Do it yourself

Thursday, November 23, 2017

Market Cap to GDP

Thought for the day

"There is no less invention in aptly applying a thought found in a book, than in being the first author of the thought."

—Pierre Bayle (French, 1647-1706)

Word for the day

Nonbook (n)

A book without artistic or literary merit or substance, especially one that has been developed primarily to exploit a fad or make a profit quickly.

Malice towards none

Regardless of the outcome of controversy around Padmavati movie, one thing is certain that 10yr hence the legend of Padmavati will have a face and that will be of Deepika Padukone, much the same way as Anarkali is imagined as Madhubala!

First random thought this morning

I can confidently say that movies inspire a lot of people in India, and may be elsewhere also. The inspirations people derive from movies vary from fashion, career choices, relationship management, political choices, crime ideas, and even life changing idea, e.g., committing or not committing suicide, etc

What I understand from media reports, the case of a young girl that unfortunately died of dengue in a Gurugram corporate hospital is very similar to what was shown in a 2015 Hindi movie starring Akshay Kumar.

I am not sure whether the movie was inspired by some real life instance (s), or the Hospital's conduct is inspired from the movie. Regardless, there is a case for implementing serious reforms in the healthcare sector.

Market Cap to GDP

One of the most popular data point used by the market participants to justify (or otherwise) the current market level is GDP to Market Capitalization ratio.

The latest argument in this context is that the last bull market peaked at 103% Market Cap to GDP ratio. The current ratio being 87%, there is still scope for market to move higher.

I have never fully understood the rationale behind applying this criterion to equity markets, especially Indian markets, for the following reasons.

(a) This argument assumes near perfect correlation between economic growth and stock market performance. This assumption may not be correct in most circumstances.

(b) This argument completely ignores the rise in private equity investments. In Indian context for example, the equity investment in self owned enterprise and home equity has risen sharply in past one decade, as compared to the decade prior to that. Besides, the size of unlisted private businesses has increased significantly. Factor in the estimated market value of Amazon India, Vodafone India, PayTM, FlipKart, Honda India, Hyundai India, LG India, Samsung India, Apple India, etc. and you will find this ratio running much higher than what the chart below shows.

(c) The rise in market cap purely due to PE re-rating due to excess liquidity or other reasons, may not actually represent any improvement in underlying economic fundamentals.

(d) The equity valuations of stressed companies and lenders to these companies may not be adequately reflecting the realizable value of assets and future business potential

Wednesday, November 22, 2017

Been there seen that

Thought for the day

"Properly speaking, history is nothing but the crimes and misfortunes of the human race."

—Pierre Bayle (French, 1647-1706)

Word for the day

Deontology (n)

Ethics, especially that branch dealing with duty, moral obligation, and right action.

Malice towards none

Some analysts are suggesting that Gujarat election outcome would be critical for stock market.

I would like to know how and why?

First random thought this morning

Fringes are playing some interesting roles in Indian politics.

The right wing fringes are distracting peoples' attention from core issues and indulging them in frivolities like Love Jihad, Beef, Padmavati, et. al.

The left wing itself is at the fringe. Nonetheless its fringes are busy in protecting the freedom of expression of Indians. They believe the only way to protect FoE is to make sure that only they are allowed to speak.

The centrist-socialist fringes are busy in cracking sickening jokes on social media so that they can make Rahul Gandhi look like a towering statesman.

Been there seen that

As mentioned yesterday (see here) a seed of worry is sprouting somewhere back of my mind. The more I strive to find the drivers of current equity rally, the more I get confused.

The rally was driven initially by macro improvements. But now most of the macro improvement seems to have peaked, and FY19 may actually see some of the macros like twin deficit and inflation may actually deteriorate.

2QFY18 has shown lots of promise for earnings improvement. But even after factoring in the rather optimistic growth forecast for FY19, the current valuations look stretched, leaving no margin for error whatsoever.

As a broader benchmark, under the current interest rate and inflation expectation scenario, a conservative investor like me would be comfortable with a PER between 15-25 for non-cyclical businesses. For cyclical commodity businesses the comfort would end in 8-10 band.

I am still not be comfortable valuing asset heavy businesses with relatively longer and unpredictable revenue cycles on price to book (P/B) or replacement cost basis; because it goes against the principle of going concern. If at all these businesses might be valued at Net Realizable Value (NRV) for limited purposes of judging solvency conditions.

Evaluating financial stocks purely on the basis of net book value is also mostly not a good idea. It is important to consider the profitability and reliability of the book as such.

These days any query on corporate database would throw a long (ominously long) list of stocks trading at EV/EBIDTA ratio of over 20. (EV = Market capitalization plus Net Debt; and EBIDTA is earnings before interest, depreciation and tax). It is even more scary to read research reports early in the morning which find stocks with EV/EBIDTA ratio of 20+ as attractively valued.

In case you find this blabbering of mine too academic, I agree. Whenever I suffer from indecisiveness or I am confounded, I go back to text books in search of a solution.

In my view currently the following three are the primary drivers of equity prices in India:

(a) Hope of material improvement in corporate earnings. Rise in public expenditure (both revenue and capital) and hope of revival in rural consumption are primary factors that are kindling this hope. Though not completely baseless, in my view hopes of 20%+ earnings growth in FY19 may not materialize. The prices may therefore have crossed over the line of reasonableness and heading towards the territory of bubbles.

(b) Incessant flow of domestic funds. Still low equity exposure of domestic investors, even after a significant rise in recent months, is motivating many investors and traders.

This time the argument is that demonetization of currency and GST have lead to material contraction in the cash economy. A large part of the household and private sector savings that were out of the formal financial markets is bound to find its way into the financial market, mostly into publicly listed equities.

This trade I have seen in early 1989-1992, mid 1994-1996, 1998-2001, and then in 2004-2008.

Every time there was an argument of structural changes in the market that would sustain the households' interest in equity investment. In early 1990s it was opening of capital markets and beginning of private mutual fund industry. In mid 1990s it was bank recapitalization, restructuring of UTI, flood of new IPOs, in late 1990s it was ESOPs and our engineers returning with bagful of dollars, and a decade back it was cheap credit, FDI reforms, tax reforms and all that.

Unfortunately, on all previous occasions, it had been ferocious — on the way up and on the way down. The upswing we are witnessing and enjoying. Please keep your seatbelts fastened for the descent, even if you can't see it around the street corner yet.

On valuations there is another rather strange argument is being relied upon heavily.

Many analysts and fund managers have argued that the current PE ratio of Sensex is much below the peaks seen in previous bull markets, and therefore, the market is nowhere close to a bubble territory.

I have two comments to make on this.

1. Since 1990, every subsequent bull market has peaked at a lower PE ratio as compared to the immediately preceding bull market.

2. The average life expectancy in India is close to 70yrs. Does it mean that people below 60yrs of age need not take care of their health as they are not likely to die anytime soon!

What if markets peaked at 25x PE ratio last time. Does it mean that they cannot correct from 20x level this time?

There are other arguments like Market Capitalization to GDP Ratio.

I would be sharing my thoughts on that in subsequent posts.

Tuesday, November 21, 2017

Valuations - Starting from the end

Thought for the day

"It is pure illusion to think that an opinion that passes down from century to century, from generation to generation, may not be entirely false."

—Pierre Bayle (French, 1647-1706)

Word for the day

Macaronic (adj)

Composed of a mixture of languages.

Malice towards none

Has the government erred in not marking the birth centenary of former Prime Minister Mrs. Indira Gandhi?

First random thought this morning

LKA build BJP from almost zero to a force to reckon with. NaMo has strengthened this force materially. But one thing that has confounded many is why LKA could not achieve what NaMo has.

I think I have solve at least first stage of the puzzle.

LKA mobilized millions in the name of Ram temple, but never tried to channelize the mob into a positive force working for betterment of life. Whereas NaMo mobilized millions of youth the name of corruption and has shown intent to channelize them into a positive force to work for clean India, self reliant India, self employed India, etc. This positive intent has made all the difference.

Karni Sena might have a lesson to learn here.

Valuations - Starting from the end

In past bull markets I have seen many analysts reengineering their valuation arguments. Instead of arriving at the fair value of a stock through the conventional earnings, cash flows and replacement value arguments, they would seek to apply innovative and fancy valuation criteria like foot falls (for retail stores), eye balls (for ecommerce portals), price to growth or PEG (for IT start ups), NAV per share (for real estate developers) etc. to justify the current market price (CMP). In this case CMP becomes the starting point of analysis.

I can see a similar trend emerging in the current market environment also.

In conventional sense, the return on the investment in publically traded equity is a function of 3 factors (a) earnings growth; (b) changes in price earnings (PE) ratio and (c) dividend.

The earnings growth is a function of multiple factors, e.g., (a) capacity (production capability); (b) demand environment (market leadership); (c) competitive landscape (pricing power, cost advantage); (d) innovation and technology advantage; (e) resource availability (raw material, labor, capital, managerial bandwidth etc.), etc.

The price earnings ratio (PER), one of the most popular equity valuation criteria, is the ratio between the earnings of a company and its market value. It broadly signifies that at the current rate of earnings how many years it will take for the company to add the value which an investor is paying today. Principally, an acceptable PER for a company's stock is defined by (a) the return on equity (RoE) a company is able to generate on sustainable basis and (b) the growth rate of earnings that could be achieved on sustainable basis. A company that could generate higher RoE consistently and is likely to grow faster, should be assigned a higher PER as compared to the ones which generate lower RoE or has low or highly cyclical earnings growth.

A rise in PER, if not commensurate with the rise in earnings profile needs deeper scrutiny. Sometime the rise in PER occurs due to correction in anomalies (undervaluation) of the past. This is a welcome move. Sometime, PER changes (re-rates) due to relative forces, e.g., rise of PER in comparable foreign markets or change in return profile of alternative assets like bonds, gold, real estate etc. This is usually unsustainable and therefore a short term phenomenon. Many times, demand-supply mismatch in publically traded equities also drives re-rating of PER (excess liquidity chasing few stocks and vice versa). This is again usually a short term phenomenon.

Sustainable rise in dividend yield is generally a sign of stable profitability growth (P&L improvement) and strong financial position (B/S improvement) and stronger cash flows. In some cases however it could reflect stagnation in growth.....to continue tomorrow

Friday, November 17, 2017

Mood of markets - divergent views

Thought for the day

"Do you know because I tell you so, or do you know, do you know."

—Gertrude Stein (American, 1874-1946)

Word for the day

Attenuate (v)

To weaken or reduce in force, intensity, effect, quantity, or value, e.g., to attenuate desire.

Malice towards none

Those clamoring for Rajput pride and opposing #Padmavati may please do something to stop female infanticide and incest that plagues their society and makes life hell for millions of living Rajasthani women.

First random thought this morning

There is section of people who is accusing judiciary and regulators for over enthusiasm and activism. Their grouse is that judiciary is overstepping its jurisdiction and may even be infringing the legislative and executive territory.

The point is how did our system reach this stage. It is clearly the failure and corruption of the legislative and executive that is driving this trend.

For example, if executive and legislature were proactive in checking the menace of pollution, why would NGT be needed at first place, and even if constituted, why would it need to pass some seemingly ridiculous orders!

Mood of markets - divergent views

In past few weeks, I have read a number of research reports and market analysis. I have also heard the views of a number of fund managers and investment strategists. Unfortunately, I have not been able to decipher much from all this. Admittedly, my prejudices could be major culprit here. Therefore, I would not like to burden my readers with my conclusions based on the views and opinions of experts.

I would however like to share some guideposts that may help readers form their own judgment about the current mood of markets.

I find that there are two distinct camps of analysts and fund managers:

(a) First camp comprises of those who have seen the exuberance that preceded the last global financial crisis (GFC) and also the melt down that followed it. Experts in this group have seen high growth, full employment, rising interest rates and double digit inflation, Lehman collapse, Merrill Lynch sale and General Motors at brink of bankruptcy. These experts were stress tested for 1930s type of global depression conditions. Many of these also completed the cycle of million dollar bonuses to no pay hike for 5-6yrs. Many of these navigated through GFC adroitly and manage to grow their stature. While others sank with the market but have staged a comeback, but with bruised egos and diminished stature. Most important, experts in this group have experienced asset price falling 50-80% in a matter of one year, from a all blue sky scenario.

(b) The second camp comprises of young people in their late 20s or early 30s, who started their investment career post GFC. These bright guys have mostly worked in 'whatever it takes" and environment, characterized by abundant liquidity, near zero interest rate, very low inflation, low growth that is acceptable as "new normal". The people in this group have only seen asset prices rising steadily while energy prices declined by more than 50%. The belief seems to be that events like Greece default, Brexit, China slowing down from 9%+ growth trajectory to 6%+ growth trajectory, major emerging economies like Russia and Brazil struggling for growth, and India growing at much slower pace are minor aberrations and asset prices have only one direction to move and that is north.

The stance and arguments extended by both the groups are obviously contrasting. Though fund managers from both the groups might be fully invested, the asset allocation and sector preferences do vary materially. Emerging Markets Debt, Gold, US Treasury, Euro, Japan, Chinese mid and small caps, Bitcoins, Frontier Markets etc. are some of the major divergences among the these two groups of experts.

Another stark difference is seen in the valuation argument, especially for equities. While the first group mostly sticks to the conventional valuation matrix, the second group is innovating methods that would justify the current price....more on this next week.

Thursday, November 16, 2017

Judging mood of market

Thought for the day

"The nineteenth century believed in science but the twentieth century does not."

—Gertrude Stein (American, 1874-1946)

Word for the day

Pneumatic (adj)

Of or relating to air, gases, or wind

Malice towards none

Rahul Gandhi - The Alchemist.

RaGa never fails to amaze us with revelation of his new side everyday!

First random thought this morning

Sometimes I find it very unfair. Price of a publicly traded equity share can rise infinitely. But it can fall only 100%.

The history of stock market therefore is dominated only by the winners. No one bothers to remember the stocks which lost 100% of their value. Even if these losers outnumber the winners by 100:1.

Judging mood of market

In the past 17 odd weeks, since Nifty first touched 10K level, the simple average traded value of Nifty has been 10064. The value will be lower if we take the volume weighted average. In this period market breadth has remained decisively negative. The net institutional flows (DII and FPI combined) have been mostly neutral in past 4months.

In period from July to October over Rs220bn have been invested in domestic equity mutual fund schemes through systematic investment plans (SIPs). The current monthly run rate for equity SIP flows is over Rs56bn/month.

This is the period when some significant economic events have taken place, the most notable being implementation of GST. The investors and businesses had been waiting eagerly for this event for past many years. Besides, implementation of new Bankruptcy code and announcement of a comprehensive plan to recapitalize beleaguered public sector lenders are being widely acclaimed as transformational events for Indian economy.

Two sets of quarterly results have been announced in this period. The general consensus amongst analysts and fund managers (at least going by their public utterances) appears to be that earnings for corporate India have bottomed out and a sharp recovery in imminent. Many reputable global fund managers and investment strategist who had turned their back on Indian equities have turned bullish on India in this period.

In the period between July and now, INR has weakened vs USD by almost 1.5%; benchmark yields have jumped up by almost 10%; RBI has cut policy rates once by 25bps and inflation has jumped higher by 200bps.

However, after scaling the mount 10K in last week of July 2017, Nifty has literally gone nowhere, despite much excitement and enthusiasm.

The moot point is weather the markets are still assimilating the changes and may make a move up after consolidating for few months; or market has already assimilated the changes and decided that rally since February 2016 is overdone and a correction would be in order....to continue

Wednesday, November 15, 2017

Strategy Review - 2

Thought for the day

"If you can do it then why do it?"

—Gertrude Stein (American, 1874-1946)

Word for the day

Wastrel (n)

A wasteful person; spendthrift.

An idler or good-for-nothing person

Malice towards none

When all the TV channels in the country unashamedly air private moments of an aspiring politician, why don't I hear a word from the crusaders of the Right to Privacy?

SC has upheld the right to privacy as a fundamental right.

Why should the police not take a suo moto action against people violating this right of Hardik Patel?

First random thought this morning

Any regular visitor to Mata Vaishno Devi Shrine would know that VIP culture has not spared this temple, like any other. It is common to see sundry government servants and their families being escorted by the soldiers in uniform. A number of people carry VIP slips for a privileged tryst with the Divine, while the common people, old and young, man and women, feeble and strong, all struggle in long queues.

The recent NGT order to limit the number of visitors to the holy Shrine will only exacerbate the VIP influence at the expense of the unprivileged devotees. But that is the story of all temples.

I find this appropriation of Deities by VIPs blasphemous, only when I fail to get a VIP ticket. What about you?

Strategy Review - 2

Considering the recent global and domestic developments (some of which I discussed in past couple of posts) I would like to factor in the following assumptions in my investment strategy for next few years.

It is important to note that these are strategic considerations in Indian context, and may or may not reflect on the short term investment strategy for 2018, that I will be sharing with the readers in 4-5weeks.

Factors be incorporated in strategy

(1) Higher inflation.

(2) Higher cost of capital.

(3) Technological disruptions in the areas of mobility and financial services. Going by the current views, the pace of obsolescence and redundancy could surprise the markets.

(4) Prospects of an intense cold war and a bi-polar world. India most likely ends up in the grouping led by US and including Japan. However, any ambivalence on part of India, might prove to be massive disaster in terms of foreign policy and trade.

(5) Greater emphasis on import substitution.

(6) Higher volatility

(7) Lower growth in real income

(8) Rise in risk premium

(9) Stronger INR

(10) Climate change

Strategy implications

· Higher weight for commodity producers and resource owners and lower weight for resource consumers.

· Higher premium to free cash flows and operating leverage.

· Lower weight to passenger mobility and conventional fuel.

· Higher weight to domestic consumption, especially upper middle class.

· Higher weight for sectors with large negative trade balance.

· Lower leverage.

· Higher allocation for expenditure necessary for more household members to go out for work.

· PE De-rating.

· Business automation; lower job-investment ratio; economies of scale.

· Lower dependence on conventional fuel.

· Also see

· In search of black swans

· Assimilating the change

Strategy Review

Tuesday, November 14, 2017

Strategy Review - 1

Thought for the day

"Everybody gets so much information all day long that they lose their common sense."

—Gertrude Stein (American, 1874-1946)

Word for the day

Eurhythmic (adj)

Characterized by a pleasing rhythm; harmoniously ordered or proportioned

Malice towards none

Besides Rakhi Sawant, Rahul Gandhi is the only person seems to be thoroughly enjoying his stint in politics, regardless of election results.

First random thought this morning

Imagine, schools shut in Cherrapunji due to rain, in Leh due to low air pressure, in Helsinki due to snowfall, or Congo due to heat wave. Obviously, children in these places will seldom get to go to school.

Why is that Children in Delhi are made to feel so weak and insecure that they are told not to come to school if it is too cold, too hot, or too dirty?

The better course would be to guide children about the risks and train them to weather these risks. Hiding them behind doors will only make them escapist and materially weaken their survival instincts.

Strategy Review - 1

In the wake of global financial crisis (GFC) in 2008-09, almost all big central bankers chose to follow what is now popularly known as non-conventional monetary policy. They expanded their balance sheets at exponential rates, by buying government as well as corporate securities; maintained rates at close to zero level (some even went below par and used negative rates). The objective was threefold: (a) To stabilize the financial markets and (b) to support sustainable faster growth; and (c) improve employment.

Most central banks were extremely successful in stabilizing the financial markets. Many large financial institutions which were at the brink of failure have revived and even strengthened their positions.

The objective of faster growth has so far been met with partial success only. There are pockets like US where growth has recovered but peaking at much below the pre-crisis level highs, whereas many other economies are still struggling to return to a sustainable growth path.

Employment conditions have improved materially in US and a few other places. But elsewhere there is not much evidence of any sustainable improvement in employment levels.

But if we see on global basis, the economic growth has not been encouraging as the large emerging economies (BRICS et. al.) that were racing fast during the crisis have slowed down considerably, since then.

Another thing that has not seen any material improvement is the status of indebtedness in various economies, especially those which were at the core of the problem. Their debt profiles have in fact worsened over past one decade.

A number of analysts has expected a hyperinflationary situation in the wake of extraordinary liquidity pumped into the global financial system as a result of quantitative easing (QE) program of various central bankers. It did surprise many that despite trillions of dollar being pumped into the system, inflation failed to pick up. Most developed world central bankers are still struggling to meet a modest 2% inflation target.

It is therefore reasonable to conclude the following from the above:

(a) The additional liquidity and fiscal profligacy since GFC has been used mostly to support markets and service the debt; and not create additional capacities or generate demand.

(b) It has perhaps been in the best interest of the debt laden governments to keep the cost of capital (interest rates) low, so that they can service the humongous debt without much difficulty.

(c) The employment levels may have improved in quantitative terms, but qualitatively there is not much improvement. Wage levels continue to remain poor and job certainty low. Consequently, higher employment levels are not reflecting to the desired levels in household demand for consumption and investment. On the contrary household leverage has risen past the pre crisis level in most economies.

(d) Since the entire effort since GFC has got mostly constricted to the financial markets and transactions, the demand for real goods, and therefore inflation, has lagged. The spurt seen in commodity prices in recent times can be attributed more to the supply restrictions (due to shut down capacities or scaled down production) rather than any pickup demand or liquidity issues.

But things may change going forward. New capacity additions and changing technology in automobile sector and popularization of renewable may be leading to rise in demand for few commodities like copper and aluminium etc.

This brings us to the our main topic of implications of the recent developments on Indian economy and the changes needed in investment strategy. In my view, the following global trends shall have meaningful impact on Indian economy in next few years:

1. The growing influence of right wing nationalism shall lead to more restrictions on trade, capital flows and labor movement. Active currency management may also gain currency even with many free market economies.

2. Higher (if not hyper) inflation shall occur and stay for long.

3. Electric mobility and renewable power shall gain popularity much faster than a majority of analysts are predicting today. Peak oil demand may also occur much before OPEC's forecast of late 2030s.

4. The geo-political tensions shall remain at higher level, even if it does not materializes in a conventional war. The cold war could be intense and protracted this time too. India so far has tried to maintain a balance, playing ball with both the potential groupings. This however may not be a sustainable strategy and Indian may eventually end up in a US led group. Worsening of relations with China, Russia and other major trade partners could have serious economic implications for India...to continue tomorrow.

Also see

In search of black swans

Assimilating the change