalances in right earnest.

For example, the statement lays strong emphasis on skill deficit, agriculture productivity, skewed sex ratio, rural-urban divide, state – center strife, sustainability of growth especially ecology-economy balance and foreign policy – economic policy imbalance.

Most important aspect is that without offering and platitudes about the global economic conditions, it straight away focuses on the internal strengths like demographics, traditions, culture, technology and presents simple programs to harness these strengths.

Alternative governance structure

Departing from the popular view of being other side of the Congress Coin, BJP leadership has shown strong commitment to a transparent, predictable, fair and accountable policy regime and governance structure. The indications so far are that the government is “running the talk”.

Promising to do away with administrative discretions that have traditionally been source of many corrupt practices is for example a welcome departure.

Tomorrow I shall present my views on market implications of the policy outline.

Few words of caution

Thought for the day

“Inferiors revolt in order that they may be equal, and equals that they may be superior. Such is the state of mind which creates revolutions.”

-          Aristotle (Greek, 384-322BC)

Word for the day

Sparge (v)

To scatter or sprinkle.

(Source: Dictionary.com)

Teaser for the day

Post Delhi election last winter, RaGa said Congress needs to learn lot from AAP.

It indeed does need to learn what not to do?

Few words of caution

Investor’s confidence has definitely taken a rocket flight in past two weeks. People who were not even willing to talk about investing in Indian equities are now desperate to listen to “multi bagger” ideas. Analysts and strategists like me have also changed their tune. While this is a welcome change from the extreme pessimism seen during past three years, I feel some words of caution would be useful.

Reproduced below is an interesting discourse from Unlearning Economics, I find extremely relevant to the current circumstances.

First, something which is expected to do a certain job - whether it's an economic system or the economists who study it - is expected to do this job all the time. If an engineer designs a bridge, you don't expect it to stand up most of the time. If your partner promises to be faithful, you don't expect them to do so most of the time. If your stock broker promises to make money but loses it after an asset bubble bursts, you won't be comforted by the fact that they were making money before the bubble burst. And if an economic system, or set of policies, promise to deliver stability, employment and growth, then the fact that it fails to do so every 7 years means that it is not achieving its stated objectives. In other words, the "invisible hand" cannot be acquitted of the charge of failing to do its job by arguing it only fails to do its job every so often.

Second, the argument implies there was no causal link between the boom and the bust, so the stable period can be understood as separate from the unstable period. Yet if the boom and the bust are caused by the same process, then understanding one entails understanding the other. In this case, the same webs of credit which fuelled the boom created enormous problems once the bubble burst and people found their incomes scarce relative to their accumulated debts. Models which failed to spot this process in its first phase inevitably missed (and misdiagnosed) the second phase. As above, the job of macroeconomic models is to understand the economy, which entails understanding it at all times, not just when nothing is going wrong - which is when we need them least.

As a final note, I can't help but wonder if this argument, even in its general political form, has roots in economic theory. Economic models (such as the Solow Growth Model) often treat the boom as the 'underlying' trend, buffeted only by exogenous shocks or slowed/stopped by frictions. A lot of the major macroeconomic frameworks (such as Infinite Horizons or Overlapping Generations models) have two main possibilities: a steady-state equilibrium path, or complete breakdown. In other words, either things are going well or they aren't - and if they aren't, it's usually because of an easily identifiable mechanism, one which constitutes a "notably rare exception" to the underlying mechanics of the model. Such a mentality implies problems, including recessions, are not of major analytical interest, or are at least easily diagnosed and remedied by a well-targeted policy. Subsequently, those versed in economic theory may have trouble envisaging a more complex process, whereby a seemingly tranquil period can contain the seeds of its own demise. This causes a mental separation of the boom and the bust periods, resulting in a failure to deal with either.”

Optimistic – absolutely, unconditionally

Thought for the day

“The weak can never forgive. Forgiveness is the attribute of the strong.”

-          Mahatma Gandhi (Indian, 1869-1948)

Word for the day

Embroil (v)

To bring into discord or conflict; involve in contention or strife.

(Source: Dictionary.com)

Teaser for the day

Will Arun Jaitley present “dream Budget” in July?

After all he has much stronger support than what MMS and PC had in 1990’s.

Even more important – will Congress openly support the reforms which UPA failed to implement supposedly due to inadequate numbers?

Optimistic – absolutely, unconditionally

In early 2011, while serving as a strategist with a large wealth management firm in Mumbai, I accompanied a senior relationship manager to his client. The client had just sold off his business and was flush with liquidity. The relationship manager wanted to capture a pie of the booty.

This was the time when markets had just completed their massive up move from March 2009 lows, and were struggling with European crisis. Macro indicators were deteriorating. Government appeared clueless and FIIs were saying good night and logging out of the “India Story”.

We were hugely underweight on equity and advising only high quality short term debt to our clients. I had no fascinating “buy” ideas as my model portfolio was full of boring consumers and IT names.

On our way to client’s office in suburban Mumbai, the Relationship Manager suggested – please do not give him any bearish views. We will get money only if we present an optimistic outlook and convince him to take market and credit risk. He gave me precisely 40minutes to redefine my strategy in which I had strong conviction. Subsequent events are not relevant here.

I remembered the cited instance as I read the latest RBI policy statement for the third time late evening yesterday. I could see him obliging a request from the finance minister – “I understand there is little economic rationale for cutting rates at this point in time, but at least sound bullish”.

The discomfort of the governor in sounding conspicuously dovish could be gauged from the following two paragraphs in the statement.

“Lead indicators point to continuing sluggishness in domestic economic activity in the first quarter of 2014-15. The outlook for agriculture is clouded by the meteorological department’s forecasts of a delay in the onset of the south-west monsoon with a 60 per cent chance of the occurrence of El Nino. The ongoing contraction in the production of consumer durables and capital goods, coupled with moderation in corporate sales and non-oil non-gold imports, is indicative of continuing weakness in both consumption and investment demand. The decisive election result, together with improved sentiment should, however, create a conducive environment for comprehensive policy actions and a revival in aggregate demand as well as a gradual recovery of growth during the course of the year.”

“The risks to the central forecast of 8 per cent CPI inflation by January 2015 remain broadly balanced. Upside risks in the form of a sub-normal/delayed monsoon on account of possible El Nino effects, geo-political tensions and their impact on fuel prices, and uncertainties surrounding the setting of administered prices appear at this stage to be balanced by the possibility of stronger Government action on food supply and better fiscal consolidation as well as the pass through of recent exchange rate appreciation. Accordingly, at this juncture, it is appropriate to leave the policy rate unchanged, and to allow the disinflationary effects of rate increases undertaken during September 2013-January 2014 to mitigate inflationary pressures in the economy.”

It is however pertinent to note that on my part I am genuinely optimistic about FY16-FY18 macro outlook; though not euphoric as yet.