Do it yourself

 The NITI Aayog recently published “India Innovation Index 2021” report, which presents “an in-depth analysis of the state of innovation in the Indian economy”. The India Innovation Index 2021 presents state-wise rankings based on the innovation landscape and performance of the country’s states and union territories. The latest framework of the index has been mapped from the Global Innovation Index, published annually by WIPO (World Intellectual Property Organization).

The report earnestly recognizes that human capital is the source of innovative ideas, knowledge, and practices. It notes that high innovation capabilities need heavy investment in human capital development at all levels to develop skills beyond technical knowledge, e.g., imaginative thinking, devising methods to tackle complex issues and keeping pace with the times.

The report emphasizes “the practice of promoting innovation at the grassroots is necessary to fully utilise the potential of the indigenous knowledge bases by engaging the local communities in the process.11 The exercise is of greater significance in a country like India where a considerable share of the population is engaged in the informal sectors. To monitor and promote grassroots innovation, the Government of India in 2000 established the National Innovation Foundation (NIF) as an autonomous body of the Department of Science and Technology. The foundation aims to drive innovation at the grassroots through documentation, protection of Intellectual Property Rights (IPR) and commercialising innovation and innovative techniques devised by unaided small-scale innovators. The institution was able to file 114 patents in the year 2019-20.”

R&D has played a significant role in the growth of developed countries. The countries that have high per capita R&D expenditure tend to have higher per capita GDP as well.

Innovation in India

In India, R&D investment has been relatively low. In the past few years, R&D investment in the country has declined from 0.8% of the GDP in 2008–09 to 0.7% in 2017-18. This is lower than the other BRICS nations—Brazil spends about 1.2%, Russia about 1.1%, China just above 2%, and South Africa around 0.8%, with the world average being about 1.8%. On the other hand, developed countries like the United States, Sweden, and Switzerland spend about 2.9%, 3.2% and 3.4%. Among all nations, Israel spends the most, 4.5%, of its GDP on R&D.

Dismal private participation in R&D

Besides very low R&D spends, another challenge in India is lack of private participation in the innovation process. About 60% of all R&D spend is incurred by the government against USA 10%, UK 6%, and Israel 1.5%. A major chunk of India’s R&D expenditure is thus on defense and space research; whereas healthcare and manufacturing account for ~13% of public sector R&D spending.

Huge regional disparities

The ability to innovate is dependent on the quality of human capital. It rests on the opportunities in terms of research and development. Lower spending on R&D, and less innovative opportunities may lead people to move from one region to another region - state/ country for better opportunity.

Overall Global Innovation Score for India is a dismal 14.56. Besides, there exist huge regional disparities within the country. Most of the R&D effort in India is concentrated in few states and cities. Some clusters in NCR, Karnataka, Tamil Nadu Maharashtra, Telengana and Gujarat account for a large proportion of overall innovation effort in the country.

Suggestion for improving the innovation rank of India

The report makes the following suggestions for improving the global innovation score of India to aid faster economic growth and development.

1.    GERD needs considerable improvement and should touch at least 2%, which would play an instrumental role in India achieving the goal of a 5 trillion economy and further influence its innovative footprint across the globe.

2.    The role of the private sector in research and development needs to pick up pace.

3.    The expenditure on human capital has been unable to create that knowledge base in the country, which could be due to the intricate reasons of bureaucracy, administration, outreach, etc. It is observed that innovation is skewed against the manufacturing sector. This requires inexorable efforts to overcome challenges and make the best use possible.

4.    India has been able to provide a conducive environment for businesses to thrive, in terms of a business environment, safety, and a legal environment, but we have not been able to support the same in terms of investment and knowledge workers. We need to harness the energy and potential of youth to augment knowledge workforce.

5.    We need to sincerely fill the gap between industry demand and what we produce through our education system.

6.    India needs to undertake efforts in creative goods and services, which have been ignored for a long time.

7.    In India, intangible assets like patents and trademarks filing process are complex and face procedural delays. We need to streamline this.

8.    Our states and Union Territories need to break silos and start working in tandem, as no state/UT can thrive alone endlessly without taking care of its peers.

About two months ago, I received a late night call from one of my close acquaintances. The man was in a tearing hurry. Almost gasping for breath, he informed me that the stock market in India is going to crash and the benchmark Nifty is certain to fall to at least 12500 levels. He had learned from some very credible sources that the markets world over are going to crash soon; and India may actually go the Sri Lanka way. “Crude prices will top US$140/bbl soon and USDINR will collapse to 85”, he sounded extremely confident. Half asleep, I did not know how to react to his claims instantaneously. To buy some time to react, I pleaded “could we discuss this in the morning, please!”.

When I called him in the afternoon, the next day, he had already liquidated half of his portfolio. He sounded quite relieved and exuded the confidence of a victor. I had no contact with him, till he called again yesterday evening. This time, he wanted to know “Could Nifty make a new high in the next 3-4months?” I again had no instant answer to his earnest inquisition. I am sure that the question was mostly rhetorical; since he sounded quite convinced about this proposition of market scaling new highs soon. I think he will deploy his cash in a day or two.

I am not sure, if this one isolated instance is indicative of a larger market trend, viz., the greed dominating the fears”. But from my experience of over three decades, I can certainly tell that this person definitely has a lot of people accompanying him “in” and “out” of markets at frequent intervals.

Many of these proudly claim themselves to be “seasoned investors”, who have the ability to read the pulse of the market and foresee the future trends well in time. They alternatively use “macroeconomic factors”; “technical charts”, “political developments”, “geopolitical events” and “valuation” arguments to camouflage their “greed and fear”.

One morning they would swear by valuations and economic fundamentals; and on other days they sound like experts and loyal followers of the Elliott Wave and Japanese Candle and Sticks. One day, they feel confident listening to the “mother of all bull market” narrative of Rakesh Jhunjhunwala and “fastest growing economy” claims of the finance minister, while the very next day they need tranquilizer to sleep because some Nancy Pelosi is boarding a flight to Taiwan. They confidently forecasted, in February 2022, the end of Ukraine within one week and beginning of WWIII.

What actually surprises me the most is that despite their frequent mood swings and mostly intuitive actions in the market, they are not only able to beat the benchmark indices consistently, but also outperform some of the most seasoned fund managers and long only investors; though they may not be earning to their full potential, meaning their actual return may be lower than what they could have made otherwise. This consistent outperformance lends them confidence and belief that their strategy and methods are the best way of “investing” in stocks.

I would never concur with them, even though I could never earn more than them from my investments. The question that arises from this is – if I cannot beat them, should I join them? My answer is an emphatic “No”. Because - I always sleep peacefully. I do not bother to call anyone at midnight to ask what is happening in the markets. I do not give a damn even if President Biden is also flying with Speaker Pelosi to Taiwan and PM Modi is flying to Tibet to meet the Dalai Lama. And I certainly do not care if Wave C of 3 is opening or it is an extended 2 Complex.

 The monsoon this year is progressing well. At midpoint of the season, about 70% of 703 districts in the country have received normal to excess rains; and only 5% districts are witnessing a large deficiency. With the dark monsoon clouds hovering over most parts of the country, the skies in markets appear bright and sunny.

The stock markets and bonds have mostly recouped the losses made in the past four months. USDINR is also trading at two months low. Economic indicators are no longer worsening – inflation is high but stable; tax collections are strong; fiscal deficit is under control; core sector growth is recovering; bank credit to industry is picking up; leading indicators like vehicle sales (especially commercial vehicles), freight carried; port & railway traffic are all showing signs of stabilization and recovery. Current accounts are a cause of concern. However, positive FPI flows in July and recent correction in global crude oil prices are providing at least some comfort; which is reflected in INR appreciation also.

The market narratives have also changed remarkably in the past couple of weeks. The phrase “Hyperinflation” has almost vanished from the market discussions. Recession, Peak rates, Peak USD, Peak crude prices, wider adoption of Bitcoin, equity market bottom etc. are now increasingly finding mention in the market commentaries. For example—

CITI Global Commodities Research recently, inter alia, noted “Most analyses of oil markets emphasize the consequences on prices of further supply disruptions. In this report we focus on the potential consequences of an increasingly likely recession. In a recession scenario with rising unemployment, household and corporate bankruptcies, commodities would chase a falling cost curve as costs deflate and margins turn negative to drive supply curtailments.”. It further noted that “It looks as though for this year and into 2023 Russian crude oil exports may remain robust, even if refined product exports may fall. Therefore, further global oil demand weakness should spell higher inventories and weaken oil prices. Yet, the distortionary impacts of Europe boycotting increasing volumes of Russian oil should continue to be headwinds for global oil prices. In a recession scenario, we would see oil prices falling to $65/bbl by year end and potentially to $45/bbl by end-2023, absent intervention by OPEC+ and a decline in short-cycle oil investment.”

Jefferies, in the latest edition of its signature report Greed & Fear '' noted that “There is no doubt that financial markets, in the midst of the silly season, have been in an awful hurry to price in the peak of inflation and the end of Fed tightening. Fed tightening expectations peaked in mid-June at 4% in early 2023 while the money markets are now discounting 50bp of easing next year after the federal funds rate peaks at an assumed 3.25-3.5% in December, or 100bp above the current level following the 75bp hike yesterday to 2.25-2.5%”.

Lazard Asset Management believes that “Despite lingering headwinds, like fallout from regulatory crackdowns and zero-COVID policy aftershocks, China’s growth trajectory is still likely to show a recovery in the second half of 2022, and opportunities may be ripe for the picking in this vast market”. It also noted in a recent report that “Emerging markets fundamentals are in a relatively solid position overall especially as higher commodity prices have improved the terms of trade for commodity-exporting countries. As such, the current account and fiscal balances for many countries have improved while debt valuations have grown significantly more attractive’ – clearly a sign of preference for a “risk on” trade.

Bank of America Research in a recent report, estimated that the US 10yr benchmark bond yields could reach 2% in less than a year.

Particularly, in the Indian context, the market participants seem quite relaxed after the recent market run up and correction in crude oil prices. Recently released World Economic Outlook by the IMF mentioned the resilience of the Indian economy, expecting it to grow ~8% in 2022 and ~6.4% in 2023 despite a widespread global slowdown. As per Emkay Research, H2FY23 may reveal India’s ‘true’ growth trajectory, based on: a slew of reforms in recent years, improving EoDB, thrust on domestic mfg., rising capacity utilization; marginal base-effect from Omicron should be a bonus.” Though the brokerage firm finds food and energy inflation a key challenge for the Indian economy, it notes that the underlying drivers of globalized inflation are cooling, overall easing the inflationary pressures. It accordingly believes that margin pressures on the commodity consumers are beginning to ease and shall reflect in 2HFY23 numbers.

Brokerage firm Edelweiss believes that “US Recession Fears Overplayed - Recessionary models show a low probability of the US undergoing recession. After a dismal H1 of the year, H2 has a better probable payoff. The U.S & European Market are likely to consolidate in the later half of the year and likely to underperform other world equity markets. Emerging markets seem to have limited downside as compared to developed markets.”

 The US Federal Reserve has comforted the global markets with assurance of maintaining strong intent to control prices while not being unnecessarily disruptive in terms of monetary tightening. The markets are apparently reading a 0.9% contraction in the US economy in 2Q2022, as sufficient ground for the Fed to be mindful of the likely disruptive impact of the future hikes; given that the US economy is technically in recession after having contracted for two consecutive quarters in 2022.

The marked slowdown in the economic activities in Europe and China; and easing of the global logistic bottlenecks has noticeably moderated the inflationary expectations, as reflected in the yield curves across the globe. The fears of 1930s type hyperinflation appear to have subsided, at least for now. The equity valuations are gradually adjusting to “above zero” and “neutral” interest rate regimes. The recognition of “positive rates” however is still missing from the popular narrative and hence remains a key risk.

The wider acceptance of the ground realities in respect of the Russia-Ukraine conflict is making it relatively easier to find amicable supply chain solutions. Gradually, the global community is beginning to accept that (i) the conflict may persist for longer than previously anticipated; (ii) stricter economic sanctions on Russia may not yields the desired results and in fact could produce material unintended consequences; and (iii) isolating Russia could provide significant impetus to the ideas of “de-globalization” and “polarization” of the world; raising the specter of multiple and larger geopolitical conflicts, and undermining the global consensus on important issue like climate change, poverty alleviation and denuclearization.

Two factors that can impede the process of returning to normalcy (yet a New Normal), in my view, are –

(1)   Compromise on the climate control targets, further aggravating the already erratic weather conditions across the globe.

The food shortages (and consequent food inflation) could worsen materially leading to reversal of advancements made towards poverty and starvation alleviation in the past three decades in particular. There could be widespread civic unrest; production and supply chain disruptions; and rise in loss of human lives due to hunger, violence and inclement weather.

(2)   Dominance of leftist ideology in global politics hampering creation of new capacities and perpetuating inflation.

As I had mentioned in one of my earlier posts (The Challenges of economic policy), a large number of countries are opting for left of center parties/leaders to govern them. Moreover, to counter the egalitarian agenda of left of center parties, even the right of center parties like conservatives in UK, BJP in India, LDP in Japan and Yemina in Israel are increasingly resorting to socialist agenda to retain power. Obviously, the top priority of governments across the world is immediate relief to the poor rather than growth. It is therefore more likely that the tighter monetary and fiscal conditions will continue to challenge the growth ecosystem in near future. The new capacity building may continue to lag; resulting in more frequent bouts of high inflation, as compared to the past two decades and hence larger volatility in financial stability and macroeconomic environment.

 The struggle between Newton's law of gravity and global markets is perennial. Many times it appears that the markets are defying the laws of gravity and breaking out of their orbit. However, in the end, it is the law of gravity that has always won. Notwithstanding the distance covered away from the “fair value zone”, and the time spent in the away zone, the asset prices invariably tend to return to the fair value zone. In the common market parlance these digressions and eventual return to normalcy is described by the phrases like Overbought, Oversold, Overvaluation, Undervaluation, Mean Reversion, etc.

It is important to note that a long time spent away from the fair value zone could be very deceptive for investors. Sometimes it gives an illusion that the fair value zone for the subject asset may have already shifted higher or lower and the current price is actually closer to the fair value zone. The investors lacking in discipline and/or conviction may fall for this deception and buy/sell the asset in the “away zone”. Two classic examples of this phenomenon are the stock price of ITC Limited and IRCTC Limited during 2019-2021.

In the past one year, all asset prices that were trying to defy gravity, without having necessary escape velocity, are crashing back to their respective ground positions. Now since the asset prices are correcting downward, trampling the traders and investors coming in their way, the questions to ponder are:

(a)   When would the asset prices hit the rock;

(b)   Whether the rock will be soft or a hard one; meaning whether the prices will jump higher immediately after hitting the rock or they will get stuck there at the bottom, till the next high tide comes to their rescue;

(c)    Which assets are fragile enough to crash and get destroyed when these hit the rock;

(d)   Which assets are flexible enough not to get damaged by hitting the rock and bounce back faster.

History could be a good guide in analyzing these points and finding appropriate answers. However, 2008-2009 may not be a good reference point in this context, in my view. The crisis began to hurt global asset prices from early 2008 as the economic growth, fuelled by a decade of exceptionally loose credit, started to fizzle out and financial leverage became unsustainable.

The process of adjustment and correction was interrupted by innovative and audacious monetary policies of large central bankers. Surprised and enthused by the "whatever it takes" approach of central bankers, traders and investors made large bets on a faster economic revival. Consequently, many asset prices in fact scaled higher peaks than seen during the bull market of 2005-2007.

As it turned out that the comfort was false. The central bankers did manage to restore stability in the financial system; but the economic recovery remained feeble and unbalanced. The global lockdown in the wake of Covid pandemic has completely exposed the fault lines of the global economy and markets. Consequently, the asset prices are now rationalizing to factor in the prospects of even slower economic recovery and further rise in global imbalances.

The process is expected to be protracted and painful. Nothing will be achieved in a year or two.

The good news, in my view, is that India is decoupling from the global pain, as the painful economic corrections implemented in the post global financial crisis era are now beginning to yield results. In fact, as one of the worst sufferers of unfavourable terms of trade, India could be a major gainer as the global imbalances get adjusted to more fair terms of trade.

I am certainly not expecting any exceptional return from the Indian equities over the next couple of years. However, it is apparent that Indian equities can give normal returns for a much longer period than their peers.

 Hikes another 75bps

The Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) hiked the federal fund rate by 75bps yesterday to the range of 2.25% - 2.50%. This is the second 75bps hike in two months. In the post meeting press interaction the Fed chairman Jerome Powell outrightly rejected the speculations that the US economy is in recession. The FOMC members are of the opinion that the strong labor market allows the US economy to tolerate rapid monetary tightening.

For the first time since February 2020, the FOMC statement did not mention Covid or coronavirus.

…leaves the door open for further data dependent hikes

Reiterating the commitment to achieve the 2% inflation target, Powell also indicated that while another unusually large increase could be appropriate at our next meeting, the FOMC would set policy on a meeting-by-meeting basis rather than offer explicit guidance on the size of their next rate move, as he has done recently; thus, leaving the future course of the FOMC action wide open.

As per the Bloomberg estimates, the market consensus is now gathering around two more 50bps hikes in September and December FOMC meetings, with the fed fund rate peeking around 3.4%, lower than the previously estimated 3.8%.

The US economy is estimated to have grown at a tepid 0.4% (QoQ, annualized) rate in 2Q2022 after recording a negative growth in 1Q2022, technically avoiding a recession. The US officially acknowledges a recession if the economy logs a negative growth for two consecutive quarters.

Markets react positively to FOMC – stock rally, yields and USD tumble

The markets took comfort from the growth outlook and Powell’s statement on future rates being data dependent. The market participants appear to have concluded that the FOMC may reach the end of the tightening cycle by the end of 2022, triggering a “risk on” rally in the markets.

·         Battered tech stocks surged strongly with the benchmark Nasdaq rising 4.06%, the largest one day gain since November 2020. The broader index S&P500 gained 2.62%.

·         US Dollar Index lost 0.66%.

·         2yr SU Treasury yields fell 10bps; while 10yr benchmark yields were down 5bps at 2.78%.

…but deeper yield curve inversion signals recession as consensus

The US yield curve is now inverted the most in two decades, highlighting that the markets strongly believe a recession is around the corner. The 2yr yields are now over 30bps lower than the benchmark 10yr yields – clearly indicating that the market sees higher risk of recession than the Fed. The deeper yield curve inversion is seen to imply that Fed may actually return to the path of easing as early as 2023.

Click here to see a nice compilation of analysts’ reactions to the FOMC statement.

The Nifty Metal Index has gained over 10% in the past one month; outperforming the benchmark Nifty50 (+4.5%) by 2x. Six out of the total fifteen Index components have gained over 10%, with Hindalco (+16%) being the top gainer amongst the metal producers.

In this period, the Bloomberg Commodity Index is down by ~2%; LME aluminum futures are down ~2.5%; LME copper futures are down ~9.5%; Brent Crude prices are down ~11%; NYMEX gold futures are down ~5.5% and China Steel Bar prices are down ~10%.

Also, in the past one month, the benchmark US 10yr Treasury Bond yields are down 9% from 3.13% to 2.78%; and the US Dollar Index (DXY) is up by 1.9%.

I find the divergence between performance of metal stocks and global trends a little intriguing. The global commodity prices, bond yields and US Dollar movement etc. are all pointing to a significant slowdown (if not recession) in demand. The outlook for the domestic demand in India is also not enthusiastic in the near term. The 1QFY23 results have indicated pressure on margins; attracting earnings downgrades.

In my view, the investors holding metal stocks in their portfolios need to analyze the following three scenarios:

1.    The ~33% correction in Nifty Metal Index during April – June 2022 quarter is an overreaction to the slowdown concerns and imposition of export duty on some steel products. The market is now rationalizing the excessive correction.

2.    The slowdown/recession concerns may be overblown, especially in the context of Indian producers of industrial and base metals. The demand for metals will remain strong in India, even if global slowdown extends to 2023 due to monetary tightening and war. The government may withdraw the export duty and even provide additional protection from cheap imports to help the domestic producers. The producers with significant global operations like Tata Steel and Hindalco will manage to recover their volumes and margins in a couple of quarters if the economic slowdown is managed well.

3.    The global commodities, especially the base and industrial metals, have not seen any significant capacity addition since the global financial crisis. During the lockdown in the wake of Covid pandemic, the inventories have been utilized. For most metals, the inventories are at historic low levels. The monetary tightening by the global central bankers is making inventory carrying cost expensive and hence discouraging inventory restocking. The global bond markets and inflation forecasts are indicating that the monetary tightening cycle may end sooner than later; and the central bankers like the US Federal Reserve may actually embark on a path of monetary easing as early as 1Q2023. In that case, we may see a sharp surge in commodity prices in 2023-2024 as the demand-supply gap tightens further.

As a strategy, I usually avoid commodity stocks in my portfolio due their cyclicality, volatility and unpredictability of their earnings and consistent need for capacity building. However, I am inclined to believe more in the third scenario playing out over the next 3-5yrs. I would therefore be on the lookout for some metal producers that have decent operating leverage (unutilized capacity); unlevered balance sheet; offering decent valuations. As of this morning, I found nothing that fits my criteria.

 In the next couple of days, the market participants world over will be focused on the FOMC statement on Fed rates, inflation & growth outlook and guidance for the monetary policy direction in the near term (next 3-6months). The “active” market participants in India, in particular, would be staying awake till late midnight on Wednesday to hear what Fed Chairman Jerome Powell has to say.

The fact that Thursday happens to be the monthly derivative settlement for July contracts, makes the Fed decision, and likely reaction in our markets on Thursday morning, even more pertinent for the derivative traders in India.

Besides the derivative traders, the currency traders; bond traders and corporate treasury managers who need to actively manage their Fx exposure, would also staying awake to see how the US Dollar, EUR and US Treasuries behaves post the FOMC statement and try to assess how Indian bonds and INR may react in near term.

Our markets may however be relieved to a great deal if the RBI makes an unscheduled rate decision on Wednesday morning itself, just like it did on 4 May 2022, preempting the pressure on Indian bonds and INR post FOMC decision. For records, in his recent statement, the RBI governor has already spoken about the inevitability of further rate hikes. It would be better if it is done tomorrow rather than a week later (04 August 2022) when the MPC of RBI is scheduled to make a statement on monetary policy.

The European Central Bank (ECB), for example, hiked 50bps last week – their first hike in 11 years- to preempt further slide in the Euro. ECB hiked despite signs of accelerated slowdown in growth and rising fiscal pressures on peripheral Europe.

Since the FOMC decision would be known in less than two days, I do not find any need to speculate on the likely outcome and the market reaction to that outcome. Nonetheless, it would be appropriate to say that the market is pregnant with the hope of a unambiguous ‘pause’ signal from the Fed and consequent weakness in USD and a rather dovish MPC. The chances of disappointment are therefore marginally higher than the chances of positive surprise, in my view.

What should be the strategy of an investor under these circumstances?

In my view, the first thing an investor should do is to have a good dinner on Wednesday; go to bed early and not watch the markets, including business newspapers & TV channels and investing handles on social media, on Thursday.

Second, investors should focus on performance of the companies in their respective portfolio, rather than bothering too much about the general impact of global macro developments. They should assess the ability of the companies in their portfolio to manage the impact of rate and currency volatility on their respective businesses. The history indicates that better managed companies in India have managed this volatility very well without letting it materially impact their performance beyond a couple of quarters in the worst case.

Third, if the change in global rate and currency outlook materially alters the investment argument for a company in their portfolio, they should place a “sell” order for it today itself.

The debate over whether “equity investing” is an art or science is never ending. There are arguments on both sides, but none of these appear strong enough to settle the debate. Almost all episodes of this debate usually end with the compromising statement - “Equity investment is both an art and a science.”

The application of quantitative research and financial models does give it a scientific color. But use of quantitative methods and financial models is highly influenced by the personal preferences, experience, estimates and prejudices of the user. Invariably, the forecasts of fundamental analysts vary based on what parameters they have used in forming their respective opinions. For example, a 50bps difference in weighted average cost of capital (WACC) used by two analysts could give dramatically different assessments for the fair value of a stock. As someone pointed out, fundamental analysis of equity stocks is like navigating a car. While all the cars are designed scientifically, the drivers have distinct styles of driving and the results – time to travel a defined distance, safety of the passengers and vehicle, fuel mileage obtained from the vehicle etc. – largely depend on the style and experience of the driver.

The “art” side of equity investing is even more complicated. Most investors view a particular stock from the vista point they are standing at that particular point in time. Their decision to buy or sell stock depends on their financial, psychological, and social condition at that particular point in time. The decision (and therefore view on a stock) can change dramatically if they move to a different vista point, i.e., their financial, psychological and/or social change.

For example, an investor who invested in a portfolio of stocks 10yrs ago for children's college fees, he/she will sell the portfolio as soon as the children get admission in college, irrespective of the future outlook of these stocks.

Parallel to the debate of ‘science” vs ‘arts”, a lot of mythical investment strategies are also commonly discussed and marketed. The investors, analysts and money managers use terms like “value vs growth”; “cyclical vs defensive”; “large cap vs midcap”; “financials vs technology”, which are mostly mythical and have no scientific basis.

·         Most large IT Services companies count BFSI as their primary customer segment. Most large financial firms are reporting spend on technology as their primary capex. How could possibly the investment in these two sectors be alternative.

·         Auto, Energy, and Banks sector equities have given positive returns over the past 3yr, 1yr and YTD2022 horizon. This period saw one of the most pervasive socio-economic disruption globally and triggered a global recession. Whereas, media, pharma and IT services are the sector that are down on 1yr and YTD2022 basis, though IT and Pharma sectors have given strong returns over the past 3yrs. The question is how would define what is cyclical and what is secular or defensive in this scenario.

·         Midcaps have outperformed Nifty over past 1yr and 3yr timeframe. So what is the relevance of largecap vs midcap debate?

The point I am trying to make is that the investors must avoid these mostly redundant and mythological distinctions and debates and focus on their investment objectives and strategy to achieve those objectives.

Last night I got a call from a friend who had been staying in London for the past 3years. He wanted to know what type of air-conditioner is better – window or split type. He sounded quite hassled as he was figuring out how the air conditioner would be installed in his rented apartment; what kind of permissions would be required; whether he can get a skilled technician to install an air conditioner; and how much would be the operational cost (electricity bill) for using an air-conditioner in London. I am sure he was overreacting to an ordinary situation, because the situation is dramatically asymmetrical to his perception of life in London.

 A recent Reuter’s article (see here) drew attention towards some ominous signs emanating from the bond pricing of emerging markets that are more vulnerable to default on their sovereign obligations. Noting the signals like weakening currencies, bond spread widening beyond 1000bps, and dwindling Fx reserves, it concludes that a record number of developing economies might be “in trouble” now.

More than US$400bn worth of sovereign debt could be facing default. While the countries like Russia, Sri Lanka, Lebanon, Zambia etc. have already defaulted on their obligation, the usual suspects like Argentina and Pakistan etc. appear on the precipice of a default. The serial defaulter Argentina (US$150bn); Ecuador 9US$40bn); and Egypt (US$45bn) may actually default much sooner. If the war drags on for a couple of more months, Ukraine may also default on US$20bn debt payments.

Of course, the sovereign defaults are not new and the US$400bn default might not look massive in the context of trillions of dollars of new money created in the past one decade. Nonetheless, so many countries defaulting in a short span of time could have serious consequences for the global financial system. For one, it could trigger a contagion if some large global institution like Lehman Brothers collapses under the weight of such default. The worst however would be if the ‘default’ loses the moral stigma attached to it, and many profligate nations find it convenient to default and start afresh.

It is pertinent to note that the Bank of Japan (BoJ) owns more than 50% of the debt taken by the Government of Japan. This effectively means that Japan has borrowed about USD one trillion from the JPY printing press in the three years 2020-2022. Considering the deteriorating demographics and anaemic growth over the past three decades, it is obvious that Japan is ‘riding a tiger’. Many developed countries like Italy and Greece are also trapped in a vicious low growth high debt cycle. Obviously, getting out of this trap is not feasible in the normal course of business.

The most relevant question at this point in time therefore ought to be “how the global economy gets out of this extortionate high debt-low growth trap?”

Historically, the following methods have been used by the governments to break out of the low growth high debt trap:

1.    Currency debasement by stimulating high inflation for long or devaluing the currency.

2.    Financial suppression by keeping the real rates negative for long.

3.    Fiscal tightening by increasing taxes disproportionately and/or reducing public spending.

4.    Incremental improvement by gradually tightening the monetary policy.

5.    Defaulting on debt obligation and negotiating waivers with the lenders.

 One good thing about the Monsoon season in North India is that this is the season for new crops of fruits from hill states. We get fresh and juicy pears, plums, apples, cherries, peaches etc.; besides, juicier varieties of mangoes like Chausa and Langda. A visit to the fruit market in Gurgaon yesterday however left a little sour taste in my mouth. None of the seasonal fruit was selling at less than Rs100kg. Apples are more than Rs200/kg. Even mangoes are selling at a rate of Rs120-250/kg.

The vendors selling from carts and smaller shops are unhappy as sales are down notably due to higher prices; and a larger than usual quantity of their merchandise is going to waste due to rotting. The consumer is obviously unhappy as even the seasonal fruits are becoming unaffordable for many of them. The importers of fruits from South East Asia and Americas are also not particularly happy as the demand for expensive and exotic fruits is diminishing consistently due to higher prices. I shall make a trip sometime in September to find out how the farmers are feeling about it.

The food and energy inflation has often remained elevated in India for the past many years due to one reason or the other. Erratic weather (poor crop), depreciating currency (imported inflation), higher support prices, and geopolitics (higher energy prices) etc. The core inflation though remained mostly tamed, except for the sharp rise in input prices post Covid.

There is no evidence to suggest any direct correlation between wage inflation, especially farm wages and non-government urban worker wages. Nonetheless, the indicators like consistent decline in household savings rate; rise in demand for currency, rise in household debt, especially credit card outstanding, could be seen as pointers to indicate that wage hikes might not have matched the household inflation.

Notwithstanding the stagflation like conditions and low visibility of any material improvement in near future, we do not see common man protesting on streets in India. The protest, if any, are feeble and rhetorical, mostly by the politicians from opposition parties. The primary reason for this broader acceptance of high inflation, in my view, is the persistence of inflation for decades, with brief periods of relief in between.

Being an economy materially reliant on agriculture (weather) and imports (edible oil, energy, gold, defence equipment, technology) the population and policymakers both have significantly higher tolerance for food and imported inflation. The phrases like “Beyond control” and “Act of God” are often used by all to accept high inflation. The consumers, investors, money managers and policy makers usually do not consider an episode of high inflation as something that may require any structural change in their respective approaches.

However, this has not been the case for many developed economies like the USA, which are witnessing high inflation after a few decades. A large proportion of the current generation of consumers, investors, money managers and policy makers have not seen any episode of high inflation (and consequent higher rates). Their tolerance to inflation is obviously very low and thus their responses could be very strong. A casual chat with some friends in the USA and UK tells me how the common people in these countries are already feeling “devastated”, even after enhanced cash support from the government. The policy makers, investors and money managers also appear panicked and reacting in haste.

Being an investor in Indian assets only, I see no reason for panic. In fact, I find many reasons to feel optimistic about the future of Indian assets and markets. In the past few years many steps have been taken to contain the imported inflation. These steps shall definitely yield positive results in the next 4-5 years. For example—

·         Focus on renewables, biofuels, local electronic, defence and chemical manufacturing, multiple FTAs etc. should either reduce reliance on imports or at least protect from volatility in global prices. The impact of increased self-reliance (import substitution) could reflect in improved trade balance taking pressure off from the Indian currency.

·         Mission scale efforts to improve production and processing of oil seeds, pulses, fruits & vegetables (horticulture) and marine products etc. have already started to show some early results. The situation could improve materially in the next 4-5years.

·         The current war between Russia and Ukraine has emphasized and reinforced the idea of having a more diversified vendor base for the global businesses. We shall definitely see more bilateral agreements (FTAs etc.) between India and other countries, especially the developed countries that relied overwhelmingly on China and Easter Europe for sourcing their manufactured goods.

·         Full operationalization of Dedicated Freight Corridors, development of multiple expressways along with industrial corridors shall improve the logistic infrastructure brining efficiency in supply chain and optimization of cost of productivity.

·         A leap forward has been taken towards INR convertibility by allowing Indian entrepreneurs to settle their cross border trades in INR. This shall in due course ease pressure on the current account and improve the terms of trade for Indian businesses.

In my view, the current phase of volatility and uncertainty in macro factors like inflation and trade deficit etc. is transient. We have successfully travelled from 12-15% inflation range to 4-8% inflation range in the past 3 decades. In the next decade inflation may stabilize in 3-4% range with materially better trade balance, and a stable INR and mostly neutral rates.

The Federation of Indian Chambers of Commerce & Industry (FICCI) in a recently released knowledge paper – “Metaverse and Emerging Opportunities” – highlighted some interesting aspects of this massive opportunity that has the potential to transform, inter alia, the way we work, study, communicate, entertain, socialize, get healthcare and transact with each other. The following are some excerpts from the FICCI paper that I believe are relevant for researching Metaverse as an investment theme.

What is Metaverse?

Meta (Beyond – Greek Word) + Universe (English) = Metaverse is an offering which provides users immersive and multisensory experiences using futuristic technologies.

In technical terms, Metaverse is a network of 3D virtual worlds focused on social connections. It is a collective virtual space, created by the convergence of virtually enhanced physical and digital reality. It is an independent virtual economy, enabled by digital currencies and non-fungible tokens (NFTs). It is device independent and is largely democratized and not owned by a single vendor. Metaverse is built on a combination of Blockchain, Virtual Reality (VR), Augmented Reality (AR), 3D hologram, and Video.

Metaverse allows people to enhance or mimic their physical activities in the virtual space. This could mean transforming the existing physical activities that one is doing or by transporting to a new virtual world. Presently, multiple Metaverses are functioning independently from each other, having a functionality of their own. However, as the concept evolves, we shall see large Metaverses encompassing all the activities with broad functionality, or even conglomerates of multiple Metaverses integrated with each other.”

The opportunity size

A recent Citi report predicts that with 5bn potential uses, the total addressable market for the Metaverse in B2B and B2C segments could be between $8 trillion and $13 trillion by 2030.

Gartner expects that by 2026, 25% of people will spend at least one hour a day in the Metaverse for work, shopping, education, social media and entertainment. Metaverse is a trillion dollar opportunity per year around 2030 onwards while it is a $60billion now in 2022.

On the B2B segment, some of the use cases include:

·         Transformation of “Workspace collaboration” with always ON conference/meeting rooms for global meetings, conferences.

·         Talent acquisition, hiring and onboarding taking a new dimension in Metaverse

·         Digital test run of products and experience different options.

·         Learning, education, training, skill development with avatars (manufacturing, factory setups will get good leverage with this tech)

·         Healthcare (Telemedicine, Therapies, Surgeries)

·         Defense (Training, On-boarding, Recuperation, Simulation)

·         Real-estate, E-commerce companies can have product demos, showcase and branding opportunities

·         Advertising will move to the next level with a unique kind of storytelling experience for the audience using 360 videos and 3D technology.

B2C use cases for Metaverse include

·         Gaming and entertainment

·         Education, Learning, Skilling

·         Travel and Tourism

As a consumer I could already imagine a few things like:

*  No need for expansive showrooms for automobiles, electrical appliances, electronics, watches etc. Virtual shopping malls could be equally popular as the traditional shopping malls.

*  Much less need to physically visit doctors for regular consultation.

*  Much less frequency of business visits. Virtual conferences, book launches.

*  Lower frequency of visits to stadiums for watching games; or to theatres for watching movies.

*  No need for physical coaching/training centers.

*  No need for builders to make a sample flat or employ a huge sales team.

All of this essentially means less traffic on roads and lesser use of air conditioning and therefore less pressure on the environment. The present generation which is reasonably tech literate and is more comfortable with virtual shopping, working and socializing could be hitched to the Metaverses with broader functionalities.

Key concepts

The Metaverse is composed of many core elements that are combined together to provide a whole new world to the users. These technologies include eXtended Reality (XR), Blockchain, Artificial Intelligence and the Internet of Things but are not limited to them.

Blockchain is a shared, immutable ledger for recording transactions, tracking assets and building trust. An asset can be tangible (a house, car, cash, land) or intangible (intellectual property, patents, copyrights, branding). Virtually anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all involved.

A non-fungible token (NFT) uses the technology of blockchain to create something that is unique and irreplaceable in the digital world.

A cryptocurrency, crypto-currency, crypto, or coin is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it. Individual coin ownership records are stored in a digital ledger, which is a computerized database using strong cryptography to secure transaction.

Artificial intelligence (AI) is the ability of a computer or computer-controlled robot to perform tasks commonly associated with intelligent beings like humans.

The eXtended Reality (XR) is a superset that covers Augmented Reality, Mixed Reality and Virtual Reality. Virtual Environments are considered as synthetic or computer-based spaces.

The Internet of Things (IoT) is a network of people, devices, and services [2] that can sense, connect to one another, make inferences, and act(uate) at scale. It is considered that over 30 billion IoT devices are already deployed globally today.

 The summer has been truly scorching in many parts of the country this year. Reportedly, land surface temperatures neared 55 degrees Celsius over many parts of northwest India; even crossing 60 degrees Celsius over several pockets (see here). The visuals of floods and inundated streets & homes from many states are also disturbing. Obviously, the weather patterns are changing rather quickly and our infrastructure is not designed to handle these changes. Power shortages, urban flooding, uncontrolled wildfires, frequent landslides, roads caving in, flight delays, traffic jams, etc. have become rather common issues.

The rating agency CRISIL highlighted in one of its latest reports (Sustainability Yearbook 2022) highlighted that over 52% of India’s GDP could be exposed to physical risks like wildfire, flood, sea-level rise, or storms by 2050. This cannot be a good augury for a large proportion of our population which is poor and largely dependent on agriculture for its sustenance.

Fortunately, the government is fully conscious about the devastating impact climate change could have on the social-economic milieu of the country. It has forcefully committed itself to ambitious climate goals. Nonetheless, the conditions may not improve much for the current generation. All those in the 15-59yr age bracket may continue to suffer every winter, summer and monsoon season. The duration of spring and autumn has been diminishing for the past many years, anyways.

One less talked about impact of climate change is the declining rate of population growth. Climate change has impacted fertility, affordability and inclination to have children.

The government data has already highlighted the sharp decline in Total Fertility Rate (TFR) of Indian women. The TFR of India is now very close to the replacement rate, indicating that our population is likely to peak much earlier than previously estimated.

Recently, a superstar of Telugu Cinema, Ramcharan Teja and his wife Upasana, were in news for their decision to not have kids in the interest of climate control. Temjen Imna, the Nagaland Minister who was trending all over social media for his comic twist to racism slur faced by the people of North East India, also tweeted, “On the occasion of #WorldPopulationDay, let us be sensible towards the issues of population growth and inculcate informed choices on child bearing. Or #StaySingle like me and together we can contribute towards a sustainable future”.

From my interactions with numerous people across the country, I know for sure that these feelings are not limited to a few celebrities or people from the higher socio-economic strata. Young couples even from smaller towns and villages are deciding not to have children. Affordability and desire to live a “free” life without the responsibility of raising children are two primary reasons offered for their decisions. In recent months, the worsening social harmony and high crime rate have also been added by some couples to the list of reasons for not having children.

I believe that this trend is a global trend, not specific to India. In my view, therefore, demographic change (ageing and population decline) is a much bigger investment theme as compared to climate control (or ESG). From a long term perspective (2-3 decades) deflation, technology, insurance, healthcare, home appliances, casual clothing, home delivery etc. should be the popular themes. Inflation, personal mobility, fashion, travel, food and water etc. should become increasingly less popular trades.