Do it yourself

Wednesday, May 22, 2019

Indian Equities: outlier and susceptible to overreaction

Some food for thought

"It is questionable if all the mechanical inventions yet made have lightened the day's toil of any human being."

—John Stuart Mill (English Philosopher, 1806-1873)

Word for the day

Scaturient (adj)

Gushing; overflowing.

First thought this morning

I was quite bewildered, looking at the admission statistics in various colleges of Delhi University in recent years. For a course like B.Com (Hons) or BA (Economics) which require virtually no additional infrastructure besides a classroom, the 12th standard cut off percentage varies from 82% to 97%. For colleges which charge almost 5x fee from the minimum, and are located in North campus of the University (at great distance from East, West and South parts of the city), craze is much highest.

Some colleges affiliated to the university have been established by private trusts and managed by the trustees, while other colleges/departments have been established by the Delhi or Central government and managed by the managing committees appointed by the government. The fee to be charged from students for a particular course varies from college to college. However, in general fee for undergraduate courses range from Rs5500 to Rs30000 per annum.

All teachers in the university are likely paid the same salaries. In case of colleges established by private trusts, about 90% of the total expenses are borne by the government and the rest is met through the charges from student. Most colleges have similar facilities for students in terms of sports infrastructure, science labs, libraries etc.

Regardless, all colleges/departments in the university follow the same curriculum and governed by the same rules and regulations of UGC and Delhi University. But still some colleges consistently attract high scoring students. Naturally these are the colleges which attract better recruiters also. And this vicious cycle continues year after year, widening the divide between students and therefore society. I think this academic apartheid needs to end.

The only point of differentiation between colleges, besides perception, I could think of is quality of teachers. In my view, it is high time to review the entire admission and academic processes in Delhi University, and all other Universities where similar situation exist. The following suggestions may be considered. These may sound radical to many. Nonetheless, I believe these are implementable if desired.

(a) The admission process must be fully centralized. All students should be required to apply to a central office, without naming any college. An algorithm may be developed that should allocate college to each qualifying student based mostly on proximity to his residence, choice of course.

(b) All the available teachers in the university should also be similarly required to apply to the central pool every year, and the algorithm should randomly assign teachers to various colleges.

(c) The businesses willing to hire students from the university should also approach to the central pool, which shall use the algorithm to assign a group of students to the recruiters (based on their specification excluding the name of college) to choose from.

(d) All future recruitments of teachers should be made by a central authority with no involvement of colleges. The colleges may though make request for faculty with specific qualifications.

(e) Universities across the country should be encouraged to sign a faculty exchange program, whereby teachers can gain experience of working in different states to gain a wider perspective.

Indian Equities: outlier and susceptible to overreaction

Indian equity markets have welcomed the outcome of exit polls for recently concluded general elections. Benchmark indices have scaled new peaks. Broader markets have also recouped some of the losses in past couple days.

Indian equities have yielded best returns amongst major global markets.

However, as per preliminary analysis done by Business Standard, "Corporate India looks set to disappoint investors for the second quarter in a row, defying D-Street prediction of strong earnings growth during the fourth quarter (Q4) of 2018-19 (FY19). The combined net profit of 564 companies (excluding financials and energy), which have declared their results for the January-March 2019 quarter, is down 10.3 per cent year-on-year (YoY), their worst showing in at least 12 quarters.

The combined net sales of this universe was up 9 per cent YoY in Q4FY19, growing at the slowest pace in six quarters, hinting at a demand slowdown in the economy." (Business Standard)

Accordingly, on the valuation map, India now appears an outlier and susceptible to overreaction in case of an adverse event.

Tuesday, May 21, 2019

Don't rush

Some food for thought

"People can have rhinoceros skin, but there's a point when something's going to hurt you."

—Janet Jackson (American Musician, 1966)

Word for the day

Whataboutism (n)

A conversational tactic in which a person responds to an argument or attack by changing the subject to focus on someone else’s misconduct, implying that all criticism is invalid

First thought this morning

Indian stock markets not only appeared relieved, but jubilant after reading the exit polls for the general elections. It did not bother to wait for the final results, scheduled to be announced on Thursday and recorded huge gains.

A plain reading of the traders' screens at 3:30PM yesterday highlighted the following:

(a) An overwhelming majority of market participants believe that prime minister Narendra Modi led NDA government would be beneficial for the businesses and markets.

(b) An overwhelming majority of market participants believe that certain businesses may do much better when a NDA government led by Prime Minister Modi is in power. (Memo: F&O 5 top gainers - Adani Entprises +27%; Adani Power +15%; Reliance Power +18%; Reliance Infra +12%; India Bulls Housing Finance +13%)

If someone argues that it could be due to short squeeze, then he/she must answer how come so many short positions were created in these counters and what has changed that requires covering these shorts in panic.

(c) Zee Entertainment was an exception to the trend. Is market giving up hope on this, regardless of the election outcome.

(Note: These are the first thoughts that came to mind after looking at trader friend's work station. It is not based on any analysis, and is certainly without any prejudice.)

Chart of the day

Don't rush

Last week, I wrote about some of the notable challenges Indian financial markets are facing. Out of the ten points mentioned (see here), the last one seems to have been adequately addressed by the exit poll results. Relieved markets recorded their best single day gains in many years. The benchmark indices closed at their all time high levels.

I would certainly not like to be a party pooper here, but nonetheless, I do find it in order to remind the readers about the following nine points in my list of concerns:

(1) Sino-US trade conflict is rattling global markets as growth outlook gets clouded.

(2) The debt market is jittery with a spate of downgrades raising possibilities of further defaults and a fresh round of slippages.

(3) Poor auto sales, NHAI warning over growth in road construction activity, contraction in manufacturing growth, class action suit for price manipulation over pharma companies, rise in H1B VISA cost and other restriction impacting IT companies, and cautious volume growth commentaries by leading consumers firms, fall in global metal prices and continued poor performance of telecom companies may lead to significant broader earnings downgrades.

(4) Many southern states have witnessed very poor rain fall in past 4months. Unusually dry season has created acute water shortages in many areas, hampering construction and farming activities. Fruit and vegetable prices have surged. Some agencies are forecasting a below par monsoon rain this year. Official forecast also suggested impact of El Nino till July.

(5) Foreign investors have resumed selling in May. Domestic equity flows have also moderated considerably. In April, net of SIP, both equity and debt funds witnessed outflows.

(6) Substantial write down of debt fund portfolios has eroded confidence of investors, as yields on savings have eroded sharply.

(7) Despite OMO and USD swap by RBI, liquidity conditions have not improved significantly.

(8) Implied volatility has shot up by almost 100% in past two months. Sensing the trouble brewing in markets, regulators have increased margin requirements materially, raising overall cost of transaction for traders.

(9) 4QFY19 earnings declared so far have been mixed. Only a few stocks have beaten the already moderated estimates, while a large number of stocks have either just met or missed the estimates.

I do believe that the next five years would be much better in terms of corporate performance as the ground prepared in past 2 decades shall soon start yielding results. Seeds like higher Power generation capacity, expanded ports, roads and rail networks, IBC, GST, are already showing green sprouts.

Any investment today therefore must be done these factors in mind, not just driven by sentiments or mob mentality.

Please do remember, past performance is no guarantee for future returns.

Friday, May 17, 2019

Learn from history, don't repeat it

"The man who has done his level best... is a success, even though the world may write him down a failure."

—B. C. Forbes (Scottish Journalist, 1880-1954)

Word for the day

Consent (v)

To permit, approve, or agree.

First thought this morning

The salvaging of erstwhile Satyam Computer is a classical case study in successful government intervention in corporate affairs. The intervention was swift, bold and effective. The troubled company was not only salvaged, its future growth was also ensured. Jobs of all 50 thousands employees were saved.

US government has also been doing similar interventions. More particularly, in the wake of global financial crisis, US administration acted swiftly and salvaged some large corporations like Merril Lynch, General Electric, General Motors, AIG, CITI, Fannie Mae, Freddie Mac savings a large number of jobs and resources. In hindsight, most of the companies bailed out under US TARP program turned out to be profitable. As per data available till February 2019, against the total TARP (Troubled Asset Relief program) bailout disbursement of US$632bn to 980 entities, a total of US$739bn have already been returned through repayments, dividend and interest resulting in a net profit of US$107bn or a return of 1.54% CAGR for the government, which is not too bad considering the near zero rate environment in US for most part of last one decade. Still an amount of US$242bn is outstanding to be recovered from 322 entities. Implying two third of the TARP recipients have successfully exited TARP. (See details)

On fails to understand, why the past successful experience have not been used in salvaging big businesses like IL&FS and Jet Airways, especially when a large number of jobs are at stake and the underlying business still makes sense.

If market rumors are to be believed, we may see some more large sized business going the Jet way, especially in financial services space.

For those who are jittery about the prospects of a third front government, it may be a pertinent to note that at the time of Satyam salvation, the decision maker was a minister in UPA government from Lalu Prasad Yadav's RJD party. TARP was implemented by a businessman from Texas (POTUS George Bush Jr), not particularly known for sophistication, suaveness or oratory skills.

Chart of the day

Learn from history, don't repeat it

I mentioned in my notes earlier this month (see here and here), that India may be standing at the threshold of an industrial revolution of its own. If the present trend continues, we may soon see the share of manufacturing in the national income rising materially.

The fear is that the current trend may reverse abruptly, just like it did in mid 1990s, and we may revert to lower 5-6% growth orbit. At this point in time I strongly disagree with this rather pessimistic and deeply prejudiced opinion. Nonetheless, I find it relevant to study more about the history of industrial development in India to find the fault lines that may still exit to derail the growth of manufacturing sector in India.

One interesting this that I noted was the role of three main development financial institutions (ICICI, IDBI and IFCI) in creating a foundation for Indian manufacturing sector as well as the financial services infrastructure. Institutions like NSE, NSDL, SHCIL, CARE, EXIM Bank, SIDBI, SCICI, CRISIL, HDFC, TDICI, TFCI etc., were promoted by these institutions.

All the three institutions suffered huge NPAs in the 1990s due to a variety of reasons, especially capacity creation in commodities like steel, fertilizer, textile becoming unviable.

Narasimham Committee on Financial Sector Reforms noted that in a market driven economy, the sustenance of DFIs may not be viable, since these institutions may be raising funds at current market rates and lending to businesses with long gestation and often high risk of failure, therefore incurring high credit cost. These institutions cannot function as pure commercial entities unless adequately supported by the government. Accordingly, the Committee recommended DFIs should be converted either to a bank or a NBFC and should be subject to full rigour of RBI regulations as applicable to respective categories. Further, no DFI should be established in future without the Central Government support. Accordingly, both ICICI and IDBI were converted into commercial banks, and IFCI was converted into an NBFC.

Another reason for doing away with these DFIs was the feeling that since the banking system has acquired the skills in managing risks in extending finance to different sectors of the economy including the long-term finance and capital market, providing larger significant resources to the corporate sector, the need for the DFIs as an exclusive provider of the development finance has diminished.

In past 15yrs, since end of IDBI, a new category of infrastructure finance companies (specialized NFBCs) and government supported DFI like India Infrastructure Finance Company (IIFCL) have emerged. But the current NPA cycle has impacted almost all banks and most NBFCs. The impact on banks and some NBFCs is as bad as it was in case of DFIs, if not more.

I feel that we need to study the evolution of financial sector in India in depth. Drawing lessons from the present and previous NPS cycles and assimilating the emerging financing needs, a new paradigm needs to be evolved in the financial sector. At present there is no specialized institution for manufacturing sector financing and funding of digital economy.

My understanding so far suggests that we do need highly specialized development financial institution for manufacturing, infrastructure and digital sectors. These institutions must be supported adequately by the government, but managed professionally. Leaving this space entirely to commercial banks and NBFCs may not be appropriate. That is if we really care about history and believe that historical mistakes are for learning and not for repeating.

To begin with large commercial banks like ICICI, HDFC, AXIS and SBI may partner with the government to promote a Manufacturing Finance and Credit Institution (MFCI) to meet long term funding needs of manufacturing units competing with global peers.