Do it yourself

Wednesday, April 22, 2020

Investment strategy for post lockdown world

For past couple of weeks I have shared many random thoughts and feedback from my sources, and views of some experts regarding the current state of affairs in India. As promised, I shall now present my thoughts on investment strategy for post lock down period.

Key message

1. The current crisis is unprecedented in the sense that it has seriously impacted the liquidity, solvency and viability of a large number of businesses, all at the same time. The number of businesses going out of business before this crisis ends would therefore be much larger than the crises faced by global economy in past 75 years since the end of WWII.

2. The only way out of this crisis is to inflate a colossal bubble in asset prices, which is equally unprecedented.

I believe that the foundation of next big global bull market will be laid in next 12 months. Like every time before, the next bull market will be much bigger than the previous one. We shall see a large bubble building in the market that will change many things in the real economy as well; much like the internet bubble of 1990s reshaped the global economy forever.

3. The new trade and strategic blocks will emerge to provide leadership to the world. The world may de-globalize, localize and re-globalize at the same time. Collective leaderships and many smaller common markets like EU having deeper cooperation may emerge. Digital international highways may become more common than the traditional physical movement of people. The assets and currencies may get further dematerialized. The international travel protocols may change to include medical tests as a prerequisite for all international travel.

4. People rather than material will become the focus of policy formulation. The demographic trends may dramatic shifts over next 2-3 decades. It could be either through liberal but orderly immigration or incentives to procreate more in developed nations.

5. The global wealth and income inequality may increase to alarming levels. The number of poor (below poverty line) may rise disproportionately across the world, especially in emerging countries. This could potentially trigger a fresh wave of communism across the world fueled by increasingly isolated China and Russia.

The next bubble

In my view, the next bubble in the market will be inflated by the disproportionate rise in investment in the global healthcare sector. The initial trends in the global markets are already indicating towards this phenomenon. Once the lock down forced by COVID-19 ends and the governments declare containment of the virus, the budgets both at state and household level could rise significantly.

I believe that this bubble could be far bigger and durable than the dotcom and subprime bubbles, as it deals with human lives directly. The politicians, bankers, investors, policy makers, administrators, businessmen, consumers et. al. who have spent weeks locked down in their houses fearing for their lives while watching the death statistics on media, would readily accept the need for much higher investment and spending on healthcare. In that sense, this bubble will be far more tangible, believable, acceptable and inflatable.

In Indian context, more than manufacturing of pharmaceutical, which may be subject to much higher degree of price & other controls due to higher government intervention in the sector, I would be positive on healthcare related services (like diagnostic, CRAMS, hospital& clinics, telemedicine, health insurance etc.), healthcare equipment & supplies manufacturers (like testing kits, hospital equipments, low value mass consumption items etc) manufacturing of key ingredients for large global manufacturers (APIs, specialty chemicals etc.) and healthcare professional education & training business.

The Strategy

Assumptions

Lock down may open before 30 June 2020 and normalcy may return in businesses and logistics by 30 September 2020.
Interest rates may remain lower fro longer.
Chemical manufacturing in India may see great impetus as global supply chain looks to shift from China.
Poverty shall rise and so shall the efforts to alleviate it, bringing greater focus on food production and availability.
India will be able to become part of some meaningful trade blocks that may emerge post lockdown

Asset allocation

I would maintain my equity overweight stance on asset allocation and increase equity allocation further to 70% from the current 65% and cutting the debt allocation from 30% to 25%. For now I will hold 25% (out of 70%) equity allocation in tactical cash to be deployed over next few months.

Equity investment strategy

I would continue to focus on a mix of large and mid cap stocks, with decent liquidity, solvency ratios and operating leverage.

(a) I would be overweight on healthcare services and IT services sectors with 35-40% allocation to these two sectors.

I would however always be mindful of the possibility that India may actually just participate in the global trend and not much may be achieved on the ground in the areas of healthcare services. So buying established businesses at reasonable valuation would be a key consideration.

(b) I will be underweight financial services and discretionary consumption.

(d) Target 12%-13% price appreciation from my equity portfolio in next 12 months.

Tuesday, April 21, 2020

Preparing for Spring - Part 2

For past one month, I have been struggling to suitably modify my investment strategy to factor in three things:

1. Narrow physical global borders and wider and more liberal and freer international information highways.

2. Zero cash flows for businesses for a protracted period. This factor used to be an integral part of equity valuation during the days of strong trade unions in 1960s to 1980s.

3. Potential new leadership that will drive the markets in 2020s.

During my quest, I remembered an event from my childhood, when we used to live in Agra town of UP. It was summer of 1979, when suddenly one day one of my uncles came to our house and announced that he will take everyone in the family to show the latest Bollywood blockbuster Gol Maal. Those were the days when children were least interested in indoor things like Cinema and TV. To lure the children, the uncle promised a grand treat post movie show.

Everyone in the family was highly surprised by the proposal, because the Uncle was known to be miser. Usually he would not spend a paisa to entertain any one, even his own children. When asked he explained that "Skylab" is going to destroy the earth tomorrow and no one shall survive. So it is last chance to enjoy the accumulated wealth. (Skylab was USA's first space station that went astray and turned into ashes on hitting the earth's orbit over Indian ocean). Later we learned that the Uncle was not alone in his celebrations of the final day. There were many others like him in Agra and nearby villages who did strange things to spend their accumulated wealth. Many prepaid their loans, as they did not want to die in debt, lest they would have to repay in their next birth!

Contrasted with Skylab, COVID-19 is much stronger and wider a fear. People across the world are fearful for their lives. The more educated, informed and rich a person is, the more fearful and pessimistic he/she is sounding. But instead of splurging their wealth, people have become spendthrift. They are not only holding their discretionary consumption back, but also promising to themselves to save more in future. This is true, not only for New York, San Fransisco, Paris, London, Rome, Amsterdam, Barcelona, Singapore, but equally for Agra, Patna, Jodhpur, Mehsana, Kota, Vijaywada, Jammu, Kashipur, Bareilly, Jabalpur, Mumbai and Delhi.

Believing that lockdown is certainly penting up demand for discretionary consumption might be a mistake in my view. The investors need to also evaluate the alternative scenario where the lock down is giving space and time to consumer to have a complete rethink on their consumption behavior and decide against discretionary consumption.

While reading and analyzing the current situation for the purposes of suitably modifying the investment strategy, I am getting a lot of mixed feedback. I am finding it little hard to read this jumbled puzzle, with many pieces still missing. The following examples of mixed signals will make it more clear what I am trying to say.

1. Employment paradox: I spoke to a restaurant owner and a civil contractor. They informed that most of their labor has gone back to their respective native places. Many of the remaining are also looking to go back and may not stay back once the lock down ends. They feel that they will have to struggle hard to get new trained labor, and may have to even pay much higher wages as compared to what they were paying in pre COVID-19 era.

I also spoke to many young professionals who shall be completing their courses this summer. Many of them have already secured jobs at campus placements. Almost all of them are worried whether the companies will honor the job offers and if not, whether they can get new jobs in next six months. They fully realize that in any case the average salary they will get is going to be much lower than what they could have expected in pre COVID-19 era.

Some of my friends and acquaintances, who are mostly senior professionals and working from homes are not confident whether their jobs will stay once the lock down ends and senior managements make an assessment of potential redundancies.

2. Automation needs: Some of the businessmen I spoke to have highlighted that they have learned a key lesson from the lockdown, viz., they must invest in automation of the business. In future they should be able to work from home seamlessly, if a need arises. They want the processes to be automated and flexible. Even my wife and many of her friends are indicating at automating the household chores like dishwashing and cleaning. They do not want to rely on temporary domestic servants. Besides, they are fearful of an outsider coming to their home daily.

At the same time, some of the farmers have indicated that lot of people who have come back to villages may not return to cities in a hurry. There would be plenty of trained labor available in the villages. Therefore, they may defer their plans to invest in larger agricultural equipments like thrasher, cultivator etc.

3. Demand supply inequilibrium: Factors like poor employment conditions, flat to negative wage growth, tendency to consume less due to fear and uncertainty etc indicate that we may see a wider and deeper demand contraction in the economy, which was not doing great even in pre COVID-19 world.

At the same time, my sources in villages and agri trade indicate that (i) the weather have been quite unusual in February and March. Heavy rains, hailstorms, dust storms etc have caused damaged to Rabi crops as well as fruits like Mango. Shortages of labor for harvesting and due to lockdown, and logistics constraints in selling the crop have worsened the situation.

The worst part is that many cold stores could not be vacated to store the new crop. Crops like peas and potatoes stored in winters are occupying significant storage capacity. In many cases, the value of the stored produce is now lower than the accumulated rent. The store owner will have no option but to either destroy the produce or dispose it at distress value to make space for the fresh produce.

All this indicates heavy bouts of cyclical food inflation later in the year and next year. Besides, higher state demand for food to feed the poor, will also add to demand supply inequilibrium later in the year.

4. Peacock vs rodents: Almost all of my friends and acquaintances have celebrated the sighting of peacocks, sparrows, deer, dolphins and enchanting flowers as the people have vacated space to nature. One month of lockdown and slower activity has made it sure that the damage to the nature is far from the point of no return and we can still undo the damage already done to the nature.

At the same time, my office boy who lives in the office is telling me that the population of rodents and insects in office has increased manifold. These have damaged the electric wiring, electronic equipments like computers, printers and air conditioner; office files etc. One of my friends who owns a clothes shop has also narrated similar stories to me. After the lock down ends, I would need to spend at least one month on repair and disinfection of my office, at significant cost.

5. Socialism vs liberalism: The lock down has threatened to relegate millions of people back to the BPL status. There is real threat that the poverty alleviation efforts made in past 3 decades may be largely undone by this. The wealth and income inequality shall definitely to new highs.

It will therefore be a great challenge for the government to create balance between the urgent need to support the poor & underprivileged and help the large corporate in availing the once in a century opportunity and make India a manufacturing hub for the world looking for alternative destinations away from China.

The political instinct would be to raise effective taxation (COVID cess etc.) and increase cash subsidy for the poor. However, the opportunity will demand liberal and competitive tax and regulatory regime for the large businesses.

The government would need to choose from pragmatic liberalism or crony socialism.

5. Health consciousness vs disease management: The social media posts on my timeline indicate that most people have taken up to a healthier lifestyle. They are exercising, doing household chores themselves, eating healthy food and observing highest standards of personal and social hygiene.

However, in personal conversations I have discovered that a month of work from home has resulted in higher number of cases of elevated levels of blood sugar, hypertension, depression, arthritis, etc.

What will drive the future consumption behavior - health consciousness or disease management is something that only time can tell.

6. Humanity or hatred: My social media time lines are also full of the stories about acts of humanity. Many people have donated money; many are providing food and clothes to the poor; many are teaching students who are unable to attend Zoom classes; health workers and policemen walking that extra mile to save people lives etc.

However, at the same time the venom being spewed in media and personal conversations against other communities and religions is unprecedented. I have not witnessed this kind of communal hatred and enmity even during worst of the many communal riots in the country or during the war with neighboring countries.

What will be the driver of social engine in post lockdown world - the humanity or hatred will also be told by the time. If the humanity wins the driving assignment, we should be galloping forward in our development endeavor. However, if hatred displaces the humanity, we may return to base 1947.

...to continue tomorrow

Friday, April 17, 2020

Preparing for Spring

I have narrated this story many times before. This is in fact one of my favorite instance from Hindu mythology.

Once the forces of good (Sura) and evil (Asura) had a protracted battle. The battle lasted so long that both the groups exhausted all their resources and valor. Completely tired, wounded, frustrated and exhausted, they approached the savior Lord Vishnu. The Savior advised them to go and explore the great ocean (Sagar Manthan) to find new resources and vigor to make a fresh beginning.

Following the advice, both the groups went to the great ocean and explored it extensively. During their exploration they discovered huge amount of wealth and resources that included the Amruta (nectar) that would immortalize the consumer and Vish (venom) that would destroy whoever consumes it.

Realizing that if the evil forces get the access to Amruta and other resources found during the exploration it would seriously jeopardize the interest of the forces of good, Lord Vishnu tricked the forces of evil and appropriated the entire nectar for consumption by the forces of good.

Lord Vishnu also requested the almighty Lord Shiva to absorb the venom so that it does not harm anyone and the balance of the universe is maintained. Obliging, Lord Shiva drank the entire venom and preserved it in his throat.

Post this the forces of good became more powerful. But whenever they deviated from the path of common good, they were overpowered by the evil forces and dethroned. Each time only after a great deal of repentance they would be rehabilitated with the help of Lord Vishnu, Lord Shiva or the Mother Supreme.

Over the years I have realized that it is not just a mythological story to be heard during religious ceremonies and forgotten immediately thereafter. It is also not a usual morality emphasizing victory of good over evil. It is much beyond. This applies to all aspects of life, even economics.

The Ocean Exploration mission (Sagar Manthan) is basically a collaborative research effort to find solution to a problem that afflicts all alike, e.g., a prolonged bloody war like World War, a pandemic like plague, smallpox, HIV AIDS or COVID-19. The experts collaborate to find solutions like vaccines, hygiene products, UNO, Nuclear deterrents, globalized markets, etc to overcome the losses and prevent recurrence of such problems.

In modern economic parlance, the ocean exploration is akin to the period of recessions followed by irrational exuberance, fiscal and monetary profligacy, and household extravagance.

When all the participants get tired, frustrated and exhausted from prolonged economic weakness, collaborative efforts are needed to stimulate the economic activity. At this time all the stakeholders muster courage, and supported by the 'authority', they do things they would never do in normal times. Invariably, this effort involves excessive and seemingly irrational borrowing, investing and spending. Capacities are built to the scale which are unfathomable during normal times. Usually this drives the asset prices to levels that cannot be explained or justified by conventional methods. These unexplained phenomenon are generally described as bubble in market parlance. The nectar or the good that emerges from these bubbles is shared by all. However the venom is consumed only by the financial investors who invariably end up poorer after every bubble is burst. The financial assets' prices correct upon the bursting of bubble but the productive capacities built during the bubble phase stay for long, supporting and promoting growth and development.

If you are not able to correlate to what I am saying - imagine would India be a ITeS superpower without Y2K or technology bubble during late 1990s! Had we built so many houses, roads, malls, power plants, cement plants etc. during the decade of 2000s but for a credit bubble! Would capital be so easily and cheaply available to Indian entrepreneurs without a QE bubble in the west! The capacities built during these bubbles shall continue to support India's growth and development for long, even though the financial investors lost significant fortunes during 2001-02 and 2008-09 burst periods.

The present crisis situation is no different, even though it is much more severe, deeper and wider in its impact. This crisis needs a much stronger collaborative at all levels - scientific research and development, social development, economic revival, political restraint, etc.

Considering that there may be only a few thousand people surviving who have experienced the catastrophic world wars, great depression, and the rebuilding effort post WWII, the present crisis managers may be slightly limited by their inexperience.

The famous American Economist Kenneth Rogoff noted in one of his recent posts - "With each passing day, the 2008 global financial crisis increasingly looks like a mere dry run for today’s economic catastrophe.

The short-term collapse in global output now underway already seems likely to rival or exceed that of any recession in the last 150 years.

Even with all-out efforts by central banks and fiscal authorities to soften the blow, asset markets in advanced economies have cratered, and capital has been pouring out of emerging markets at a breathtaking pace.

A deep economic slump and financial crisis are unavoidable."

This appears to be the common view amongst economists, strategists, analysts, banker and politicians across the world.

I would tend to agree with these experts on almost all issues. As I said yesterday (see here), this crisis is unprecedented in the sense that it has seriously impacted the liquidity, solvency and viability of a large number of businesses, all at the same time. Nonetheless, I am sure that the global community will inflate a bubble to find a way out of this crisis.

The bubble so created will obviously have a direct reflection on stock prices and hence investment strategy.

...to continue next week

Thursday, April 16, 2020

Sit back, relax and wait for the spring

The rise in stock markets world over must be baffling the investors as well analysts alike. At this time - when the world is staring at a high probability of deepest ever recession in global growth, disproportionate demand destruction; severe financial stress for households, prolonged disruption in global trade; colossal debt defaults; unsustainable monetary expansion; and total collapse in consumer sentiments - rise in prices of high risk asset like equity is definitely perplexing. It is however neither unprecedented nor surprising to me.

During July 2007 to December 2007, Nifty had recorded its highest ever levels, despite the sword of sub-prime collapse hanging on its head.

What we are witnessing is a similar phenomenon, commonly known as distribution pattern in technical analysis parlance.

As an investor, I need to persistently remind myself the following and many other similar things:

Many tenants are refusing (are unable) to pay rent worldwide
Many employers have either refused to pay salaries or cut the payout materially.
Farmers have been unable to harvest their crop.
Borrowers are refusing (are unable) to pay EMIs and interest.
Trade creditors are refusing (are unable) to settle their accounts.
Temples are closed and Deities are refusing to meet devotees.
2008-09 Global financial Crisis was mostly about liquidity. This time it is equally about both liquidity and solvency.

What else I need to remind myself is that the seed of next big bull market will be laid during this autumn of the market only. Like every time before, the next bull market will be much bigger than the previous one. We shall see a large bubble building in the market that will change many things in the real economy as well.

Tomorrow, I shall share some of my random thoughts on what could possibly drive the next bull market in equities.

Wednesday, April 15, 2020

Some random thoughts Post COVID-19 world - Part 3

Continuing from last week (see here and here), I would like to share some of my random thoughts on what this outbreak of COVID-19 could potentially mean for India, particularly in the short to medium term.

The present state of affairs

India is in the state of total lock down since past 3 weeks. In this period about 40-45% of the overall economic activities which are exempted from the lock down stipulations are only working. Presently it is estimated that it may take 3-6 months before the economy could return to the pre March level of activity.

It is important to note that the Indian economy had been consistently slowing down for past 3 years, especially due to the impact of demonetization (November 2016) and GST (July 2017). Unusual weather pattern have resulted in wide divergence in the regional economic performances. The rural stress in the regions that suffered from poor weather (flood, drought, etc) has been elevated; even though the overall farm sector growth recorded decent performance.

It is widely accepted that after discounting for the elevated government sector consumption and fiscal support to the rural sector (loan waivers, cash subsidy payments etc), the GDP growth of India had been significantly below par. The growth rate of almost all key components (savings, investment, private consumption etc.) of the economy has declined.

Besides, the second half of FY20 had witnessed widespread disruptions due to protests against implementation of Citizenship Amendment Act and some related matter. Thus, pre-March situation was not good enough; and here in the best case we are looking at reaching that "not good enough" situation in next 2-3 quarter, provided the virus is contained soon and lockdown does not need to be extended beyond 3rd May 2020.

The GDP growth estimates of various agencies for FY20 and FY21 now range between 3.5% to 4.7% and 0% to 4.2% respectively.

Challenge to make a fresh start

A large number of businesses, especially MSMEs, are facing serious challenges. For them it is not 40-50days of break. For many of them it would be like starting the business all over again with little capital and poor credit score. These businesses are staring at material discontinuity losses and cash flow problems, besides demand issues. Exporters in particular are in deep trouble as their overseas payments are stuck, future demand outlook is heavily clouded, inventory obsolescence risk is high, and expenses continue.

This would directly reflect on (i) employment conditions, (ii) economic growth, and (iii) asset quality of lenders. Indirectly, it may adversely impact (a) economic factors like discretionary consumption, savings, tax collection, and (b) social factors like number of people below poverty line, socio-economic inequalities, cases of petty crimes and non-compliance, mental health of people due to elevated stress & anxiety levels, physical health of people suffering from diabetes, hypertension, obesity etc.

It is natural to celebrate the fresh air in cities, clean water in rivers, lakes and sea, peacocks on terraces, deer on roads. Many of the children and youth in cities may have never experienced nature like this. But once the lock down is lifted we will have to deal with materially increased population of rodents and insects which are harmful for our health and inventories in shops, godowns, restaurants, etc.

Global challenges

India shall face multiple global challenges in the aftermath of COVID-19 outbreak. Poor export demand for traditional Indian products like textile & leather, automobile, gems & jewelry etc., lesser employment opportunities for young professionals, poor capital flows especially for startups etc are some of the obvious economic challenges.

The worst however could be the change in global outlook for the process of globalization itself. The developed nations which are bearing the worst impact of COVID-19 in terms of human losses, may be inclined towards closing (or narrowing) their borders to international trade and labor movement.

If the belief that COVID-19 spread is a consequence of Chinese irresponsibility or conspiracy, sustains, we may see substantial rise in geopolitical tension and trade & currency conflicts which have already impacted the global economy meaningfully in past three years.

In any case, if all goes well, it would be reasonable to expect travel restrictions and fear amongst travelers also.

The opportunity

Shift of global supply chain away from China

Post COVID-19, it is possible that China may be regarded as an irresponsible power, and may not be accepted as a major global leader or supplier. In particular, the mistrust between US and China may increase manifolds. We may likely see a Sino-China cold war that may last for many years, or may be decades.

The global supply chain presently relies heavily on China for components as well as manufacturing services. There is strong possibility that the businesses in developed economies may seek to establish manufacturing and/or sourcing facilities in other countries to reduce their reliance on China. Japan government for example has already announced incentives for shifting factories from China.

The window of this opportunity shall remain open for only a short while, as the competition is really tough with tens of Asian countries competing with each other to avail this opportunity. We would need to move really fast if we actually want to turn this crisis into a massive opportunity that could support India's economic growth for next couple of decades at least.

Investment in health infrastructure

The outbreak of COVID-19 has exposed gaps in the global healthcare infrastructure and protocols. I am confident that post COVID-19 containment the world will embark on an unprecedented investment mission to improve health infrastructure and protocols.

Many Indian businesses, especially the companies engaged in IT services, CRAM services, telemedicine and diagnostic services etc. shall have opportunity of gigantic proportion knocking on their doors.

Improvement in domestic health infrastructure

Incorporating the learnings from efforts to contain COVID-19, and existing programs & schemes for public health, sanitation, personal hygiene, etc., the government has the opportunity to materially improve the healthcare infrastructure in the country.

It may consider merging all such schemes & programs into a mega national mission. to ensure adequate healthcare facilities to all citizens through public and PPP ventures, total sanitation, comprehensive garbage management, preventing littering of all sorts, management of epidemics, seasonal diseases etc.