Sanitizing portfolio for higher cost of funds

Some food for thought

"We are put on this earth to have a good time. This makes other people feel good. And the cycle continues."

—Wolfman Jack (American Entertainer, 1938-1995)

Word for the day

Shirty (adj)

Bad-tempered; irritable; cranky

 

First thought this morning

Delhi Police has sought the approval of Delhi Government to file a charge sheet against some students of prestigious JNU. The allegation is that three years ago these students organized a protest within the university campus and shouted anti India and pro terrorist slogans, which as per the Police, tantamount to an act of sedition. On Tuesday, Delhi Police apparently selectively leaked a forensically certified video recording of the event to media, showing the students shouting slogans against the country, Indian Army, CRPF, and favoring a terrorist.

Media, politicians and their sympathizers have expectedly taken a partisan view on the issue.

Holding multiple studio trials, BJP and its sympathizers pronounced these people guilty of sedition and demanded strictest possible punishment for them.

Communists are backing the students strongly, palpably less for their commitment to democratic values and freedom of expression, and more out of their hatred for PM Modi and Sangh parivar.

Congressmen are taking a trademark ambivalent stand. Closer to elections they certainly do not want to take a firm stand against the move, simply for the fear that BJP may highlight numerous past instances when Congress Party misused Section 124A (Sedition) to silence its opponents. Supporting these students openly would be nothing less than stepping on a landmine given the charged sentiments.

Most other parties have either avoided taking a stand or have taken a safer "let the law take its own course" or "democracy is threatened" stand.

Asked by many readers to take a stand, I do not mind taking one. In my view, there are at least three dimensions to the issue.

Moral: From moral standpoint, aspiring to disintegrate the Nation is totally unwarranted and unacceptable, notwithstanding the severity of provocation. This should be condemned in no ambivalent words, and I do so.

Legal: In strict legal sense, I would like to go with the opinion of Justice (Retd) Markandey Katju. So far there is no evidence presented to show that the protests held in JNU and slogans shouted there could possibly have actually motivated an act against the State. Mere shouting slogan may not be enough to prove a charge u/s 124A of IPC.

Governance: From governance standpoint, I find the response of the state inappropriate. The State which is always willing to talk and exonerate Naxalites in Central India and militants in North East and J&K - the people who have actually taken up arms against the state, killed hundreds of security personnel, officials, innocent civilians - apparently did not make any attempt to meet these young students and ask what has agitated them so much that they decided to shout such slogans.

I find the Home Minister, the HRD Minister and JNU administration lacking in discharge of their governance responsibilities.

To sum up, in my view, the students may be guilty of moral turpitude; the ministers may be guilty of violating constitutional oath of commitment to act "without fear or favor, without ill will or affection"; and police may be guilty of acting under influence of their political masters.

 

Sanitizing portfolio for higher cost of funds

There is near consensus that in next 12months the global growth may be the weakest since the financial crisis a decade ago.

The monetary policy tightening by Fed and impact of trade related conflicts may be leading the slowdown in US. Euro Zone and UK are apparently deteriorating due to poor business and consumer sentiments caused by political developments. China slowdown is mix of slowing exports, financial stress, and sustainability measures. China shall take most of the emerging Asia down along with it. India may slow down as fiscal profligacy in run up to general elections constricts the government spending post elections. The poor commodity demand consequent to slower growth may check growth in most of Latin America, Australia and Africa.

The consensus is also emerging that weaker economic activity shall keep the inflationary expectations under check, forcing the central bankers to review their commitment to tightening the monetary policy. The popular discourse has mostly shifted from "hikes" to "cuts". ECB and BoJ, which were widely expected to join the US Fed in normalization of monetary policy by withdrawing stimulus and ending the zero rate policies, are now expected to stay put.

Under the circumstances, investors shall be well advised to note, inter alia, the following points, and adjust their investment strategy accordingly:

(a)   Debt has jumped even higher over the past ten years with various forms of quantitative easing across the globe. Non-financial debt has grown to over 200% of GDP and, with rates rising, could become more and more costly to repay, putting a strain on country health.

 

 

(b)   Stock valuations are their highest since dot com bubble. The US S&P500 CAPE ratio – the P/E ratio based on inflation adjusted earnings over the past ten years that it smoothens out the earnings over time, removing some quarterly noise and including an inflation component relevant to gold valuation, is elevated. The only time this ratio was higher was during the dot-com bubble and all other periods of elevated levels have preceded sharp market sell-offs.

India valuation premium to global peers as well as long term averages is also tracking much higher levels.

 

 

(c)    It is reasonable to expect the cost of funds to rise and stay higher in midterm. Complete tapering of QE by Fed, ECB and perhaps BoJ will results in lower demand for bonds. The fiscal discipline seen in the wake of global financial crisis is waning and fiscal deficits are rising, especially in US. Past 10year have seen minimal capacity building. Many large corporate have used cheaper debt and earnings to buy back their stock, to augment the stock price. Consequently, the cash to debt ratio has got distorted, with no improvement in productivity or earnings potential. Rising fiscal pressures may keep currencies under pressure.

(d)   If US is going to have higher rates for longer, a host of EMs will have their BoP become unmanageable. Trade deficit countries like India have been rather complacent about CAD, since the non trade flows were regular and easy to come by. If we have to make real hard efforts to get portfolio investment and FDI, the policy paradigm will have to shift dramatically.

(e)    In the meantime, many corporate who have borrowed in USD and acted smart to save the hedging cost, may learn what the Asian crisis was all about, all over again!

I shall look to sanitize my portfolio for—

• Material USD debt without total hedge
• High PE ratio, mostly due to TINA factor
• Higher sensitivity to tax rates
• Higher sensitivity to currency fluctuations

 

Market still some distance from the Rock

Some food for thought

"I looked real Neanderthal. I could have been Mexican, I could have been black; I could have been anything."

—Wolfman Jack (American Entertainer, 1938-1995)

Word for the day

Substantive (adj)

Important, real, or meaningful

 

First thought this morning

Following the top political leaders on their election campaign leaves one with a pungent sour taste in mouth. No one, yes none, is presenting a vision for the future to the growing youth population of the country. Most leaders look like pied pipers trying to lure the populace towards dark forests, totally oblivious of the fact what lies there.

The principal opposition Congress is criticizing the incumbent government for failure in alleviating rural distress and creating enough jobs for the youth of this country. It has however, not provided an iota of hint how, if brought to power, it would solve these problems.

The regional parties, which face some opposition from BJP, are mostly indulging in scaremongering. They are painting the incumbent PM as an anarchist, and seeking support to save the country from becoming a totalitarian state by voting him out. Giving their undivided attention to the immediate problem at hand, i.e., PM Modi, they do not even appear considering presenting a socio-economic agenda for future.

The other regional parties, e.g., in Tamil Nadu, Andhra Pradesh, Telangana, Kerala, Punjab, are busy with parochial issues. Nonetheless, they do talk about issues of development, employment, inclusion etc.

The situation of BJP is however most peculiar.

The incumbent government has initiated a number of programs, the execution of which might well extend into next 3-10years, e..g, Urban Rejuvenation (Smart Cities), Infrastructure (Railways, Expressways, Irrigation, Civil Aviation-Udaan, etc.), Social upliftment & Security (Housing for All, Power for All, Cleanliness, Health Insurance, Quota for hitherto Unreserved, Clean Cooking Fuel for all, Self Employment through MUDRA loans etc.).

The problem is that BJP is finding hard to make any fresh promise. It is feeling like the old father who has handed over all its assets to his Children, and now no is bothered about him! Every morning, the father invokes the question of morality, ethics, righteousness and duty to his children. He would keep reminding them what all he did for them. But, who cares!

Having spent all arrows in their quiver, and even the Brahmastra (10% Quota for EWS), BJP appears like a headless chicken moving in circles, not actually moving anywhere.

The worst, in past five years BJP has undermined its traditional agenda - Ram Mandir for Muslim votes, Article 370 for forming a government in coalition with PDP, and Uniform Civil Code for expanding footprints in North East and Kerala). It is hence finding it challenging to keep its core support base intact.

The 2019 Lok Sabha election may therefore be the most localized election so far; only a slightly less than a local body election. Most people may be voting for the candidate and not the party or leadership. The faces of Rahul Gandhi and Narendra Modi might not be too much relevant in the forthcoming elections, after all.

The issues to dominate will also be mostly municipal and favoritism. The candidates most seen in the constituency, and friendly with the constituents, would stand a better chance.

 

Market still some distance from the Rock

Many investors, especially the young ones, are bewildered by the resilience of benchmark indices, in an environment when diversified portfolios are virtually yielding no (or even negative) return in most cases. Many SIP investors have started to question their wisdom in continuing with their strategy of rupee cost averaging.

I receive many queries from readers seeking suggestions about the appropriate strategy under the circumstances. I may clarify that I am in no position to offer any advice or suggestions in this regard. For this they need to consult a qualified investment advisor.

Nonetheless, I may help by sharing how I see the markets.

Historically, the market cycles in India have seen broader markets outdoing the benchmark indices in both the rising and falling phases. In the first phase of a market cycle, small and midcap stocks rise materially more than their large cap peers; whereas in the second phase they fall much more than their large cap peers.

For the full cycle, optically the performance of large is marginally better. However, adjusted for the transitory stocks, i.e., the stocks that migrate from small or midcap category to large cap category, during a market cycle, generally there is little to distinguish.

Now analyzing the current market cycle, there is little consensus over the duration of the cycle.

Many analysts recognize that the current market cycle started from lows of February 2016. But I believe that the current market cycle started from late August 2013, along with significant macro corrections and is still continuing. In any case, I feel that the market cycle peaked in January 2018 and the rally from February 2018 to August 2018 was purely a bear market rally.

I would therefore analyze the cycle from both view points.

View: Market cycle started from August 2013, peaked in January 2018, and bottoming process is on.

If we take this view, we find that the broader markets are still outperforming the benchmark indices materially. In fact, even after one year of peaking, the market cycle compares very well with the beginning to peak phase (July 2006 to January 2008) of the previous major market cycle (July 2006 to March 2009). This is actually little strange given the near absence of earnings growth in the present cycle.

For record, for the entire duration of August 2013 to January 2019, broader markets are giving ~21% return, as compared to 14% for the benchmark Sensex. That is a 50% outperformance. Historically, this kind of outperformance has not been sustainable.

I like this view, because the beginning to peak return of benchmark as well as beginning to current return of benchmark is more aligned to historical averages and correspond well to the nominal GDP growth trends. It would therefore be reasonable to believe that though the bottoming process started a year ago, the market may still be some distance from actually bottoming out and being ready for commencing a fresh market cycle.

 

View: Market cycle started from February 2016, peaked in January 2018, and bottoming process is on.

If we take the duration of the current market cycle from February 2016, we find that the performance of broader markets is already aligned to the benchmark.

Since the current rate of return is still higher than the historical trends, I would think that market is still some distance from the rock.