Do it yourself

The year 2020 has been a period of extremes for markets. During past 12months, the equity markets have kept swinging between extreme fear and greed. The year began on a buoyant note. The benchmark indices scaled their all-time high levels on 24 January, after rallying for past 4 months. In the following 2 months the indices corrected ~40% from their January highs, refreshing the fading memories of 2008 crash. A sustained rally thereafter saw the benchmark indices scaling new highs in next 9 months. This rally was remarkably different from September 2019-January 2020 rally in terms of volumes, market breadth, and participation. Foreign investors and domestic household investor have been notable buyers in 2020 rally, while the domestic institutions have been net sellers.

In my view the top 10 highlights of the performance of Indian equities in 2020 were as follows:

1.    Though benchmark indices indicate that mid and small cap indices have done materially better than the benchmark Nifty; the market breadth has not been encouraging. Relatively less represented sectors IT and Pharma outperformed strongly, while the most represented financials and energy were massive underperformers.

2.    Market breadth was positive only for 5months, while in seven months market breadth was negative. March 2020 was the worst month and August 2020 was the best month in terms of market breadth.

3.    Indian equities were average performers, in comparison to the global peers. However, it underperformed its emerging market peers notably.

4.    A lot of discussion has taken place around the strong foreign flows into Indian equities. It is however worth noting that foreign investors have invested close to Rs48,000 crores in Indian equities during 2020. But most of this has come as switch from the Indian debt. The net foreign flows to India in 2020 are marginally negative.

5.    The long term Nifty return (5yr CAGR) is now consistent around 11-12% for past five year. Only 2019 was an exception with 8% long term return. This is the longest stretch of consistent returns. This highlights the maturity of Indian markets; and also lesser probability of exceptional gains in near future.

6.    Nifty averaged around 10985 in the year 2020. This is about 4% lower than 2019 average. During previous two crisis periods (2001-2002 and 20008-2009), the fall in yearly average traded value of Nifty lasted for two consecutive years. But the third year saw strong recovery in the average traded value. If the history repeats, the Nifty may average below 10985 in 2021.

7.    The market saw sharp rise in speculative trading activities during the year. The percentage of total shares traded to the shares delivered fell from 20.5% in March to 15.05% in June. However, it has again improved to 19.6% in November.

The net new money invested in equity trades (NSE net pay in) was highest in March 2020 when the market correctly sharply; implying that the first fall bought aggressively. May-June also witnessed higher new money.

The size of average trade increased to Rs32462 in November 2020 from the low of Rs22314 in March 2020; implying that the smaller investors are now less active in the market.

8.    After losing ~30% in 1Q2020; Nifty gained ~20% in 2Q2020; ~9% in 3Q2020 and ~20% in 4Q2020. The gains in last three quarters have come without any correction. Only the month of May2020 has yielded negative return of (-)2.8% since April 2020.

9.    Despite the crises and sharp correction in the market early in the year, the volatility has not spiked like the previous two crisis periods. Consequently, the arbitrage funds have sharply underperformed, yielding less than the liquid fund returns. Gold ETFs outperformed most of the equity fund categories.

10.  The Nifty earnings have seen a spate of upgrades in recent weeks. However, normalized for the base effect of FY21, the growth continues to remain anemic. Most of the appreciation in equity prices therefore could be purely due to PE rerating to factor in lower interest rates. This implies, interest is perhaps the single most critical factor to watch in 2021. Any sign of hike in rates could result in sharp correction in equity prices.

 The two thousand twentieth year of Christ is coming to an end. This year has been totally forgettable and remarkably transforming at the same time. It reminds me of the title of the autobiography of legendry poet Dr. Harivansh Rai Bachachan – “क्या भूलूँ, क्या याद करूँ”.

Notwithstanding the all-time high levels of stock market indices in most countries; the global financial system inundated with trillions of dollars in free liquidity; over US$20trn worth of bonds yielding negative return globally; the massive economic and social shock of Covid-19 pandemic has left billions of people in distress. The inequalities of income, wealth and opportunities have risen to new highs.

Significant developments have been reported on the front of vaccine development to check the spread of Covid-19 virus. Many countries have already authorized emergency use of some vaccines; and people are being administered such authorized vaccines. Nonetheless, recently a fresh wave of mutated version of Covid-19 virus has been reported from some places in Europe (especially UK), resulting in fresh set of mobility restrictions. This indicates towards the possibility that the world may not return to total normalcy in many months to come. As per various estimates, it will take 15-18months to inoculate a sizeable population to reach a stage of herd immunity against the Covid-19 virus.

On the positive side, the pandemic has accelerated many trends that may help the cause of sustainable faster development in the medium to long term.

There have been many events in 2020 that must be taken note of by the investors. However, as a tine investor in Indian assets, I would in particular like to remember the following eight for next many years.

1.    The Indian government imposed a total socio-economic lockdown in the country in the wake of the outbreak of pandemic from 25^th March 2020. The restrictions were relaxed gradually from June onward.

In my view, it is almost impossible to assess the utility and true impact of lockdown exercise. We would never know, what could have been the situation if a total lockdown was not imposed in March. It could have been worse in terms of economic and health shocks; or perhaps the economic loss could have been less pronounced, sans total lock down.

This episode however has further strengthened my already strong view that the incumbent government is unpredictable. It can take decisions having far reaching repercussions rather quickly; without adequate planning; and without bothering about the immediate consequences in terms of human suffering. I shall continue to incorporate this feature in my investment strategy for midterm.

2.    During the lockdown, when the human activities and mobility were restricted to a great deal globally, the nature attempted to reclaim its space. The instances of peacock dancing on city streets, deer, sheep and even lions roaming freely on public roads, air quality improving to “serene” from “severe”; visibility improving to few hundred kilometers from few meters; children learning that the color of sky is “azure” and not “pigeon blue”. However, within 15 days of unlocking, the human reclaimed the entire territory from the nature.

Notwithstanding the enthusiasm behind sharing pictures of “pure nature” on social media, it is clear that we have moved too far on the path of self-destruction.

On the other hand, “work from home” and “digital meetings” have been adopted as fait accompli by many businesses. This because it brings immediate tangible benefits to both, the employer and the employee.

This leads me to conclude that any global agreement on climate will not succeed unless it has immediate and tangible economic payoff for the parties. The Paris accord, fails on this test, just like the Kyoto protocol. I shall therefore not be looking for investment opportunities in Paris accord, unless I see tangible economic gains for Indian businesses and consumers.

3.    On 20^th April 2020, something happened in global commodities market, which was unheard of. The WTI Crude Oil Future in New York crashed to a negative US$37.63 price. This event, though rare, has added a new dimension to the risk management process; option pricing methods; and trading strategies.

4.    The benchmark crypto currency “Bitcoin” has been vogue since 2009. Even though it was accepted as a medium of exchange in many jurisdictions, it never gained wider acceptance as legitimate asset like gold or store of value like currency. In 2020, most of the reputable global investors and strategists have accepted Bitcoin as futuristic “store of value”, just like gold and USD. This acceptance has come on the back of Bitcoin’s sharp outperformance vs precious metals and USD. I believe that this marks the beginning of a new era on global monetary system. Neutral digital currencies shall continue to gain prominence in global monetary system in future. May be this prominence would diminish the dominance popularity of gold and USD as global reserve currencies.

5.    The year saw a brilliant thaw between the traditional enemies the Arabs and the Israelis. Some strategic initiatives were taken by Israel, UAE and Saudi governments to reduce tension in the region. This also saw Arabs increasing distance from Pakistan. I see this as a good omen. It may result in sustainable reduction in terror support and funding globally. However, this has pushed Pakistan closer to China. The tension at Indian northern, western and eastern borders may sustain and even increase in short term. More frequent hostilities at borders  is something we would need to incorporate in our investment strategies.

6.    Reliance Industries, led by Mr. Mukesh Ambani managed to convince global business leaders like Facebook and Amazon, and investors like KKR, Carlyle, GIC, ADIA etc to invest in its digital and retail ventures. Global petroleum majors British Petroleum and Aramco have also committed large investments in fuel business of the company. If these investments are consummated successfully in next 2-3years, we shall see many large Indian businesses gaining attention of the global business leaders and investors. I shall be reevaluating some of the large, viable but heavily indebted businesses from this viewpoint.

7.    First protests against the Citizenship Amendment Act (CAA and Shaheen Bagh) and now protests against the three acts to reform the farm sector in the country have further strengthened my belief that the mistrust between the ruling BJP and opposition parties has breached the red line. The political environment shall get further vicious, once the BJP tries to conquer the Forts of East (West Bengal and Odisha) next year. I shall not be expecting political consensus on any issue for next few years, for my investment strategy. Although with Congress weakening further, getting majority votes in Rajya Sabha may not be an issue for the government, nonetheless, the threat of reversal of contentious legislative changes shall always prevail, should a united opposition manage to dethrone BJP in 2024. (I agree that as of this morning this looks almost improbable).

8.    India recorded its first recession in past four decades in 2020. Though many analysts are terming it a technical recession due to lockdown; I would like to wait and see the trajectory of recovery to conclude if a lasting damage has been caused to the growth prospects.

In the recent Global Competitiveness Report, the World Economic Forum examined how different countries are traversing on the road to recovery from the health and economic shock of Covid-19 pandemic, which “impacted the livelihoods of millions of households, disrupted business activities, and exposed the fault lines in today’s social protection and healthcare systems”. On the positive side, the shock is believed to have accelerated “Fourth Industrial Revolution on trade, skills, digitization, competition and employment”.

There is large section of observers who reject World Economic Forum in general and its research in particular, as mostly elitist and prejudiced against developing economies. I do not have any strong objection to the views of this section of people. However, I do occasionally study the work done under the aegis of WEF and find it useful for identifying the problem areas and directions for further study. I read the Global Competitiveness Report 2020 also with this perspective. The following are some of the points that I find mostly incontrovertible and useful in making a reasonable assessment of the present situation.

·         Before pandemic high levels of debt in selected economies as well as widening inequalities was a major area of concern. The emergency and stimulus measures have pushed already high public debt to unprecedented levels, while tax bases have continued eroding or shifting. Now, the priority should be on preparing support measures for highly indebted low-income countries and plan for future public debt deleveraging. In the longer run (transformation phase) countries should focus on shifting to more progressive taxation, rethinking how corporations, wealth and labour are taxed.

·         The COVID-19 crisis has accelerated digitalization in advanced economies and made catching up more difficult for countries or regions that were lagging even before the crisis. In the revival phase, countries should upgrade utilities and other infrastructure as well as closing the digital divide within and across countries for both firms and households.

·         Skills mismatches, talent shortages and increasing misalignment between incentives and rewards for workers had been a major problem for advancing productivity, prosperity and inclusion for many decades. The focus should now turn to new labour market opportunities, scaling up reskilling and upskilling programmes and rethinking active labour market policies. The leaders should work to update education curricula and expand investment in the skills needed for jobs in “markets of tomorrow”.

·         The pandemic has highlighted how healthcare systems’ capacity has lagged behind increasing populations in the developing world and ageing populations in the developed world. Now, the health system capacity needs to be expanded to manage the dual burden of current pandemic and future healthcare needs. Especially, there should be an effort to expand eldercare, childcare and healthcare infrastructure and innovation.

·         Over the past decade, while financial systems have become sounder compared to the pre-financial crisis situation, they continued to display some fragility, including increased corporate debt risks and liquidity mismatches. The countries now prioritize reinforcing financial markets stability, while starting to introduce financial incentives for companies to engage in sustainable and inclusive investments.

·         Pre-crisis, there was increasing market concentration, with large productivity and profitability gaps between the top companies in each sector and all others; and the fallout from the pandemic and associated recession is likely to exacerbate these trends. In the revival phase, therefore, the effort should be to strike a balance between continuing measures to support firms and prevent excessive industry consolidation with sufficient flexibility to avoid keeping “zombie firms” in the system.

·         Post global financial crisis, a trend was seen emerging against globalization. In revival strategies, countries should lay the foundations for better balancing the international movement of goods and people with local prosperity and strategic local resilience in supply chains.

It is emphasized that “The global economic outlook for 2021 is highly dependent both on the evolution of the pandemic and on the effectiveness of the recovery strategies of governments”. It is critical to assimilate that the governments across the globe have deployed US$12trn to support households and businesses with emergency income and cash flows. This support shall begin to expire as the process of “unlocking” progresses. The recent economic recovery with the support of these support measures may not be a guidepost for the future economic trends. “Instead, the road towards economic recovery will be long, asymmetric and asynchronous across different economies”.

Where does India stand on the road to recovery?

1.    Amongst G-20 countries, India is a dismal and distant last in terms of percentage change in the skills of graduates during 2016-2020. Suadi Arab, China and South Korea share the podium positions in this area.

2.    India with 9.5% NPA level (2018 data) has the lowest score of soundness of banks amongst selected countries and ranks at the bottom (only better than South Africa) in terms of finance access to SME.

3.    India is placed close to the bottom in terms of share of global patent applications.

4.    Global business leaders see no significant improvement in the globalization of India’s value chain in future.

5.    India ranks much below the global average on workforce upgrade (law and social protection), investment in of skills and upgrading education curricula, digital access, rethink on competition and antitrust framework, creating markets of tomorrow, investment in R&D and innovation, diversity & inclusion,

6.    India is placed in the 9^th declie (bottom 20%) in terms of readiness for economic transformation post pandemic.

In view this gives a fair idea of areas where we are lacking and need to work hard. As an investor, this also allows me to upgrade my matrix of key factors that I focus on for identifying major risks and opportunities.

 The benchmark indices are scaling new highs every week for past seven weeks as least. The sharp recovery in markets, from deep correction in March, must have surprised most market participants. Many who panicked and sold off in summer are wondering whether it’s time to “Buy” again. Many who remained invested are wondering whether it’s time to ‘Sell”.

The broader question therefore seems to be, whether we are in a new bull market since April 2020, and the stock prices have a long way to travel north before any meaningful correction sets in; or it is a bear market rally that is normalizing the steep fall in March 2020 in the wake of total lockdown announced post outbreak of pandemic.

The last bull market started from August 2013 and lasted 5yrs till August 2018. In case we believe that it is new bull market that would mean that the bear market that started in August 2018 ended with panic bottom of March 2020.

However, if we believe that March 2020 panic fall was an aberration and the current sharp up move is just normalizing that aberration, and the regular bear market will play out after this normalizing cycle is completed in next couple of months. In this case we shall see markets stabilize around in 11500-12100 range and then decline gradually for some time. We had seen a similar situation in 2006-2009. In May 2006, markets corrected 25% in 3weeks as the first signs of subprime crisis emerged. But then markets rallied almost 100% (from lows of June 2006) in June 2006-January 2008 period; only to bottom around June 2006 levels in March 2009.

The moot point is how do we decide what state the stock market is in at present! The signals from the markets are indicating that regardless of the one way move in the market, the popular opinion is divided.

For example, the following are some signs indicate to a bull market:

(a)   Many IPOs since March 2020 have got tremendous response from investors.

(b)   Analysts are either ignoring bad news or finding positive angles in bad news . For example, consider the following:

·         One of the key argument for support of consumption related stock was the government support to the rural population. However, the news of PM-Kissan disbursement not happening (see here) was given a positive twist to imply that fiscal situation may not worsen after all.

·         M&M subsidiary SsangYong default on debt was given a positive twist to imply that M&M is sticking to its commitment of not investing more capital in loss making subsidiary.

·         Despite concerns over rising defaults on unsecured loans after the forbearance period ends, the valuations of many consumer focused NBFCs have breached the red lines. Analysts are supporting these valuations in the name of business consolidation, potential bank licenses etc.

·        S&P forecast of 7.7% contraction in India’s FY21 GDP was widely reported as “upgrade”.

 

(c)    All sellers are seen regretting almost immediately after the trade, as prices rise further before the payout is received.

(d)   Traders, investors and even fund managers are searching for stocks that have underperformed the peers, and betting new money on them in the name of “value”.

(e)    The social media timelines are overwhelmingly populated with success stories of popular traders and investors. The cautious investors are being guilt shamed by taunts of “I told you so”; and “I bought xyz in March 2020 and made return of $$$% in 9months”.

On the other hand, the following signs point to the possibility that it is a bear market rally that is normalizing the excesses of March 2020.

(a)   There is no particular theme or trend in the recent rally in stock prices. Stocks from diverse sectors like Bajaj Finance and Kotak Banks have become most expensive stocks perhaps globally, while ICICI Bank and HDFC Bank have lagged. Tata Steel has reached peak valuation while Hindalco has lagged. Tech Mahindra has ralled hard, while Infosys and TCS have lagged. Asian Paint has outperformed HUL massively. RIL has outperformed Bharti.

(b)   Domestic mutual funds have faced redemption in past couple of months. Domestic institutions have been net sellers so far this year, while foreign institutions have been net buyers.  However, there is no clear pattern in the flows, indicating tentativeness and lack of conviction. Overall net institutional flows have been marginal ($3.5bn) YTD.

(c)    Most of the rise in market has occurred due to valuation rating and not supported by earnings or forecast of earnings growth.

 

(d)   Last week the top gainer in NSE500 included some companies facing survival issues.

Personally, I am more inclined towards the second view (bear market rally). But I would leave it to readers to apply their own wisdom and decided their strategy.

 

 In a recent note, Matthew Hombach, Chief Rates Strategist of Morgan Stanley, wrote that Central Banks will inject another $2.8trn of liquidity in the global financial system in 2021. This would be the double the amount of highest liquidity injection in any year prior to 2020. This abundant liquidity, in Matthew’s view, will support the riskier investments at the expense of investments entailing lesser risk; implying weaker USD and US Treasuries and Stronger EM currencies and Equities. The caveat however is “if central banks signal a reduction in liquidity earlier than we expect, or our economists’ buoyant expectations aren’t met, risky assets could experience a wobble, a theme that might very well feature in our 2021 mid-year outlook”.

The conventional theory is that as the supply of transactional currency (money) rises, the price of money (interest rate) decreases. The lower interest rate results in lower cost of owning and carrying assets resulting in higher demand, and therefore higher price, for assets. Lower cost of money is also traditionally believed to increase the risk taking ability of the borrowers, resulting in higher demand for riskier assets, e.g., equities (over debt), emerging market assets (over developed market assets) etc. Lower cost of money is also seen to be catalyzing the flow of savings (surplus liquidity) from low yielding assets (e.g., USD, JPY, developed countries’ bonds etc.) to high yielding assets (e.g., emerging market currencies & bonds).

Also, as per conventional theory, the rise in supply of money which is not matched by rise in production of goods and services, inevitably results in rise in prices of goods and services (inflation).

However, the market trend seems to have strongly defied these conventional theories in past 10 years. Ever since the global central banks adopted the new normal monetary policies of abundant liquidity and near zero to negative interest rates, the demand and prices for developed market assets (USD, Developed market bonds and equities etc) have mostly outperformed the emerging markets and the prices of physical commodities have remained low, notwithstanding the small bump in recent months.

I think, the investment strategy needs to assimilate the trends in monetary policy, asset prices and inflation (of goods and services) in a holistic manner rather than drawing conclusion from the bits and pieces. The economic and financial research may better focus on the issue whether—

(a)   The excess (or additional) money printed in since the internet revolution started in late 1990s is to adjust the stock of money for rise in productivity, dematerialization, colossal rise in income and wealth inequalities and consequent changes in consumption, trading and investment patterns, changes in velocity of money etc.; or

(b)   The conventional theories are still valid and we are just protracting the inevitable, i.e., hyperinflation in prices of goods and service

Formulating an investment strategy for investors in India had never been as challenging as it appears today.

For past three decades, the secular growth narrative built on economic reforms, infrastructure development, demographics (large middle class, secular demand growth, accelerated urbanization, educated workforce, etc) and deeper and wider integration of Indian economy into the global economy, made the job of investment strategists easier. All policy failures, inadequacies in terms of physical and social infrastructure, political instability (especially mid 1990s), civil unrest, terrorist violence, geopolitical tensions, and market corrections due to these factors were accepted as “opportunities” to buy a secular long term growth story at a bargain price; and all such adventures were rewarded handsomely by quick reversal in mrket trends.

What you needed to be a successful investor in India, in my view, was the following–

(a)        Courage to take risk.

(b)        Deeper and wider to information.

(c)        Inertia to flow with the current.

(Contrarians who resisted the current and tried to swim against it were mostly annihilated, even though they were right about the unsustainability of the stock prices.)

(d)        Smartness to stay with the industry leaders, rather than spreading your capital too thin.

(e)        All stars favorably aligned in your horoscope.

Alternatively, the ability and resources to manipulate the markets would have also helped you, provided you were not too greedy and exited well in time.

It is pertinent to note that there is no evidence of Indian markets having a rally (or bust) based on their own investment theme in past three decades. Our market has just been passive participants in the global booms and busts (Commodities early 1990s; Financials mid 1990s; ITeS late 1990s; credit fueled construction mid 2000s; financials in mid 2010s, and digitalization of services and healthcare recently. Regardless, the mythology of Indian stock market is full of folklores about how the smart investors have identified the trends and businesses and made fortunes.

The things, however, do not appear to be that simple now. The “secular growth” narrative that drove the markets in past three decades is no longer unchallenged. There is an alternative narrative building. This counter narrative is based on the assumptions like the following:

(i)    India is failing in exploiting its demographic dividend.

(ii)   The pace of infrastructure building is lacking urgency and lags even many smaller emerging economies.

(iii)  The failure to maintain an adequate rate of investment has resulted in insufficient capacities to support the employment for rising youth population.

(iv)   The trend in quality of human capital has reversed due to failure of education and HRD policies.

(v)    A series of poorly planned reforms have diminished the popular appetite for any more radical reforms.

(vi)   The present government is not making sufficient efforts to build socio-political consensus for implementing key reforms to accelerate the growth.

(vii)  The potential growth trajectory of Indian economy has shifted downward to 6-7% and is grossly insufficient to support the rising aspirations of young demography.

The challenge of investment strategy is to find a balance between these narratives by neither getting overwhelmed by the negative narrative nor believing in the “secular growth” story of Indian economy blindly.

In next decade, either Indian equities will either have a theme of their own; or these shall lose the attention of global fund. In past couple of years a tendency to invest in global equities has emerged amongst Indian investors. This tendency may gain momentum in case the Indian economy fails to enhance its potential and realize such enhanced potential. Russia could be a relevant case in point to study in this context.

To support the positive narrative, the following excerpts from a recent Fidelity report could be useful.

“Throughout modern economic history, an expanding manufacturing sector has been essential to boosting employment and incomes. It’s a lesson that’s been driven home repeatedly, by the development of postwar Japan, the export boom in the Asian ‘tiger economies’ and most recently (and emphatically) China’s rise.

…..

India’s fixed asset investment has also lagged China’s and been on a declining trend in the past 10 years. In the 1990s, both countries had FAI at similar levels relative to GDP. Even though China has arguably spent too much on FAI in recent years, such investment is needed in the earlier stages of development and that’s where India missed the boat.

….

Today, India could be at an inflection point in the development of its manufacturing sector, as we think the government’s most recent package of reforms, known as Make in India 2.0, can be a game-changer if executed well.

The plan is to create 100 million manufacturing jobs and increase the manufacturing sector’s contribution to GDP to 25 per cent by 2025 from the current 16 per cent. It also features a doubling of infrastructure spending in the next five years versus the previous five years.

….

Overall, we expect an immediate contribution of around 0.5 percentage points of incremental GDP growth, and eventually the multiplier effects may lead to a contribution of about 2.5 percentage points.

…

Increased investment in infrastructure and manufacturing would also lead to productivity gains per capita. In absolute dollar terms of output per worker, India trails far behind other big developing markets like China and Brazil, not to mention the US or Europe.

With the increase in access to higher education, by 2030 India is expected to have a bigger tertiary-educated population than China. Meanwhile, urbanisation in India is forecast to increase from 35 per cent in 2020 to 43 per cent in 2035.

As a result, income levels in India are rising, as are the number of middle-class and high-income households. This will lead to a corresponding increase in consumer demand, which should translate into deeper penetration of sales of consumer items ranging from white goods to automobiles. Beyond consumer goods, other sectors that stand to gain from an acceleration in structural reforms include financials, industrials and healthcare.

The winners will be those firms that benefit firstly from structural growth, as penetration of their products and services increase in the country, and secondly, those that gain market share from weaker and less efficient players. For example, we expect this to include India’s private sector banks. Besides benefiting from structural growth, they will continue to gain market share from public sector banks due to their strong deposit franchises, conservative underwriting culture, well capitalised and strong balance sheets, and focus on technology.

The growing ranks of young affluent consumers means strong increases in housing demand, which translates into more mortgage business and other forms of consumer credit (not least, credit cards usage).

….

As a key emerging market and a proxy for global risk appetite, India took the full brunt of investor sell-offs when Covid-19 hit in early 2020. Going into 2021, while uncertainties remain, we expect the economy to continue its recovery path.

The recent rally has been narrow, focused on sectors such as healthcare, IT services and materials. Meanwhile valuations remain attractive across a number of areas including financials and industrials. As India’s economy gradually emerges from the Covid shock and corporate earnings start to improve, we think the long-term structural opportunities will again come into focus.”

 Before I say anything, I would like to make it clear that I use the terms “investor”, “trader” and “punter” in the context of equity investments, very judiciously.

To me an investor is a person who thoughtfully invests his money in a business to participate in the future growth of that business. A trader is person who is trying to optimize his return on capital by choosing from the best instruments available at any given point in time. It may be bond, fixed deposit, equity stock, gold, crypto currency, foreign exchange, other commodities etc. or a mix of these. Traders do not invest with the objective of “wealth creation”. Their focus is usually earning more than the risk free return while maintaining liquidity of his money. Punters buy financial assets or commodities just like lottery tickets. They get kicked by the prospects of hitting a jackpot someday and do not mind losing their entire capital in the process.

Here we are talking about investors only.

In summer of 2007, the global equity markets were doing great. Most global indices were close to their all-time levels. The global fund managers were exploring the world like Cristopher Columbus. Emerging Markets, BRICS, MENA, Frontier Markets etc were the hot themes. Everyone was deep in the money. Indian markets were no different. Then appeared first signs of sub-prime crisis and a sharp correction occurred in July 2007. However, the losses in correction were entirely recouped in no time and markets surged to their new highs by January 2008. The 14months after that were nothing less than a nightmare. The global equity indices saw cuts ranging from 35% to 75%.

The investors who had conviction in the strengths of the businesses they were invested in stayed the course and emerged winners. The punters lost their entire capital and much more. The traders also lost money.

In July 2007, at peak of the market, one investor invested in the stock of Mahindra and Mahindra Limited; the other investor invested in the stock of Reliance Industries; and a retired person invested in the Gilt Fund that invests in long duration government securities.

If they stayed invested in these instruments till today, the two investors in M&M and RIL stocks would be making about 9.25% CAGR (excluding dividends) on their investment; while the retired person would be making 9.5%.

A plain reading of previous two paragraphs may prompt the readers to jump to many conclusions. When I sent these two paragraphs to some of the readers for their comments, I got many responses. I find the following five responses as representative of the entire sample:

·         “Are you suggesting over a longer time frame, investment in gilt and stocks yield similar returns, but risk adjusted return are far superior in gilt.”

·         “If equities of front line companies have matched the return of Gilt, even after weathering two unprecedented crises (GFC, 2008-09 and Covid, 2020), then next decade perhaps equities will give phenomenal returns.”

·         “RIL gives you excitement’ but M&M is a steady performer.”

·         “If you are a long term investor, do not try to time the market. Over a longer period, returns would automatically get normalized.”

·         “Investment in reliance is like making a fixed deposit in SBI. You can never lose money.”

However, the responses could be very different, if I show the following chart to the respondents. This chart shows the relative performance of the stocks of M&M and RIL from July 2007 till date. The stock of M&M gave the entire return during first seven years (2007-2014) period. The current price of stock is almost same as it was in August 2014. The stock of RIL did not give any return for 9years (2007-2016). The price of the stock in December 2016 was almost the same as it was in July 2007.

A trader would immediately think, “December 2016 was the best time to sell M&M and buy RIL. This way one could have made the 2x the return of an investor.”

But an investor who is convinced about the business prospects of either M&M or RIL or both, the long intervening periods of no return are quite painful. The one who learns to manage this pain ultimately comes winner. The ones who succumb to this pain of non-performance, would sell RIL in 2016 and buy M&M, and end up as total losers.

If you want to fully assimilate the point I am trying to make here, then please talk to someone who had sold ITC and bought RIL in September this year, after getting no return in ITC for 5yrs.

 Inflation has been one of the central themes in global trading strategies in past one decade. During 2010-19, the central banks of developed countries (primarily US Federal Reserve, European Central Bank and Bank of Japan) struggled to build inflationary pressure in their respective economies, to attain a minimum level of inflation they considered necessary to motivate investments and sustainable growth. Incidentally, none of the Central Bank targeting higher inflation has so far been successful in their endeavor. Nonetheless, the sharp rise in global commodity prices in past few months has triggered a rush for “The inflation trade”.

 In Indian context, prices of all key commodities (metals, energy, food, cement, textile, and plastic etc), communication, healthcare and education, etc have seen strong inflation in past 6 months.

In its latest monetary policy statement, RBI admitted that “The outlook for inflation has turned adverse relative to expectations in the last two months”. The RBI expects the inflation to remain above its tolerance range for at least six months more. The policy statement reads, “Cost-push pressures continue to impinge on core inflation, which has remained sticky and could firm up as economic activity normalises and demand picks up. Taking into consideration all these factors, CPI inflation is projected at 6.8 per cent for Q3:2020-21, 5.8 per cent for Q4:2020-21; and 5.2 per cent to 4.6 per cent in H1:2021-22, with risks broadly balanced.”

The commodity sector has been one of the best performing sectors in the Indian stock markets in past 6 weeks. A number of brokerages have upgraded their outlook for steel, cement, gas, and chemical etc producers. Many have argued this to be a sustainable and durable trend and once in a decade opportunity to trade the inflation. For example, the brokerage firm Edelweiss expressed exuberance over steel prices and said, “Going ahead, we expect a blockbuster Q3FY21 with record margins in store. Furthermore, structural shortage of steel implies the rally in ferrous stocks has more legs despite their recent run-up. We remain positive on ferrous”.

I spoke with some steel and cement dealers, in Delhi, UP, MP and Bihar, in past two days. All of them appeared bewildered by the rise in prices. All of them cater to the small private construction segment, and none of them confirmed any sign of demand pick up in that segment. Being in trade for many decades, they were sure that demand is certainly one of the key factors driving the prices of steel and cement higher. They guessed, it could be a mix of supply chain disruptions, import restrictions, large inventory building by China and most importantly, the “understanding” between the domestic producers that could be driving the prices.

On the other side, Chinese Yuan has appreciated dramatically in past couple of months. This CNY appreciation has come along with first contraction in the Chinese consumer price index, since global financial crisis. At this point in time, it is tough to say how much of Chinese deflation is consequence of CNY appreciation, but it must certainly have some role. If the strength in CNY reflects the policy decision of Chinese authorities, we need to worry about deflation which China will be exporting rather than the inflation.

My take on the inflation trade, especially in Indian context, is as follows:

A large part of the global inflation in past 9 months could be the consequence of (i) supply disruption due to logistic constraints; (ii) inventory building by large consumers like China; and (iii) weakness in USD.

After reading and listening to views of various experts, I have concluded that that China might have built large inventories of all essential commodities (especially metals and energy) to hedge against (i) Trump victory and consequently intensifying trade war; (ii) longer lockdown due to pandemic Both these conditions have failed. Regardless of popular opinion, my view is that CNY strength is a Chinese gesture to US for ending trade dispute. If Biden reciprocates well to this gesture, inflation may not be a concern for next 10yrs at least.

I shall therefore avoid “The inflation trade” for now. However, if I see a sustainable pickup in demand next year, I shall be inclined to buy some domestic commodities like cement and chemicals (primarily import substitute).

 

UK has allowed the administration of vaccine for SARS-CoV-2 virus (commonly known as Covid-19) developed by Pfizer. Russia and Chinese authorities have also confirmed approval of separate vaccines. In India also couple of developers has expressed confidence that an effective vaccine will soon be available for Indian population.

This is certainly a matter of relief for the distressed mankind living in fear since outbreak of the pandemic. However, for the investors in stock markets wider availability of vaccine could be a matter of slight concern.

So far the investors in equity have had a decent run in 2020, regardless of the severe correction in the early days of the pandemic. In my view, a large part of the price gains in equity stocks could be attributed to the accommodative monetary policy adopted by the central bankers world over.

In past 9 months, a significant part of the cheap and abundant money may have actually flown to the financial assets (mostly equities) as (i) the requirement of money in real businesses have been less; and (ii) the interest rates have persisted at lower levels making it un-remunerative for investors to keep money in short term debt or deposits.

The rising certainty about vaccine availability and subsequent normalization of the accommodative monetary policies may rock the stock market party in 2021. It may be pertinent to recall the impact of taper tantrums on stock markets in 2013, when Fed started to wind up the QE used for supporting and stimulating the economy in the aftermath of global financial crisis in 2008-09.

In a 2017 study, Anusha Chari and others (National Bureau of Economic Research, Cambridge, see here), examined the impact of monetary policy surprises extracted around FOMC meetings on capital flows from the United States to a range of emerging markets. The study revealed “substantial heterogeneity in the monetary policy shock implications for flows versus asset prices, across asset classes, and during across the various policy periods.”, as per the study—

“The most robust finding is that the evolution in overall emerging market debt and equity positions between various policy sub-periods 14 Not reported but available from the authors. 33 appear to be largely driven by U.S. monetary policy induced valuation changes. In nearly every specification, the effect of monetary policy shocks on asset values is larger than that for physical capital flows.

Further, there is an order-of-magnitude difference between the effects of monetary policy on all types of emerging-market portfolio flows between pre-crisis conventional monetary policy period, the QE period and the subsequent tapering period. We detect some significant effects of monetary policy on flows and valuations during the period of unconventional monetary policy (QE). However, the effects are not consistent over all dependent variables. In contrast, during the period following the first mentioning of policy tapering, we uncover a consistent and large effect of monetary policy shocks on nearly all variables of interest.”

Normalization of global trade to pre pandemic levels may essentially obliterate the supply chain bottlenecks and ease commodity inflation. Remember, the pandemic has not caused any physical destruction, as is usually the case with a larger war. Therefore, normalization would not require any major reconstruction or rebuilding endeavor. The damage is mostly to the personal finances and small businesses. This will keep hurting the demand growth for few years and keep the need for additional capacity building low. The new capacities would all be built in healthcare and digital space, not much in the physical space.

In Indian context, in past six months, the yield curve has steepened the most in past two decades at least.

As per media reports, many private companies are able to raise 3month money at 3-3.3%, a rate lower than the policy reverse repo rate as well the corresponding bank fixed deposit rate. Obviously this is an anomalous situation and may not sustain for long.

There is little doubt in my mind that any further steepening of the curve could fuel Nifty to the realm of 15000 in no time. But I have serious doubts whether in a fast normalizing economy, as claimed by various government officials, economists and other experts, the short yields may continue to soften, or even sustain at the current level, especially when the inflation is seen bottoming at or above the RBI target rate.

Any sign of “withdrawal” might shock the brave traders, who are assuming unabated flow of cheap money. Beware!

 

 As per an old maxim, “beauty is in the eyes of the beholder”. This essentially implies that beauty or attractiveness of something (or someone) is mostly subjective. It is entirely possible that someone finds something beautiful, while at the same time someone else considers this thing to be ugly.

This maxim applies, mutatis mutandis, to equity investing also. A stock is found attractively values and prohibitively expensive by different market participants (analysts, fund managers, and investors) at the same time and price point; even though all of them may have access to the same set of data and information about the underlying company. The stock of ITC is a classic example of this dichotomy in the present day context. The stock is believed to be a top wealth creator and wealth destroyer at the same time by the different set of people.

I am sure no one would have any problem with this divergence in views about the future prospects of various businesses and companies. In fact this divergence in the views is what keeps the markets moving. Imagine a situation where there is no divergence in views about the future prospects and fair present value of the prospective earnings and growth of any company. There will be no trade in such stock as there would only be buyers or seller for that. The very purpose of stock markets will be defeated in that case. The more the divergence in views about companies and businesses, the better it is for the markets and market participants.

The real problem occurs when the market participants start looking at stocks from the eyes of “others” and begin to practice the greater fool theory. They start buying stocks of companies in which they have little conviction, believing that someone else will find “value” in this stock at a price higher than what have paid for it.

In past one month, I have observed numerous instances where brokerages and “market influencers” on social media are seen marketing stocks of bankrupt or loss making companies. Some brokerages have written sensational reports about “deep value” in public sector companies, which lay completely neglected three months selling at one half or one third the current market price (CMP).

Numerous equity analysts, fund managers and traders have written or spoken about the value in mid and small cap category stocks, suggesting how the current rally in this category of stocks may continue for next 2-3 years. Many these reports and interviews are totally silent on the fact that in almost all market and business cycles, a mostly different set of stocks perform well, and losers of previous cycles hardly perform well in subsequent market and business cycles.

I find the following, particularly relevant to highlight the point I am trying to make here:

 

I have no issues with these views or the people expressing these views. I just do not concur with these views. Given the current high momentum in the markets, I have two options either flow with the current to stay on the side lines and wait for the waters to calm. I am opting for the second alternative. My experience of past 30years guides me that I may not have to regret this decision 6 months later.