Do it yourself

Wednesday, December 6, 2017

Choose your economic model

Thought for the day

"In fact, you couldn't give me anything to make me go back to being a teenager. Never. No, I hated it."

—J. K. Rowling (English, 1965-)

Word for the day

Literatim (adv)

Literally. Letter-for-Letter

Malice towards none

Mainstream media loves to designate every election in the country as the litmus test for NaMo. They have even extensively covered elections to Delhi University Student Union and Local Bodies in a number of states, hoping whatever.

They may please note my RWA is holding elections early next month:)

First random thought this morning

While all the parties to the Ayodhya dispute are eagerly waiting for the Supreme Court's judgment, no one is apparently ready to take verdict that goes against them.

This means what?

(a) No one actually believes that this matter could be decided by the court.

(b) No one is actually interested in this matter getting resolved. The pending court case is just a delaying tactic.

(d) None of the above

Choose your economic model

It is widely expected that the vehicle that transited most economies from underdeveloped to developing to middle income is fired by two engines - real estate and exports. Technology advancement and higher productivity have mostly played a supportive role in (a) enhancing export competiveness; and (b) raising affordability levels of households for buying houses.

For most larger economies the improvement in social indicators inclusiveness, sustainability, equity, quality of life etc. appear to have followed the economic development with lag (often in decades).

To keep things simple, I therefore like to assess the efficacy or otherwise of any economic development model on these two basis.

As the economy begin to open up in 1991, Indian exports started to rise noticeably. The growth however gained tremendous impetus from 2004 onwards. A lot of this I would like to contribute to the brave reform efforts made by the NDA government led by AB Vajpayee during 1998-2004.

Developing industrial and trade infrastructure at unprecedented pace through privatization of most core sectors was hallmark of that government. The technical capabilities developed, though under compulsion due to international sanctions post 1998 nuclear tests, during that period also aided the exports growth in engineering, technology and pharma sectors.

Stronger currency, stronger fiscal and stronger current account resulted in sharp decline in interest rates in the subsequent years. Low rates, higher employment level, rising wages, better connectivity and accessibility all combined to lead a strong growth cycle in real estate.

The subsequent government however could not manage the growth well, especially in terms of regulating the credit, resource allocation and managing fiscal balance. Fiscal profligacy (high subsidies and unproductive welfare spending) for political advantage soon frittered away the low rate advantage. The global financial crisis also played an important part as exports slowed down and capital flows were affected.

The consequences are half dead real estate sector, exports moving in slow lane, humongous pile of nonperforming assets, poor investment growth, stagnant real wages and falling employment level.

In past three years, the incumbent government has made some progress in sorting out these issues. Unproductive subsidies have been rationalized (even at the cost of political advantage), inflation has been mostly reigned, resource allocation has been mostly regularized, NPA mess has begin to sort out, real estate sector now regulated is coming out of slumber, export decline has been arrested, and may begin to look up.

But I would like to add here, it is the Vajpayee model of development and not the Gujarat model of development (if there is any) that has succeeded. The learned economist Dr. Manmohan Singh's model of development is seriously questionable, in my view. Comments are welcome.

Tuesday, December 5, 2017

"To cut" or "To raise"

Thought for the day

"It takes a great deal of bravery to stand up to our enemies, but just as much to stand up to our friends."

—J. K. Rowling (English, 1965-)

Word for the day

Gerontocracy

A state or government in which old people rule.

Malice towards none

Ravan was son of a Brahmin and devotee of Shiva!

So what's the point?

First random thought this morning

While Baba Ramdev was kept busy fighting war on MNC tooth paste, confectionary and cosmetic brands, the global mobile phone makers (mostly Chinese), automobile makers, and readymade garment sellers have "plundered" billions from "gullible" Indian consumers.

Moreover, even on cosmetics, hair oil, ayurvedic products like Chyvanprash etc., confectionary and grocery etc. also, Baba may be competing more with pure domestic players like Dabur, Emami, Parle, LT Foods, DFM, Baidyanath, Marico, etc., rather than P&G, Colgate and HUL.

Should someone call his bluff and restrain him for carrying out a mostly misleading campaign?

"To cut" or "To raise"

When the members of Monetary Policy Committee (MPC) of RBI meets today for the Fifth Bi-Monthly review of monetary policy for FY18, the question before it might be "to raise or not to raise" rather than "to cut or not to cut".

An overwhelming majority of experts is forecasting a status quo on rates.

A near unanimity amongst forecasters over the likely decision of MPC on policy rates is rather unusual. Overwhelming consensus on any issue involving human intervention always bewilders my strategist mind. Consensus on economic issues is even more perturbing as it is against the basic concept of market.

In my view, MPC is presently faced with unprecedented complexities in policy making. Though the stated objective is to manage inflationary expectations, MPC must deal with prospects of worsening twin deficit, slowing growth and likely global liquidity and rate events.

As the recent GDP data (2QFY18) showed that Private consumption growth (6.5% in Q2) was weakest after Sep 2015 despite festive season and some pick-up in rural demand. The consumer confidence pointed that the urban consumer sentiment has stayed weak over this period, which suggests that the impact of 7th Pay Commission has mostly been digested, and a decent stimulus may be needed to encourage private consumption.

Government consumption growth dropped sharply to 4.1% in Q2 (17.2% in Q1) as fiscal deficit concerns prompt some belt-tightening. The rate hike by some banks on bulk deposits amply highlight the tight liquidity conditions. This tightness in my view is mostly due to the government's fiscal management jugglery (delay or deny tax refunds, delay contractor payments, delay subsidy payments and defer consumption and investment). This will reflect badly on FY19 fiscal, which may face political pressures also as general elections draw near.

The 4.7% growth in investment demand (GFCF) was the best in 5qtrs but as a proportion of GDP it remains ominously low. Given the still very low capacity utilization level and fiscal constraints, the visibility of investment demand recovering in FY19, without a significant stimulus, appears low.

The stimulus in turn will depend on improvement in revenue collections, which may largely be a function of consumption growth and revival in export demand. Exchange rate may play a critical role here. Many experts believe that a more than 10% correction in INR value would be needed to improve the competitiveness of our exports.

While the need for a monetary stimulus (rate cut) may appear overwhelming, as the finance ministry officials have also been insisting, the specter of inflation is rising (may rise aggressively if INR depreciates 10%) and trajectory of rates in global markets is no longer heading south.

So, my sympathies with MPC, especially the market economists sitting on the committee, who would obviously want an aggressive easing.

Friday, December 1, 2017

Outlook for 2018 - 2

Thought for the day

"I think you could ask 10 English people the same question about class and get a very different answer."

—J. K. Rowling (English, 1965-)

Word for the day

Scrummy (adj)

Very pleasing, especially to the senses. Delectable. Splendid. Scrumptious.

Malice towards none

What has changed in West Bengal after the end of 35yrs of communist rule?

What will change if 22yrs of BJP rule does come to an end in Gujarat?

Fail to understand what this all brouhaha is all about!

First random thought this morning

In past two days the two principal political parties in the countries have used important terms like Hindu, Brahmin, Janeyu (sacred thread), Shiv Bhakt, Non-Hindu, rather contemptuously.

As per the traditional view of RSS and BJP, duly endorsed by SC, Hindu is not a religion but a way of living. At times they have said anyone living in Aryavrata (between Hindukush and Indian Ocean) is Hindu. Then how RaGa becomes a non-hindu, just on the basis of following a different way of worshipping.

Congress claims RaGa to be a Janeyu bearing Brahmin. Do they believe in caste system which says Brahmin is son of Brahmin? Or do they believe that Brahmin is any learned soul which works for the elevation of society? Does anyone become Brahmin just by bearing Janeyu? And Shiva Bhakti is mostly about renunciation, altruism, and abstinence. From what angle RaGa appears a Shaivaite?

Outlook for 2018 - 2

As highlighted yesterday (see here) the Economic Intelligence Unit (EIU) of The Economist released its outlook for six key industries for 2018. The summary of the outlook is reproduced below:

Automotive industry

In 2018 the automotive industry will see sales growth in all but eight of the 60 countries we cover, yet the industry will face huge challenges in its biggest markets, the US and China. Aggressive new targets on electric vehicles (EVs) in China will force the pace of their rollout worldwide. Governments will adjust the way in which they deploy incentives to spur take-up of EVs: a mix of congestion charges, parking permits and other measures will start to supplement or even supplant traditional subsidies. This will bring opportunities for carmakers, but also threats. EV development will require heavy investment, and it may not pay off for all carmakers. In China, for instance, local conditions favour domestic players, while elsewhere the plethora of new launches will lead to tough competition.

For the auto industry as a whole, rising trade barriers will be another dampening factor in 2018. On this front, the US’s desire to renegotiate the North Atlantic Free-Trade Agreement (NAFTA) is the greatest risk.

Consumer goods and retail

The outlook for consumer goods and retail firms looks brighter—but only superficially. Sales volumes will grow by 2.5% in 2018, slightly slower than in 2017. Bright spots will include the opening-up of markets such as Vietnam and Iran, but not everyone will benefit.

Among the countries facing a sales downturn is the UK, where Brexit will finally bite.

E-tailers are also likely to thrive more than bricks-and-mortar stores in both developed and developing markets. Alibaba, China’s e-tailing giant, will continue to report strong growth, while Amazon (US) is set for another year of aggressive expansion despite regulatory scrutiny: 2018 may even bring a push into ready-to-eat meals.

Amazon’s foray into bricks-and-mortar selling is especially disconcerting for traditional chains. The “retail apocalypse” feared by some will not materialise in 2018, but the rise of e-commerce will shake many old-fashioned shops and bring some crashing down.

Old retail’s troubles will be especially severe in the US, a US$4trn market, but will extend well beyond it. Consumer-goods makers will not only have to adapt to the changes in distribution but are also being harried by activist investors and upstart boutique brands.

Energy

In energy, it promises to be another year when US policies will be out of kilter with the rest of the world. Donald Trump’s administration will noisily try to dismantle the more climate-friendly policies of his predecessor, Barrack Obama, in a bid to boost the coal and oil industries. Slowly but irreversibly, though, the world is making the shift to cleaner energy. In green-minded Europe, Germany’s new coalition government will struggle to hammer out a coherent stance on energy policy, but the UK will take further steps towards decarbonising its economy. Most momentously, China will boost its renewables capacity by roughly 60 gigawatts in 2018—the equivalent of South Africa’s entire electricity needs.

OPEC will continue its herculean efforts to make oil more expensive—partly motivated, in Saudi Arabia, by the upcoming listing of a valuable stake in its national oil company, Saudi Aramco. A barrel of Brent crude will cost an average of just US$59 in 2018, barely up from 2017.

Financial Services

The deep scar left by GFC on the financial services sector will at last start to feel healed. Steady economic growth, loftier interest rates and a plateau in re-regulation will give financial firms renewed confidence. Banks, especially those headquartered in Asia, will chase after opportunities abroad. As interest rates rise gradually, higher bond yields should burnish the appeal of fixed-income products, taking the shine off equities.

There are risks to our optimistic outlook for finance, chief among them China’s massive debt pile. But the state—headed by Xi Jinping, his powers newly reinforced by a recent reshuffle at the top—has ample resources to fend off a devastating outcome. Neighbouring India will start to recapitalise its lenders in 2018. Wobbly banks in parts of Europe will keep tumbling, but the threat will not be systemic. Taxpayers, who must mop up the mess, may still fume.

Healthcare

US health spending will hit US$3.5trn, over two-fifths of the global total, yet outcomes will remain average for such a wealthy country. The news agenda will be dominated by Republicans’ continued efforts to replace Barrack Obama’s Affordable Care Act.

Other countries will make better headway with health reforms, among them developing nations such as India and Pakistan, which are extending care to more of their citizens. China will bolster its national health system.

Population ageing will add to the pressures on health systems, particularly in Japan. By 2018, 18m Japanese people will be 75 or older, and their ranks are set to swell fast. So too are the associated long-term care costs, lending urgency to Japan’s health reforms in 2018. Pharma companies will watch nervously as the UK’s departure from the EU nears, praying that negotiators can avoid a precipitous rise in non-tariff barriers.

Telecom

Telecoms companies, meanwhile, will face both opportunities and threats from the global rollout of mobile networks. For every 100 people around the world there will be an average of 113 mobile subscriptions in 2018, with rapid growth in places such as India and Sub-Saharan Africa. In developing countries, the focus will increasingly be on expanding 4G coverage, while in developed ones it will be on testing 5G technologies. Consumers will take advantage of the opportunity to bring yet more of their lives online.

But funding this is placing an intense strain on telecoms companies’ balance sheets. Simultaneously, competition is pushing down prices for consumers—who are adding to operators’ woes by favouring over-the-top providers of services such as messaging apps, which piggyback on utilities’ networks. Another blight will be the close regulatory scrutiny of mergers, particularly in Europe. Still, at least in the US telecoms companies can look forward to the slashing of red tape.

I shall be sharing my views on implications for Indian industries later this month, when I present my thoughts on my strategy for 2018.

Thursday, November 30, 2017

Outlook for 2018 - 1

Thought for the day

"I would like to be remembered as someone who did the best she could with the talent she had."

—J. K. Rowling (English, 1965-)

Word for the day

Benevolence (n)

Desire to do good to others; goodwill; charitableness

Malice towards none

A CM of a state, who happens to be an ex IRS officer, calls certain action of IT department a political vendetta.

I do not know who is on the right side in this case.

But whosoever it is, the one on the wrong side should not go unpunished, if we want people to respect institutions.

First random thought this morning

As per popular sayings a diamond cuts the diamond, steel cuts the steel, venom cures the venom and lion defeats lion, so on and so forth.

Our politicians have taken these adages too seriously. They are trying to counter false propaganda of their opponents by even bigger lies.

The mud-slinging match between them is no longer funny. The sight has rather become repugnant.

A revolution would be in order here. Any correction may not work.

Outlook for 2018 - 1

The Economic Intelligence Unit (EIU) of The Economist released its outlook for global economy and industries for 2018.

In general the economic outlook is cautious. EIU believes that "global economic conditions will not be bad—although not quite as good as in 2017".

A summary of the global economic outlook of EIU is reproduced below:

"The global economy has been at its healthiest for some time in 2017, but this will prove a fleeting state. Inflation will pick up and central banks will begin to tighten somewhat more aggressively. The European Central Bank (ECB) will start to taper its quantitative easing in 2018. Moreover, political risk is at its highest level for years: there is long-term policy uncertainty in the US, little clarity on Brexit negotiations in the EU, and North Korea is flexing its muscles. Global GDP growth will thus tail off slightly in 2018, to 2.7% at market exchange rates.

The non-OECD world will manage to grow by 4.4%, while the expansion among OECD countries will slow gently to 2%. The US economy will grow by 2.2%, a level that is fast becoming the new normal. The greatest shadow of unpredictability hangs over the world’s largest economy. Donald Trump is an erratic leader, making him a difficult ally at home (for his fellow Republicans) and abroad. This will give the US’s rivals, including Russia and China, the chance to extend their influence.

Still, the debt-laden Chinese economy will slow to 5.8% in 2018, marking a steeper decline compared with recent years. The slowdown will be policy-induced, however, so the credit bubble will deflate rather than burst. Countries such as Australia, Chile and Mongolia, which export non-oil commodities to China, will also feel the chill.

Higher oil demand in Asia and OPEC members’ willingness to extend a supply agreement into 2018 will at least offer some support to oil prices, which will rise to US$59/barrel, from an estimated US$55/barrel in 2017. In oil-dependent Russia, structural weaknesses will dampen economic growth, and The Economist Intelligence Unit does not expect significant reforms before the presidential election in March 2018.

In Europe, political risks will again be in evidence, but the biggest challenge for the euro zone will come from the economy, given the underperformance of markets in southern Europe, such as Italy and Greece. Higher borrowing costs in the US, China and Europe will also temper global growth—another reason why it will fall a touch in 2018."

EIU has also made some very interesting forecast about the likely trend in six key industrial sectors. I shall be discussing these forecast and my views on that tomorrow.

Wednesday, November 29, 2017

Driver of rally suffer from fatigue

Thought for the day

"It is our choices... that show what we truly are, far more than our abilities."

—J. K. Rowling (English, 1965-)

Word for the day

Complicit (adj)

Choosing to be involved in an illegal or questionable act, especially with others; having complicity.

Malice towards none

There is no Punjabi pride working for Virat Kohli. Who will root for a Bharat Ratna for him?

First random thought this morning

Nothing could be more unfortunate that the fact that after 70yrs of independence from alien rule, we are still debating who, how, when and where should sing the National Anthem.

The courts of law, already saddled with millions of pending cases, are busy hearing these mostly frivolous cases and passing some ridiculous orders. State administrations have to force students, and even older citizens to sing the Anthem, and stand up when singing.

Don't you think, this is one of the three major failures of our political establishment in post independence era, besides failure to eradicate manual scavenging and prevent female infanticide.

Driver of rally suffer from fatigue

The current bull market in Indian equities, that started in August 2013, is mostly driven by macroeconomic improvements and political changes.

The twin deficit situation improved materially. Interest rates fell over 200bps. RBI successfully targeted inflation and tamed it effectively. INR decline was arrested and forex reserves improved significantly. Change in political leadership led to improvement in sentiments and confidence. Some key pending economic reforms like GST, regulator for real estate sector, modern bankruptcy law, have been implemented.

The upmove has been strongly supported by abundant liquidity in the global financial system, declining domestic investment demand and poor real estate market.

The corporate earnings though have not shown any encouraging trend in past four years.

All these driver of the current bull market in India appear fatigued now. For example—

(a) The current account deficit improvement that started with drastic steps taken by the then new RBI governor and the then Finance Minister working in tandem, has peaked at 0.7% of GDP a few months back and is forecast to deteriorate to 1.75% by 2020. Higher energy import bill and lower export growth are primary reasons for the deterioration.

(b) The gross fiscal deficit of the central government is peaking in range of 3-3.5% of GDP. It is highly unlikely to improve any further from here. To the contrary there is a strong case for it to deteriorate in next couple of years as we approach the next general election.

(d) The chances of any further cut in interest rates appear dim. Bond yields have risen sharply over past few weeks. INRUSD also likely bottomed close to Rs64/USD.

(e) The global flow look uncertain as central bankers in the developed world look to contract their respective balance sheets.

(f) The popularity of political leadership is at the peak. The improvement in sentiment and confidence of businesses and consumer seems to be peaking close to decade high level.

(g) Investment demand continues to struggle.

(h) The impact of wage hike post implementation of 7th pay commission and OROP has been mostly factored. The implementation by PSUs and state governments may occur over next 12months.

(i) Earning downgrades continue, though at a slower pace. But given that the consensus is estimating a 25-30% earnings growth over next one and a half year, the disappointment is more likely there.

Tuesday, November 28, 2017

Bull markets are all same, or are they?

Thought for the day

"Youth cannot know how age thinks and feels. But old men are guilty if they forget what it was to be young."

—J. K. Rowling (English, 1965-)

Word for the day

Hearth (n)

Home, Fireside

The floor of a fireplace, usually of stone, brick, etc., often extending a short distance into a room.

Malice towards none

Controversy over Padmavati is not yet settled and an MLA and former minister in Bihar, hs threatens the Deputy CM, and the Deputy CM had to shift the venue of his Son's wedding.

"Law & Order"— is anyone bothered?

First random thought this morning

Last week I had the opportunity to interact with school children of a government school in a small town of UP. While I was sharing my experiences and thoughts with intermediate students, a young teacher raised a question. She asked, "why do we celebrate achievements of Indians living abroad, like Satya Nadella, Sundar Pichai et. al. These individuals indubitably have done very well for themselves. But what have they done for the country. And for that matter why are we celebrating an Indian girl winning Miss World title. The girls who won this title in past, have not really done anything for the country or countrymen to feel proud about, unless you want to feel proud over Priyanka Chopra playing a role in an English TV serial?"

As the question was fired out of blue, I could not answer this young lady. But I do want to satisfy her inquisition. May I seek your help!

Bull markets are all same, or are they?

In my view, most human being are naturally inclined towards positivity, progress, and prosperity. The cynics and skeptics are usually in abysmal minority. Celebrating rise in asset prices causing increase in wealth hence is a natural human reaction.

Bull markets are therefore usually welcome. The up cycles in real asset prices are mostly celebrated uniformly. However, the bull market in financial assets are fiercely contested, almost always. The current instance is no different. The reasons could be varied and justified. But that is not the point I want to discuss here. My point is limited to analyze the current bull market in India to optimize my returns on my investment portfolio.

In my view, though most bull markets in equities look the same from 35k feet, a closer look would reveal a different set of drivers in each case. It is important to note because it is the fatigue of these driver that eventually causes the reversal in price trends.

For example, the key driver of previous bull market in Indian equities (2003-2007) was the surge in credit. An unprecedented investment cycle was unleashed by easy credit.

Asian Financial crisis and successive poor monsoon resulted in economic growth plummeting in 1997-2003 to an average of 5.4 per cent. Economic sanctions post 1998 nuclear tests also played their role. The government responded with fiscal compromises and massive economic reforms. The government gave away its control over key sectors like roads, coal, energy, telecom, ports, airports and opened multiple areas for FDI. Implementation of VAT at state levels and expansion of Service Tax augmented the revenue considerably.

Consequently, fiscal discipline was restored after FY03, with the next five years up to FY08 witnessing a major reduction in the combined fiscal deficit from 9.3% of GDP in FY03 to a then record low of 4.7% in FY08. Lower fiscal deficits led to materially lower interest rates, which promoted higher investment and growth, which, in turn, increased revenues and thus further reduced deficits. Economic growth soared to record highs to average 8.7% during 2003-08.

The equity market celebrated its best bull market in history with Nifty rising from a low of 920 in April 2003 to a high of 6357 in January 2008 a 7x rise in less than five years, regardless of the most popular PM losing elections.

The market faltered when fiscal discipline was set aside in FY09 (combined deficit @ 10.6%) and the easy credit (rates begin to rise and NPA begin to build up) and freedom to operate to infra developers (scams in telecom, coal, real estate, roads) that drove the market started to falter. Global financial crisis pushed the markets deeper into abyss. The house of cards collapsed, with an unusually large number of infra builders losing over 80% of their market value and lenders left to collect the debris....to continue tomorrow

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.