Vijay Kumar Gaba

Wednesday, August 21, 2013

Humpty dumpty sat on a wall

Humpty Dumpty sat on a wall,

Humpty Dumpty had a great fall,

All the king's horses and all the King's men,

Couldn't put Humpty together again.

The prime minister, finance minister, their advisors, and RBI governor, all would be wondering why the markets are not listening to them. They have been repeatedly and vehemently exhorting the participants in Indian financial markets and businessmen that there is no need to panic over falling INR, higher CAD, rising inflation, declining growth, etc.

They also have been making attempts to convince people that situation is not as worse as 1991. The finance minister also suggested a couple of days ago, that the Indian markets should only be concerned about the events in India and should not react to data and concerns emanating from other economies like US and EU.

The following questions beg answers:

(a) Why there is so much emphasis on 1991?

(b) Through measures like imposing custom duty on import flat screen TVs for personal use, and barring Indian nationals from buying property abroad, what the government actually wants to achieve?

(c) Does FM seriously believe that India is still a closed and controlled economy that it was during Asian currency crisis of 1997?

In our view, the situation is actually much worse than 1991 and calls for substantially larger structural reforms that those initiated in 1991. May be 1991 timeline is critical for the image of the prime minister, as he would not like to be remembered as someone who undid his own legacy, i.e., economic reforms. But you cannot escape any peril just by acting ostrich.

Secondly, by denying any interference in the currency market and then taking some random irrelevant measures, they are giving all the wrong signals to the market. In our view, sooner the market forces discover the true and fair value of INR, better it would be for the economy. For example, USDINR at 70 may bring current account to equilibrium faster through destroying demand for imported goods, especially transportation fuel and consumer discretionary, and giving some edge to exporters.

Thirdly, the fast worsening economic conditions in other Asian emerging markets like Indonesia and Thailand, suggests that the current situation has the potential to degenerate into a full blown Asian crisis. Japn Korea currency war is not helping either. India being not so closed and insulated as it was in 1997, may suffer substantially through flight of capital out of Asian emerging economies. It is therefore naïve to suggest that Indian markets should not watch or react to the external events.

Insofar as the markets are concerned, we maintain the following targets:

· Bank Nifty ~8000 by March 2014. Sell all rallies.

· Nifty in 4730 – 5850 range till March 2014, with some downside risk. Risk reward negative at current levels. Sell all rallies.

· A consistent 3% annual depreciation in INR in next many years, after the current volatility subsides and USDINR finds an equilibrium.

· Yield curve to stay inverted till March 2014 at the least. Stay parked in the short term debt (upto 2years).

Thought for the day

“It's discouraging to think how many people are shocked by honesty and how few by deceit.”

- Noël Coward (1899-1973)

Word of the day

Psaltery (n)

An ancient musical instrument consisting of a flat box with strings which are plucked.

(Source: Dictionary.com)

Shri Nārada Uvāca

Rajan announces his arrival with India QE.

Is USD1.3bn long dated bond buying enough to defend yields and currency?

Why not, for God sake, say we will buy USD100bn, beginning with USD1.3bn this Friday.

Tuesday, August 20, 2013

Hold your shopping plans till Diwali

Every time market volatility rises and prices move sharply, a valuation debate gets automatically triggered. While it is universally acknowledged that the current market price (CMP) of equity stock is based on future outlook, it is not uncommon to hear buy-sell arguments based on historical data.

In our view, CMP as determined by the collective wisdom of all the market participants is mostly true and fair value of a particular stock under the given circumstances.

However, there are brief periods of extreme market momentum (as the one we are witnessing currently), where CMP may not reflect the collective wisdom of market participants due to some technical factors like involuntary forced supply due to liquidity issues or absence of execution of demand due to non-financial non-economic reasons like some rumors, political uncertainty etc. These deviations from the true and fair value however do not last long and usually get corrected in short periods of time.

The valuation debate therefore is mostly irrelevant inasmuch as it hardly provides any actionable theme.

Insofar as the actionable at current juncture is concerned, we believe that the return on investment in publically traded equity is a function of 3 factors (a) earnings growth; (b) changes in price earnings (PE) ratio and (c) dividend.

(a) 1QFY14 has seen first earning contraction since 2QFY10. Post results FY14 consensus Sensex earnings have been downgraded by ~4%. In our view, 2QFY14 results will likely be much worse than 1QFY14 and therefore earnings will be downgraded further.

(b) In next 8months India shall hold general elections for Lok Sabha or the lower house of the Parliament. Given the current fluid political scenario, the perceived political and policy risk in the country is high.

Therefore, given the low growth, stressed balance sheets, policy risk, uncertainty over continuation of global flows and fragile global economic conditions, there is little probability of any noteworthy re-rating of Indian markets in next 9months at the least.

(c) Given rising cost of capital, tight liquidity, slowing growth, and margin compression, the dividend payouts are more likely to contract.

Under these circumstances, the most optimistic equity return that could be expected in next 12months is 5-12%, with equal chance of similar losses. The most likely scenario is single digit return with high risk.

With risk free debt returns running close to 9% and bank deposit rates on the rise, any investment strategy has to consider this matrix to be practical.

A lame duck government at the helm, prospects of tighter global liquidity, inflation bottoming, currency in doldrums, we suggest wait till this period of indecision is over and the market arrives at true and fair value for making any fresh investment in Indian equities. We expect to go out for shopping closer to Diwali by when 2QFY14 macro and corporate performance data would be known and true and fair value discovered.

Thought for the day

“I am the wisest man alive, for I know one thing, and that is that I know nothing.”

- Socrates (469-399BC)

Word of the day

Lacerate (v):

To tear roughly; mangle.

(Source: Dictionary.com)

Shri Nārada Uvāca

All denials notwithstanding, the government on Monday disallowed import of flat screen televisions as part of free baggage allowance! An instance of penny foolish and pound foolish.

Monday, August 19, 2013

Live for another day

“Have faith in God. But never forget to lock your car.”

Indian equity markets witnessed substantial rise in volatility and short term momentum last week. There were multiple immediate triggers to cause this.

Some hope raising economic data from western world that sparked the fears of Fed tapering the magnitude of monthly bond buying. Some knee jerk reactions from RBI and government raised concerns that clock may be set back to early 1990’s on Liberalized Exchange Rate Management System (LERMS) and Liberalized Remittance Scheme (LRS). Onions threatened to undo whatever governor Subbarao achieved in past couple of years. Yield curve topping ~9%, raising fears of imminent rise in lending rates jeopardizing prospects of any imminent economic recovery. Prospects of some distress selling by large brokers to fill the hole created by reincarnation of Harshad Mehta in NSEL.

Thankfully, no one yet talked about a systemic crisis in equity market; though sharp spike in implied volatility and consequently option prices does make a case for a crisis this week. Watch out for liquidity in at the money (ATM) and close to ATM put options. Any sign of illiquidity there should prompt a panic like reaction. Remember, on past two occasions, options becoming illiquid after a couple of days of rise in IVs, has led Nifty to move 5-10% in a single trading session.

The just concluded result season and latest round of macro data has not offered much hope. The commentary, except from handful of technology and pharma managements, has been guarded. The good part is that the hope appeared still alive. The bad part is that investors are not willing to give any benefit of doubt. Any sign of weakness in performance or lack of conviction in outlook has been punished severely.

We would therefore like to reiterate the strategy discussed earlier this month:

(a) Overweight on consumer companies (FMCG and Auto). Telecom likely to do well, but we suggest avoid due to continuing regulatory uncertainty. In our view, with consistent margin improvement and ~3-5% volume growth, these companies will more than address the valuation concerns, insofar as currently high P/E ratio is concerned. Moreover, expect payout and ROEC to increase.

(b) Nil to extremely low weight on financials. Some financials have reported decent growth in income and margins though the asset quality has deteriorated substantially. The market reaction to their results is a clear indicator that investors are not convinced about the sustainability of their profitability. There is obviously more pain to come in following quarters.

(d) Nil to very low weight in capital goods and infrastructure. Remarkably positive commentary about future outlook suggests that many of these companies continue to be denial mode and therefore may not have taken adequate corrective measures.

(e) NIL weight in commodities Most of these have indicated sever margin pressure, lower capacity utilization and cut in capex plans.

Thought for the day

“How do you nurture a positive attitude when all the statistics say you're a dead man? You go to work.”

-Patrick Swayze (1952-2009)

Word of the day

Impolitic (Adj):

Not politic, expedient, or judicious

(Source: Dictionary.com)

Shri Nārada Uvāca

Will 2% CSR spend by companies likely go to fund local politicians only?

Friday, August 16, 2013

Urgently required – a Gandhian face

The recent utterances by the prime minister & finance minister and the steps taken by the RBI & government to handle the economic problems being faced by the country confirm at least three things:

I. The government is unwillingly coming out of denial mode and accepting that the economy is in a serious mess.

II. The policy makers are terribly short of ideas to get out of this mess.

III. The country is losing badly in the game of perception, at a time when most troubled countries, including China, Italy and Spain, have successfully managed the perceptions.

This provides further support to our fear that in this corrective phase we might regress all the way to 1967-1975 period rather than halting at 1991.

Consider the following:

(a) The political leadership of the country is feeling as insecure as Mrs. Gandhi might have in the years prior to imposition of emergency.

(b) At a time when the general public is overwhelmingly concerned with price of onions, the prime minister is promising 13 new airports as a solution!

(c) By bringing back capital controls, the government has successfully mismanaged the perceptions. The club circuit has already started discussing reincarnation of FERA. No surprise if lower BTQ, overseas travel tax, 25% duty on gold imports are next on the agenda. Money laundering through over-invoicing of imports and under-invoicing of exports would be the logical follow up.

(d) The rising strife between (i)) bureaucracy and executive, and (ii) judiciary and legislature is also reminiscent of that period.

(e) Scuttling the move to bring political parties under RTI and restricting criminals from contesting elections are also indicative of low political tolerance.

(f) With an onerous responsibility to provide cheap food to 800mn people under the National Food Security Bill, the food grain trade may likely get nationalized at state level. Rationing, hoarding, black marketing, restriction on interstate trade, crop mismanagement etc may stage comeback. The trial is already on with the government setting up vegetable shops in various parts of the country.

(g) Unable to manage stress, most power and commercial road projects could get devolved on public financial institutions and thus get nationalized, much the same way as banks were done in late 1960s’.

(h) The perception of threat from external forces is being fueled much like 70’s and 80’s.

Last but not the least, Narendra Modi is trying hard to create a JP like national movement making the establishment more jittery. So far, he has not been able to enlist much support from non-BJP parties. A strong movement led by Modi with a Morarji Bhai like Gandhian face as PM could perhaps spring some hope. Amen!

Also read:

Cyclical vs structural

Do not bother about buying and holding

Higher growth – unsustainable and unmanageable

Thought for the day

“You never know how soon it will be too late.”

- R. W. Emerson(1803-1882)

Word of the day

Jilt (v):

To reject or cast aside (a lover or sweetheart), especially abruptly or unfeelingly.

(Source: Dictionary.com)

Shri Nārada Uvāca

Everyone concerned in the world, except BJP parliamentary board, seems to have acknowledged that Narendra Modi is a candidate for PMship and does stand a chance.

Wednesday, August 14, 2013

Higher growth – unsustainable and unmanageable

We have highlighted in some of our earlier writings (E.g., see I and II) that to achieve higher growth during

2004-2010 India has let structure of its real economy severely tempered, though still not irretrievably.

The rush to accumulate cheap credit and unreasonably benefit from often ill conceived policy relaxations, has lead to excessive debt both at government as well as corporate level and dissipation of resources. This has brought a lot of unmanageable demand forward in time. The consequences are gross and extravagant misallocation of capital and unmanageable changes in consumption patterns.

The following chart shows cyclically adjusted growth (5yr CAGR) since first plan period. After growing 2-4% during 1951-1975, a steady progress was made to 4-6% orbit in next 30years. However, a sudden spurt in growth during FY05 to FY11 has led to serious distortion in macro framework of the country, suggesting that (a) this high growth is unsustainable and unmanageable and (b) the correction or descend back 4-6% orbit is going to be sharp and excruciating.

Some structural deficiencies created by higher growth during FY05 to FY11

· Consumer inflation rose to 7-10% from 3-5%

· External debt rose to US$306bn from US$134bn

· Trade deficit rose to US$131bn from US$34bn

· CAD grew to over 3% of GDP from under 0.5%.

· Subsidies rose to over 2% from 1% of GDP.

· Debt service ratio fell from over 16 to under 5.

· Gross fiscal deficit remained around 7%, suggesting effective tax incidence increased.

Corrections as said earlier, will be sharp and painful.

Thought for the day

“The worst form of inequality is to try to make unequal things equal.”

-Aristotle (384-322BC)

Word of the day

Matador (n):

The principal bullfighter in a bullfight; a torero.

(Source: Dictionary.com)

Shri Nārada Uvāca

Q. How many ministers are there in India’s Union Council of Ministers?

Ans. P. Chidambram; and Umhh…ahh….hmm, that one what’s his name!

Tuesday, August 13, 2013

Do not bother about buying and holding

Indian equities are popularly compared to the fabled Capital Hotel, in which guests can enter but can never exit. Usually high volatility in macro and corporate performance, frequent scams in financial and corporate sector, rampant malpractices and shallow market depth have ensured that no secular bull market evolves. Consider the following:

(a) For buy and hold investors since 1991 the Indian equities returns might have marginally beaten the bank deposits. A monthly SIP in Indian equities (BSE 500 that represents 97% of market capitalization) during January 1991 to July 2013 would have given an 11% CAGR, not much better than debt return, especially if you adjust it for the high risk.

(b) For 1991-95 returns were just 1.6% CAGR. Most of these returns were earned in just six months from Jan92 to Mar 92 which returned ~150% absolute return over Dec92 closing and Nov93 to Jan94 which returned 58% absolute return over Oct93 closing. The real return in this period was hugely negative, considering high inflation.

(d) 2001-2005 was the best period for Indian equities yielding 36% CAGR.

(e) 2006-2010 again yielded positive return of 16% CAGR. Though most of these returns would have come during Sep07-Oct07 and Mar09-May09 periods. Volatility was huge and therefore risk very high.

(f) On annual basis just 10 out of 23 years have given positive real return. And income funds would have beaten equity returns even when not adjusted for risk.

The point we are trying to make is that Indian equity market collectively is a cyclical investment, which could be traded in small proportions during good times, especially when liquidity is abundant and credit is easy to access.

Do not bother about buying and holding as yet.

Also read:

Cyclical vs structural

Thought for the day

“I am patient with stupidity but not with those who are proud of it.”

-Edith Sitwell (1887-1964)

Word of the day

Ravine (n):
A narrow steep-sided valley commonly eroded by running water.

(Source: Dictionary.com)

Shri Nārada Uvāca

Can we?

Monday, August 5, 2013

A forgettable week

Last week was certainly forgettable for the investors in Indian financial markets. Currency, equities and bonds all plunged, inflicting serious losses to investors.

The worst part was that the government still appeared to be under the impression that the current economic conditions are part of a routine downtrend that could be managed by taking some incremental steps like increasing interest subvention on export credit by 1%; hiking import duty on gold by 2%, or tweaking FDI rules etc.

Current account deficit is consequence of some long standing structural problems in the country. But various measures announced by RBI and the government appear to suggest that CAD is a problem in itself that could be resolved simply by kneeling in front of foreign investors. The fact however is that the more they see Indian government genuflecting, more they are turning skeptical about the India story.

RBI took some steps to curb the volatility in currency. But the statement of the governor was so guilt laden that market chose to completely ignore the effort and the message, taking both the INR/USD and bond yields to new closing highs.

Continuing with the tradition set in past few months, few more stocks lost over 50% of their market value in a week. IRB Infra, Financial Technologies and MCX met the same fate as Gitanjali Gems, Wockhardt, Strides Arcolab, etc.

NSEL (National Spot Exchange) fiasco suggested that after 21years, couple of JPCs and humongous losses to investors we have not learned anything from Harshad Mehta and Ketan Parekh episodes. As the popular fear suggests, we might see encore of Bank Receipt scam of Harshad Mehta in this episode. The response of official machinery appeared slow and inadequate thus exacerbating the confusion and jitteriness.

On corporate performance front, there were numerous forgettable results. All PSU banks reported serious deterioration in asset quality and stagnant credit growth. Siemens, Cummins, JPA, Suzlon etc. all highlighted that (a) 5% GDP growth may be too difficult to achieve, at least in first half of the current fiscal and (b) stress on asset quality is only going to rise in coming quarters.

The most noteworthy however was BHEL – once touted as synonym of India’s famous growth story. The results are a serious setback to the argument of value investors.

The question for the week – Will BHEL be the star loser for the week?

On our part, we continue with our strategy of NIL to serious underweight on financials, industrials and commodities (other than cement).

Despite recent gains in telecom stocks, we continue to believe that regulatory interference in the sector shall remain high. Besides, competitive intensity is only going to rise, so is the capital intensity. We are pleased to let this opportunity pass.

Thought for the day

“There are risks and costs to action. But they are far less than the long range risks of comfortable inaction.”

- John F. Kennedy(1917-1968)

Word of the day

Lam (v):

To beat; thrash

(Source: Dictionary.com)

Shri Nārada Uvāca

Ms. Sonia Gandhi takes up the cause of Durga Shakti.

What about Ashok Khemkha?

Friday, August 2, 2013

Investment strategy for August 2013 – March 2014

The 1QFY14 results so far have conspicuously shown some trends that need to be noticed and considered while updating and executing investment strategy.

In particular, we would like to highlight the following trends:

Most consumer companies with their eyes and ears on the ground have discerned the structural decline in India’s growth potential. Accordingly, the companies like HUL, ITC, Dabur, Nestle, IDEA, Bharti, Maruti, Bajaj Auto, Hero Honda, etc. have re-worked their strategy to shift focus from volume growth to margin protection and improvement. Price hikes, cost savings, lower promotion spend, better working capital and inventory management, are clearly visible.

In our view, with consistent margin improvement and ~3-5% volume growth, these companies will more than address the valuation concerns, insofar as currently high P/E ratio is concerned. Moreover, expect payout and ROEC to increase.

We suggest overweight on consumer companies (FMCG, auto, telecom).

Most financials have reported decent growth in income and margins though the asset quality has deteriorated substantially. The market reaction to their results is a clear indicator that investors are not convinced about the sustainability of their profitability.

There is obviously more pain to come in following quarters. We suggest NIL to very low weight on the sector.

The global services businesses like large IT and pharma have guided a challenging but stable demand and pricing environment. The improving data in US and EU is fully reflected in their operational numbers. Besides, lower cost statistics suggests that most of these companies have appeared to tighten their belt. The cost savings appear more permanent in nature.

The trend is however not reflected in many middle and lower rung companies. It is therefore advisable to keep overweight on top rung IT (TCS, Infosys, Wipro, HCL Tech, Tech Mahindra) and pharma (Sun Pharma, Lupin, Dr Reddy, and Cipla) companies.

Results of most capital goods, heavy engineering and infrastructure companies clearly indicate slower order inflows, intense margin pressure, higher working capital cycle, rise in debt and financing cost.

However, remarkably positive commentary about future outlook suggests that many of these companies continue to be denial mode and therefore may not have taken adequate corrective measures.

We suggest NIL to very low weight on the sector.

The commodities results have also indicated lower demand and margin pressures. Most of these have indicated lower capacity utilization and cut in capex plans.

We suggest NIL weight in global commodities and low weight in cement.

Thought for the day

“Wise men speak because they have something to say; Fools because they have to say something.”

- Plato (427-347BC)

Word of the day

Bemused (adj):

Bewildered or confused.

(Source: Dictionary.com)

Shri Nārada Uvāca

Telangana pushed back by 6months.

Is Congress having a rethink?

It just wants to push it closer to election so that full dividend could be reaped!

Thursday, August 1, 2013

Believe it or not!

Finance Minister P. Chidambaram’s obsession with “we are still the second fastest growing economy in the world” seems to growing with every passing day. Despite being reminded by many observers that this not only irrelevant but also factually incorrect. Nevertheless, the tendency to blame the economic troubles on the global challenges and sheltering behind this ‘second fastest’ argument is growing.

Yesterday, FM promised a whole lot of measures to tackle the problems of rising CAD, falling INR, slowing growth. He also promised that he will deliver all this without compromising on fiscal deficit targets. He made the following promises. We leave it to you how much you want to believe.

· We have succeeded in containing fiscal deficit and look forward to a growth rate between 5.5 - 6%.

· Will ease long term External Commercial Borrowings

· Will tackle both deficits; red lines will not be breached

· Expect to fully finance CAD; will not draw into reserves

· Have provided additional funds -- Rs 2,000 crore to boost exports

· Will take steps to up inflows; ask PSBs to invest

· Will ease long term external commercial borrowing

· Looking at some measures to attract long term external borrowings. Propose to liberalise overseas

borrowing norms

· Looking at measures to up NRI investment

· Some import compression will take place on luxury goods

· June - July gold imports down on year basis. Hope to contain gold imports well below last year’s

aggregate

· Sovereign bond issue an option but won't rush into it

· Will provide more money for subsidies, if needed

· Expect Agriculture growth to be better than last year

· Industrial sector presents a mixed picture

· No reason to doubt revenue target

· PSU balance sheets strong enough to issue overseas bonds

· Govt, RBI on same page to contain forex volatility

· Core inflation at lowest level in many years

· Every economy in the world is challenged

· All banks with NRI Accounts to be allowed to raise funds abroad

· FDI in Multi Brand Retail will come in once cabinet takes a decision

· Must address issues related to Safe Harbour Rules; Will be out by August 7

· Must do everything possible to improve exports

· Will urge banks to provide Agri loans in excess of Rs 7 lakh a year (BS)

Thought for the day

“He who has a why to live can bear almost any how.”

- Friedrich Nietzsche (1844-1900)

Word of the day

Residuum (n):

The residue, remainder, or rest of something.

(Source: Dictionary.com)

Shri Nārada Uvāca

Let’s become The United States of India with 50 states and some administrated regions or union territories.

At least some more people will be able to fulfill their aspirations of becoming Governor, Chief Minister, Deputy Chief Minister, Chief Secretary, State Party President, Leader of Opposition, Chief Justice etc. etc.!

3D view of India

In our view, the present state of Indian economy is characterized by Denial, Dithering and Dilemma (3D). Both the government and RBI seem to be in complete denial mode insofar as the growth and macro economic problems are concerned. RBI has been dithering in taking a decisive action since past many quarters and hence letting the situation to exacerbate itself. The government is facing classic democracy dilemma in choosing between convenient politics and sound economics.

The consequences could be serious if immediate corrective steps are not taken. Waiting for the formation of new government could be too late. May be by then we would have lost the whole two decades of progress.

Come out of denial

(a) Both the government and the regulator need to accept that 5% growth is normal and good if it is inclusive and sustainable. Faster we realize this, sooner we will be able to effect necessary structural changes in the planning process and realign the resource allocation accordingly. Raising labor intensity of growth and sustainable exploitation of natural resources would mostly alleviate the problems being faced at present.

(b) Unlike social inclusion, efforts aimed at economic inclusion made during past two decades have at best been partially successful. As the coverage ratio of food security law indicates, years of provisioning for the poor has failed in enabling most of them. Unemployment levels are rising and so are socio-economic disparities.

Stop dithering

(c) Even a plain reading of RBI’s statements unambiguously brings out the dithering in RBI’s policy stance. For example, the latest statement clearly admits that macroeconomic conditions are bad and worsening fast. The hope of recovery later in the year is a plain platitude, not supported by any evidence.

(d) RBI should take a decisive “WHATEVER IT TAKES” stand and guided the financial markets with a firm resolve, rather than making the policy an issue of morality.

(e) Though it has reluctantly admitted to slow growth, it has done little to guide capital flows to achieve inclusiveness.

Shed dilemma

(f) The experience of various democracies world over has proved time and again that sound economics often makes for good politics, but vice versa is often not true.

(g) Secondly, under pressure the government is sounding too desperate vulnerable. In these difficult times, it is willing to compromise on many issues that could have significant long-term implications on growth. For example, relaxing FDI norms in key sectors; allowing exploitation of natural resources in hazardous manner, or ad hoc changes in taxation, subsidies or resource allocation which would be difficult to reverse later.

Thought for the day

“All the powers in the universe are already ours. It is we who have put our hands before our eyes and cry that it is dark.”

- Swami Vivekanand (1863-1902)

Word of the day

Cyclopean (Adj):
Gigantic; vast.

(Source: Dictionary.com)

Shri Nārada Uvāca

Has the division of states on lingual basis outlived its utility?

Should The States Reorganisation Act, 1956 be re-drafted to re-organize states on economic criteria?

Not learning from Chandigarh, Congress proposes Hyderabad sharing.