Do it yourself

Last week, the Parliament passed three important piece of legislation with stated objective to reform and liberalize the production, trade, and pricing of agriculture produce in the country.

The Farmers' Produce Trade and Commerce (Promotion and Facilitation) Bill

This law purports to allow farmers the freedom to sell their produce outside the regulated Mandi (APMC) framework. The idea seems to be enable development of a new ecosystem where farmers and traders would enjoy freedom of choice in sale and purchase of agri-produce; and the control of state over trade in agriculture produce would reduce to minimum.

It is important to note that this reform was initiated in 2003 with introduction of Model Act. Many states and union territories have already de regulated marketing of fruits and vegetable, trading on electronic platforms like e-NAM, setting up of agri produce markets (Mandis) in private sector, direct marketing of agri produce etc. The reason behind this new law therefore could be lack of adequate response to model law on part of many state governments.

The Farmers' (Empowerment and Protection) Agreement on Price Assurance and Farm Services Bill, 2020

This law aims to permit farmers to enter into supply contracts with large buyers. These contracts could be exclusive and long term and provide more predictability to income of farmers and help them plan better in terms of adopting better technology and inputs.

This bill effectively facilitates large scale contract farming, whereby large corporate consumers can engage farmers to exclusively produce for them as per given specification and at pre determined price. The bill provides for pegging of prices to the Mandi prices. The famers adopting this arrangement may not avail the protection of minimum support prices as they would be bound by the terms of the contract. All such contracts are proposed to have civil jurisdiction and breach of contract shall have no criminal implications.

Essential Commodities (Amendment) Bill 2020

This bill essentially allows large business consumers to maintain stock of agriculture commodities, purportedly to meet the objective of price stabilization. This may also help in building post harvest infrastructure like warehouses and cold storages etc.

The opinion about the long term implications of these bills is vertically divided.

The supporters of the proposed regime believe that these changes would bring transformative changes to the agriculture and food processing sectors in India. The noted agriculture economist Ashok Gulati, equated these proposals to the industrial reforms and liberalization in early 1990s. It is argued that removing the shackles of state controls and allowing private businesses and farmers to collaborate will lead to significant acceleration in development of farm sector in India, and aid sustainable and faster overall economic growth of the country.

The people and organizations opposing the legislative changes believe that the proposed laws are ill conceived and are being enforced without adequate consultation with the stakeholders. In their view, many of these provisions are already present on the statute book and have not brought any meaningful change to the farmers' conditions in past decade.

It is also argued that these changes will bring back the pre independence colonial model in the Indian agriculture, where the large corporates will decide the crop and prices. The farmers will continue to be exploited; and the shield of MSP will also be removed.

In my view, the intent behind the proposed legislations is good. The farm sector in India definitely needs urgent and transformative reforms. But for reforms to have the desired impact, these needs to be comprehensive and holistic, not selective as proposed....to continue

US Federal Reserve Chairman Jerome Powell tried to set many speculations aside in his statement post the recent meeting of the Federal Open Market Committee (FOMC), Powell made the following three things very clear:

1.    US Fed policy Bank Rates, and therefore general rate environment, shall stay low till at least 2023.

2.    There is no threat of material rise in inflation in near term, and 2% inflation target shall remain valid till 2023. Even a temporary violation of 2% inflation target before 2023 shall not impact the decision to keep rates near zero till 2023.

This is in sharp contrast to the forecasts made by many global strategists, economists and fund managers, who believe that inflation could become a serious problem in 2021-22. In fact Powell expressed his concerns about the disinflationary pressures persisting.

3.    The job market is expected to improve and below trend unemployment rate of 4% shall be achieved by 2023.

The Federal Reserve however refrained from announcing any additional liquidity enhancement measures, including increasing the bond buying.

The consensus is reading the Federal Reserve's latest policy statement to mean that (a)   USD weakness may persist for some more time at least; (b) The market may continue to drive the Federal Reserve's action insofar as the monetary support (bond or stock buying etc) is concerned; (c) Powell backstop is there but may not be as strong as Draghi backstop.

This long term guidance by Fed must comfort markets and fuel the risk appetite of market participants. I would not like to read too much into the sell-off in markets post the Powell comments. It might be due to unwinding of the positions taken specifically for this event. No announcement related to enhancing Fed's asset purchase program may have disappointed many who were expecting Powell to announce this. But this is most likely a knee jerk reaction.

In this context, the recent statement of RBI Governor Shaktikanta Das is pertinent to note. Addressing to the National Executive Committee of FICCI, Das emphasized as follows:

"On the back of large policy stimulus and indications of the hesitant economic recovery, global financial markets have turned upbeat. Equity markets in both advanced and emerging market economies have bounced back, scaling new peaks after the ‘COVID crash’ in February-March. Bond yields have hardened in advanced economies on improvement in risk appetite, fuelling shift in investor’s preferences towards riskier assets. Portfolio flows to EMEs have resumed, and this has pushed up EME currencies, aided also by the US dollar’s weakness following the Fed’s recent communication on pursuing an average inflation target. Gold prices moderated after reaching an all-time high in the first week of August 2020 on prospects of economic recovery.

Financial market conditions in India have eased significantly across segments in response to the frontloaded cuts in the policy repo rate and large system-wide as well as targeted infusion of liquidity by the RBI. Despite substantial increase in the borrowing programme of the Government, persistently large surplus liquidity conditions have ensured non-disruptive mobilisation of resources at the lowest borrowing costs in a decade. In August 2020, the yield on 10-year G-sec benchmark surged by 35 basis points amidst concerns over inflation and further increase in supply of government papers. Following the RBI’s announcement of special open market operations (OMOs) and other measures to restore orderly functioning of the G-sec market, bond yields have softened and traded in a narrow range in September."

The governor was very guarded in his outlook for the economy. he stated, "high frequency indicators of agricultural activity, the purchasing managing index (PMI) for manufacturing and private estimates for unemployment point to some stabilisation of economic activity in Q2, while contractions in several sectors are also easing. The recovery is, however, not yet fully entrenched and moreover, in some sectors, upticks in June and July appear to be levelling off. By all indications, the recovery is likely to be gradual as efforts towards reopening of the economy are confronted with rising infections. (emphasis supplied)

Obviously, the incumbent governor does not concur with one of his predecessors Dr. C. Rangrajan who appears quite buoyant about the economic recovery in India.

What does it mean for Indian investors?

• Unless there is a Lehman type moment in global markets, the Indian equities may continue to remain supported.

• Precious metal trade should take a hit.

• The bond yields may remain stable, and RBI may maintain yields around current levels even if the food inflation shoots up in next couple of months.

• MPC may maintain status quo on policy rates in its next meeting, while continuing to maintain accommodative stance.

• Economic growth and therefore corporate earnings may not see a sharp recovery even in FY22.

In recent days the following three global trends have evoked much interest amongst market participants:

1.    The production, consumption and import of commodities in China have increased materially.

2.    The USD weakness is persisting. The China letting CNY appreciate against USD is noteworthy.

3.    BP in its yearly outlook virtually declared "peak oil" demand, stating that the oil demand growth may not be seen through 2050.

These three trends are important in my view as these could materially influence the markets in short term.

For past two decades, China has been a major driver of the commodities' demand and hence prices in the global market. The slowdown in Chinese economy in past 5years has led to correction in commodity prices, impacting a large number of commodity driven economies like Australia, Canada, OPEC countries, Brazil etc. This is cited as one of the reasons of sustained deflationary pressure on US, Japan and EU economies. The central bankers in these economies have been able to unabashedly print money to support their fiscal profligacy as the inflation has not been a concern.

As per the latest reports that trend might be about to change. As per a recent ING Bank research report, "Domestic demand is driving China's economic growth. Retail sales returned to positive growth. And new-infra and traditional infrastructure investments increased, which matched the growth in these items in industrial production. But external circulation may remain a challenge to growth." The reports further highlights that "China’s new-infra plan and traditional infrastructure projects in transportation have led overall investment spending. Fixed asset investment (FAI) shrank only -0.3%YoY YTD in August from - 1.6%YoY YTD in July. The "computer, telecommunication" category, which represents new-infra investment plans, grew 11.7%YoY YTD, which results in part from China’s push towards self-reliance in technology. Rail transportation investment also grew 6.4%YoY YTD.

These growth numbers are high compared to the headline growth rates, which means these are the engine of investment growth in China currently."

The Chinese monetary authorities recently allowed CNY to appreciate below 6.8/USD level. This could be seen as a reconciliatory gesture by Chinese authorities to the global community. China has allowed CNY to weaken even above 7/USD level in the trade and currency war with USA and Japan. The international relations of China have worsened materially after the outbreak of COVID-19 pandemic. This reversal of CNY could be seen as first, though small, sign of China wilting under global pressure. This could be comforting news for the global markets.

British Petroleum's (BP) annual outlook fo energy market is respected world over. Last year, BP forecasted demand for fossil fuels could peak by 2030. However, in 2020 outlook, BP has made a major shift in its assessment. As per the energy major, peak demand for oil may have already happened. The report implies that global crude demand may never again surpasses 2019’s average of around 100 million B/D. A natural corollary to this is that that 2019 could also mark the peak of carbon emissions from energy use.

This may potentially change many things - global trade balance, sustainability investments, geopolitics, cost of doing manufacturing, etc. Arab world countries making conciliatory moves towards Israel may, for example, be just one of the effects of this. BP announcing major investment plans with RIL in renewable energy sector to support electric mobility is another.

The September 2020 Global Fund Managers' survey conducted by the Bank of America research team found that 58% of the global fund managers believe that global equities are now in a bull market. This percentage is materially higher than the 46% in August 2020. The proportion of fund manager who believe it to be a bear market rally has reduced in September 2020 to 29% from 35% in August 2020.

An overwhelming proportion of fund managers believe that "Long US Tech Stocks" is the most crowded trade. Though, the fund managers believing gold to be a crowded trade has reduced materially in September, as compared to August. "Short USD" trade is also seen gaining some popularity .

Continuing with the theme, JP Morgan Research (as quoted by Niels Jensen of Absolute Partners), finds that S&P500 is now pricing in almost 0% probability of a recession in US; while 5yr US Treasuries are pricing in almost 100% probability of a recession.

In his latest communication to investors, Niels warns that investors (and fund managers) may be flirting dangerously with TINA (There is No Alternative) in their chase for equities, especially US Tech Stocks. As per Niels, One of the most reliable predictors of long-term equity returns is the starting earnings multiple. When earnings multiples are in the low 20s, the best you can hope for over the next ten years is low single digit annual returns. As you can see, 10-year returns turn negative when the starting multiple is about 25 or higher.

Niels highlights that, as per Shiller's Cyclically Adjusted  P/E Ratio (CAPE), S&P500 trades at massive 32x earnings multiple, which means apocalypse may just around the corner and the investors must be running to the hills.

In a later post, I would like to evaluate where India stands in all this.

The last weekend was unusually hectic for most participants. Friday evening, the market regulator issued fresh guidelines for asset allocation by the mutual fund schemes operational under the "multicap fund" category. The guidelines specify that these mutual fund schemes must allocate at least 25% of assets under management to each of large cap, mid cap and small cap category of stocks. SEBI also directed that the minimum equity allocation of these funds shall be 75% (presently 65%) at any given point in time. The mutual funds are required to comply by these directions in six months, i.e., by February 2021. SEBI further clarified that these guidelines have been issued further to the guidelines regarding categorization and rationalization of Mutual Fund Schemes issued in October 2017.

It is pertinent to note that as per SEBI directions, top 100 listed companies in terms of market capitalization are categorized as Large Cap. Companies ranked 101 to 250 are categorized as Mid Cap and the others come under small cap category. As such, NMDC is 100trh ranked stocks with Market of Rs27500cr; P&G is 250th ranked stocks with Rs8100cr market cap. So stocks below Rs8100cr market cap are small cap stocks.

Over weekend most of the brokerages and AMCs came out with their views on the proposed changes. The brokerages' reports were mostly focused on two aspects" (i) how much money will have to be reallocated from large cap to mid and small cap stocks to comply with these guidelines; and (ii) which are the stocks that could see higher demand due to this reallocation exercise and what is the trade opportunity in this. The AMCs mostly focused on highlighting the challenges in compliance.

I am sure that any guideline followed or not followed by mutual funds has any bearing on my investment process or investment strategy. Given the past track record of a large majority of Indian mutual funds, I do not draw any comfort from the due diligence done by mutual funds as to the quality of any business or credibility of any company (and management).

I do not find any substance in the argument of higher demand from mutual funds leading to sustainable re-rating of a stock. We all have seen in recent past, the high MFs holding into a small cap stock is a two edged sword. In the good times, the stocks run up sharply; and when the tide recedes the losses are also overwhelming (remember 8K Miles, HEG, Graphite, Eveready etc.) Even the best of the fund managers have lost huge money in stocks like JP Associates, HCC, NCC, Jet Airways etc. In the present times also I find many mutual fund schemes holding commodity (including chemicals) stocks where the companies have seen sharp rise in earnings due to temporary commodity price cycle. We shall see a repeat of HEG & Graphite in these stocks in 2021 for sure.

Another thing I am missing is that no one has dared question the validity of the rationale and authority behind the October 2017 and the current circular of SEBI. In my view, the following questions need to be asked to SEBI:

1.    Why AMFI does not have an SRO status? As a signatory to IOSCO charter, it is responsibility of SEBI to promote self regulation in securities market. It is 28years since private mutual funds were allowed in Indian markets. The industry has grown materially in past 10years. Why SEBI is not able to persuade AMFI to become an SRO?

2.    A mutual fund investment is a contract between an investor and AMC. The Key information Memorandum (KIM) is an essential part of this contract. SEBI forcing MFS o change KIM for the investments already made may not be good as per the law of contracts.

3.    Fund management is not one of the various businesses of SEBI. Why it is not left to AMCs? In case SEBI finds that AMCs are indulging in unfair practices or their conduct is prejudicial to the interest of investors or securities' market, it has enough powers to reprimand and punish the respective AMC, including cancellation of its registration.