Vijay Kumar Gaba

Tuesday, October 29, 2013

Fathoming the unfathomable

Thought for the day

“Every choice you make has an end result.”

- Zig Ziglar (American, 1926)

Word of the day

Mishpocha (n)

An entire family network comprising relatives by blood and marriage and sometimes including close friends; clan.

(Source: Dictionary.com)

Shri Nārada Uvāca

If “Dynasty” is good for Doctors, Lawyers, CAs, Civil Servants, Actors, Singers, Musicians, Painters, Authors, Soldiers, Farmers, Goldsmiths, Business Owners and Managers, et. al. – then why not for politicians?

Fathoming the unfathomable

Earlier this month, we expressed our view that the latest debt deal by US politicians has created a breeding ground for black swans. We shall see them flocking the horizon in next 12-15months.

We received tremendous response to our view. While most readers focused on next couple of years, some of them provoked us to think little longer.

Based on exchange of communication with our readers during past one week, we could list the following eventualities which are not completely unfathomable at this point in time, but may still be considered black swan on occurrence as very few would be willing to bet money on these events in next few years.

(a) European Union disintegrates. The move may begin by non-Euro participants like UK and exacerbate on weaker economy choosing to have their own money printing power to handle their fiscal mess.

(b) Global investors’ patience with US politicians runs it complete course. Repeated episode of debt ceiling, shut down and dithering on a firm monetary policy stance could lead to substantial erosion in “safe haven” status of USD and US treasuries.

(c) USD declines without a proper succession plan in place. With no fiat alternative in place, the world is forced to adopt gold standard after a chaotic year in the global financial system and market place.

(d) Withdrawal of the US forces from Middle East leads to a mayhem. As disparate forces rush to take control of regions mineral resources and strategic posts, serious supply disruption occur in global energy market.

(e) The imbalances in the internal economy of the US grow beyond control leading to eruption of a civil war leading to renewed aggression for secession by resource rich states.

(f) Germany attempts to take control of indebted smaller European nations to safeguard his financial interest and in the process create a strategic alliance (as opposed to mere financial) of European nations. This leads to emergence of multiple poles in a largely unipolar world. Rise in Sino-Japan rivalry may provide further impetus to polarization. This could eventually lead to end of the era of peace that has existed post WWII. Given the demographic changes since WWII, EU and Japan could be major losers in the process.

(g) The commodity super cycle ends abruptly led by hard landing in China and stalled growth in other emerging markets. This leads chaos in commodity driven markets like Australia, Russia, Brazil etc. causing a global recession.

(h) Unlimited QE eventually fails in pulling out the world out of prolonged slow down and the world slips into recession – the deepest and worst ever.

It is important to clarify that these are not our views and we assign Nil probability to most of these outcome.

Friday, October 25, 2013

Reality check @Nifty 6200 - IV

Thought for the day

“I'm a true believer in karma. You get what you give, whether it's bad or good.”

- Sandra Bullock (American, 1964 - )

Word of the day

Falderal (n)

Mere nonsense; foolish talk or ideas.

(Source: Dictionary.com)

Shri Nārada Uvāca

What led to brutal assassination of Rahul Gandhi’s father and grandmother?

Reality check @Nifty 6200 - IV

Valuations

We recognize that in past couple of years, Indian equity markets have seen extreme polarization in terms of level of activity and valuations. Most of the activity is now concentrated in a handful of stocks. In fact the National Stock Exchange (NSE) has recognized the phenomenon and launched LIX 15, an index based on top 15 liquid stocks, which as per NSE tracks close to 95% of the prime 50 stock index CNX NIFTY. Accordingly, valuations of these top stocks have diverged substantially from the broader market.

Nonetheless, for the sake of argument, the valuations of benchmark indices are used.

Based on current estimates of next 12months earnings, Sensex is closing close to its long term average PE ratio of 15x. Given the low growth, stressed balance sheets, uncertainty over continuation of global flows and fragile global economic conditions, there is little probability of any sustainable re-rating of Indian markets in next 12 months at the least.

Even if we assume a 10% re-rating to 16x and best case 15% earnings growth in FY15, Sensex may offer 14-15% return. The risk reward ratio at this stage is therefore evenly poised. However, any further rise from current level in next couple of months would make this ratio adverse and susceptible to sharp sell-off.

On price to book basis Sensex is trading cheaper to its long term average. However, given the asset utilization ratio at decade low, higher leverage, chances of asset impairment and stress in receivable, this appears logical and does not need any improvement.

With the yield gap (1yr forward Sensex yield vs. 10yr bond yield) at over 150bps, the bull market is certainly far away.

…to continue on Monday

Also read:

Reality Check Part I

Reality Check Part II

Reality check Part III

Case for Nifty 6700

Case for Nifty 4700

Thursday, October 24, 2013

Reality check @Nifty 6200 - III

Thought for the day

“Legend remains victorious in spite of history.”

- Sarah Bernhardt (French, 1845-1923)

Word of the day

Chattel (n)

A movable article of personal property.

(Source: Dictionary.com)

Shri Nārada Uvāca

Wonder why have we not heard the name of Guru Ji Shibu Soren in connection with Coalgate?

Reality check @Nifty 6200 - III

Corporate profitability

The corporate profitability in India is at decade low. As per a recent report by brokerage firm Jefferies “return on equity (RoE) for Nifty (ex. financials) has declined from its peak of 26% in FY05 to near its decade lows at 14.8% in FY13. The decline has been led by a fall in asset utilization, lower margins and higher tax rate, in that order. While the decline has been mostly due to a cyclical downturn in economy, some sectors have seen structural decline on various parameters.”

The report highlights that Asset utilization for most sectors, except pharma and energy (due to crude price), has declined in recent years. Margins for most sectors, except IT, pharma and staples, have also declined. Moreover, RoEs for four of the ten sectors are currently below the cost of equity.

…to continue tomorrow

. Also read:

Reality Check Part I

Reality Check Part II

Wednesday, October 23, 2013

Reality check @Nifty 6200 - II

Thought for the day

“Stand upright, speak thy thoughts, declare The truth thou hast, that all may share;”

- Voltaire (French, 1694-1778)

Word of the day

Analysand (n)

A person undergoing psychoanalysis.

(Source: Dictionary.com)

Shri Nārada Uvāca

Could we draw some parallel between Malala and Modi or the thought is completely blasphemous?

Reality check @Nifty 6200 - II

Rates

In September RBI began to unwind the exceptional liquidity tightening measures announced in June-August period to stem the slid in INR. It was maintained that the difference between the MSF and repo rate will be brought down to 100 basis points. Since then MSF rates have been reduced by 125bps and Repo rates have hiked by 25bps. Currently the difference between short term MSF (9%) and Repo rates (7.5%) stands at 150bps.

RBI also announced an intention to return to normal monetary operations where the repo rate will return to being the effective policy, recognizing that inflationary pressures are mounting. The governor expressed his intent that when the repo rate becomes the effective policy rate, it should be consistent with inflationary conditions in the economy. The governor also highlighted that “Let us remember that the postponement of tapering is only that, a postponement. We must use this time to create a bullet proof national balance sheet and growth agenda, which creates confidence in citizens and investors alike.”

This read with (a) firming yields globally (b) persisting inflationary pressure and (c) constant need to defend INR by augmenting reserves through higher flows – implies that we may likely see repo rates rising by 25bps on 29^th October and perhaps another 25bps in December.

Benchmark 10yr yields currently at 8.6% are therefore not likely to come down in any significant proportion in next few months. For all, these may actually firm up a little.

Historically, with yields close to 9%, inflation at 7%, GDP growth sub 5% and earnings growth in single digit, equities have not done well for too long.

For household investors with long term tax free bonds yielding close to 9%, the bull case equity returns from current level are certainly not attractive enough.

Liquidity

Despite the recent measures taken by RBI to ease liquidity conditions, money market continues to be tight with overnight rates averaging over 9% and daily deficit persisting over INR1000bn.

The informal money market rates are currently running over 24% pa, a sign of extreme tight liquidity conditions. With busy season already on, and elections on the horizon, the situation is not likely to ease in next few months.

To the contrary, worsening working capital cycle, fiscal tightening leading to lower government spending and likely withdrawal of PSU cash balance from the banking system (for dividend or capex) could further accentuate the tightness. The recipients of dividend from PSU would be government, DFI and household investors. None of these is likely to re-invest in equity market.

The global liquidity though is easy at this point in time. This may remain so for next few months at the least. So keep watching daily FII flows and hold your breath.

…to continue tomorrow

Tuesday, October 22, 2013

Reality check @Nifty 6200

Thought for the day

“The object of life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane.”

- Marcus Aurelius (Greek, 121-180)

Word of the day

Ennoble (v)

To elevate in degree, excellence, or respect; dignify; exalt: a personality ennobled by true generosity.

(Source: Dictionary.com)

Shri Nārada Uvāca

With PMO now out in open without any shield and SP also preparing to distance itself from Congress ahead of general elections next year, what business you expect to be conducted in Winter Session of Parliament?

Reality check @Nifty 6200

Growth

GDP growth is likely to remain in 4.5-5% range in FY14 and pick up only marginally in FY15.

Most forecasters, other than government of India, have GDP growth forecast ranging between 4 and 5% for FY14 and marginal pick up in FY15.

In the last policy statement, RBI had categorically stated that “On the domestic front, growth has weakened with continuing sluggishness in industrial activity and services. The pace of infrastructure project completion is subdued and new project starts remain muted. Consumption, while relatively firm so far, is starting to weaken even in rural areas, with durable goods consumption hit hard. Consequently, growth is trailing below potential and the output gap is widening. Some pick-up is expected on account of the brightening prospects for agriculture due to Kharif output and the upturn in exports. Also, as infrastructure investments are expedited, and as projects cleared by the Cabinet Committee on Investment come on stream, growth could pick up in the second half of the year.

As the optimism on CCI initiatives has waned substantially in recent days, and Winter session of the Parliament is expected to be a Wash Out in light of the recent developments in Coal Block Allocation case and UP parties (SP and BSP) distancing themselves from Congress ahead of general elections, due to local political compulsions.

In view of this next 2-3 quarters are not likely to witness any conspicuous pick up in growth.

Inflation

Both WPI and CPI are showing tendency to rise again. Easy outlook on global liquidity may fuel commodity prices when INR is bottoming at an elevated 61/USD level

Both WPI and CPI have shown tendency to rise in past couple of months. It is more likely to exacerbate in coming months as high base effect wanes, easy global liquidity expectations fuel commodity prices and INR bottoms out at elevated 61/USD levels.

As RBI highlighted “WPI inflation, which had eased in Q1 of 2013-14, has started rising again as the pass-through of fuel price increases has been compounded by the sharp depreciation of the rupee and rising international commodity prices.”

It is expected that the negative output gap will eventually exercise downward pressure on inflation, and the process will be aided as supply side constraints, especially relating to food and infrastructure, ease.

In RBI’s assessment “However, the current assessment is that in the absence of an appropriate policy response, WPI inflation will be higher than initially projected over the rest of the year. What is equally worrisome is that inflation at the retail level, measured by the CPI, has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence. Although better prospects of a robust kharifcharvest will lead to some moderation in CPI inflation, there is no room for complacency.”

…to continue tomorrow

Also read Case for Nifty 6700 and Case for Nifty 4700

Monday, October 21, 2013

Flock of black swans on the horizon

Thought for the day

“Republics decline into democracies and democracies degenerate into despotisms”

- Aristotle (Greek, 384-322BC)

Word of the day

Exiguous (Adj)

Extremely scanty; meager.

(Source: Dictionary.com)

Shri Nārada Uvāca

Is Modi focusing too much on the Gandhi family in his discourse?

In case he wants to veer the traditional Congress voters away from the Family, he should set a positive socio-economic agenda to which Congress Party cannot reply.

What he is doing will only strengthen the bond between the Family and the loyalists.

Flock of black swans on the horizon

When we boldly suggested that QE is here to stay not going anywhere in May 2013, we were criticized by many for being unnecessarily contrarian. The analysis during most of July-September quarter was debating the extent of moderation in Fed’s bond buying program (“tapering”). Estimates ranged between USD10-25bn and consensus was building around USD10bn.

We believed that the conventional wisdom suggest that QE shall continue and strengthen till it is being noticed and talked about. Any talk of tapering is thus contrarian. In fact being conformist is quintessential to our investment strategy. (See here)

We find the following post of Tyler Durden of Zero Hedge worth reproducing, in this context:

“If there is anything the market has shown in the past 16 days of government shutdown, which is set to reopen this morning in grandiose fashion following last night's 10pm'th hour vote in the House, is that it no longer needs Washington not only to function but to ramp higher. All it needs is the Fed, which in turn needs an unlimited debt issuance capacity by the US Treasury which it can monetize indefinitely, which is why the debt ceiling was always the far more pressing issue. In other words, the good news is that the can has been kicked, and now the government workers (who will need about a week to get up to speed), can resume releasing various government data showing just how much 5 years of now-open ended QE have impaired the US economy, and why as a result, even more years of unlimited QE are in stock (because in a Keynesian world, what caused the problem is obviously what will fix it). The bad news: the whole charade will be repeated in three months.

More importantly, with futures no longer having the hopium bogey on the horizon, namely the always last minute debt deal, they have finally sold off on the back of a weaker USD. It is unclear if the reason for this has more to do with climbing the wall of shorters which is now gone at least until February when the soap opera returns, or what for now, has been an absolutely abysmal Q3 earnings season. Luckily, in a centrally-planned world, plunging stocks is bullish for stocks, as it means even more Fed intervention, and so on ad inf.

And since a repeat of the whole soap opera in January is highly likely and the government will be shuttered once more, the only thing that will really be impaired - not government workers, they love the paid vacation with retroactive salaries - will be concurrent government data, so "very critical" for the Fed to decide on future policy, which simply means if the BLS' random number generators stop humming in early 2014, all that will happen is for the Taper, which is now expected to take place between March and June 2014, to be delayed once more in what is now the playbook: shut down government 2-3 months before taper is due, kick can, rinse, repeat.”

In our view, the latest debt deal by US politicians has created a breeding ground for black swans. We shall see them flocking the horizon in next 12-15months.

Friday, October 18, 2013

Prefer low beta to domestic growth

Thought for the day

“Apparently there is nothing that cannot happen today”

- Mark Twain (American, 1835-1910)

Word of the day

Pinion (n)

A gear with small number of teeth.

(Source: Dictionary.com)

Shri Nārada Uvāca

Naming Ex Coal Secretary Parekh in Coalgate is to save PM’s skins or first step in process of implicating him?

The caged parrot perhaps is taking its revenge in Godfather like manner.

Remember "Revenge is a dish that tastes best when it is cold".

Prefer low beta to domestic growth

The result season has started on the expected lines. So far, the exporters, Infosys, TCS, HCL Tech, RIL and Bajaj Auto, etc. have exceeded the expectations on account of weaker currency as well as better external demand environment. Financials HDFC Bank and, AXIS Bank have indicated weaker domestic demand environment, rising stress on asset quality and margin pressure. Deposit growth may further suffer if PSUs are forced to shell out special dividends (as some reports are suggesting) out of their Rs2.8lakh crore cash chest.

The latest RBI data on credit and deposit growth and industrial growth number for 2QFY14 have not been encouraging and point to continuous poor investment demand conditions. The factors like withdrawal of RFQ for Chhattisgarh UMPP, abandoning of projects by POSCO and ArcelorMittal and poor execution of NHAI projects continue to cloud the sentiment and outlook for investment growth.

The details emerging out of the latest episode in Coal Block Allocation controversy, suggest that the Cabinet Committee on Investment (CCI) may after all not be as effective as the Finance Minister is trying to suggest at various press briefings and investors meets.

With L&T announcing the 2QFY14 results today, the real picture about the domestic investment environment will begin to unfold.

The government, economists, analysts and market participants are all seems to be betting too much on rise in consumption due to better than average monsoon rains. In our view this has created scope for disappointment.

A quick fact finding survey conducted by us suggests that Eastern part of the country where the consumption propensity is relatively higher due to demographic (more youth population) and economic (more poor) reasons have not benefitted from the monsoon. These regions have suffered from erratic rains and flash floods. Late rains have affected vegetable crops across north and east India. Moreover, floods in UP, MP and Bihar have affected logistics severely leading to crop losses.

Rural indebtedness is apparently high due to last year’s drought and higher input prices. The interest rates in informal money market have prevailed at highest level in a decade, impacting profitability of smaller and marginal farmers. Bumper crop and thus lower prices may actually lead to losses for many of these farmers. The tight fiscal situation does not augur well for any pre-election loan waiver etc.

Moreover, social sector spending including MNREGA have fallen significantly this year.

Historically, elections have led to higher consumption demand. However, due to likely lower number of candidates due to latest Supreme Court ruling on people with criminal record contesting elections, and more vigilant Election Commission strictly watching the election expense, we might see the overall election spending to come down too.

We are increasingly growing more confident about our high quality, higher global exposure, and low beta to domestic economic growth model portfolio.

Thursday, October 17, 2013

What are we celebrating?

Thought for the day

“There are people who want to make men's lives more difficult for no other reason than the chance it provides them afterwards to offer their prescription for alleviating life;”

- Friedrich Nietzsche (German, 1844-1900)

Word of the day

Hector (n)

A bully

(Source: Dictionary.com)

Shri Nārada Uvāca

Praise Narendra Modi and get CBI on your tail.

What are we celebrating?

“Clearly, the ineptitude, brazen populism and lack of appropriate policies from the government is the largest part of the problem. You really get a feeling that no one is in control, and the markets are responding to that.”

---- 28 August 2013, Surjit Bhallla, Oxus Investments

"The new RBI governor has market credibility. For now, he's saying all the right things."

- 15 October 2013 Geoffrey Kendrick, Currency and rates strategy, Morgan Stanley

‘From pariah to world’s favorite”, if the media headlines are any guide, analysts have already declared the victory for INR. The mood has changed rather quickly in past 6weeks. INR has jumped ~10% from 68.75/USD to 61.50/USD, and Nifty has jumped ~17% from 5200 to 6100.

The applause has been for the new Suave RBI governor Raghuram Rajan, and correctly so. But now what? How long a central bank can “talk currency up or down”? Eventually, the economic fundamentals will have to take over, in our view.

In this context, there are three points that need to be pondered over. These points are critical as these will also decide the direction and momentum of equity markets in next couple of years.

(a) Whether Raghuram Rajan has enough rabbits in his hat that could be pulled out every month?

(b) Whether the structural issues plaguing the Indian trade balance, demand-supply equilibrium and therefore currency strength have been addressed in any sustainable manner over past couple of months?

Four measures are primarily responsible for the gains in the INR value. (a) Taking the largest participants, i.e., PSU Oil Marketing Companies (BPCL, IOC and HPCL) out of the currency market; (b) Providing huge subsidy to banks for mobilizing foreign currency deposits; (c) Suppressing gold demand through tariff (raising duty) and non-tariff (import restrictions etc.); and (d) Allowing banks to raise more debt funds in foreign currency.

In our view, these are temporary solutions and if continued for long may likely introduce more distortions in the equilibrium.

Monetary policy has so far been ineffective in providing any solution to the demand – supply inequilibrium and inflationary pressures are only rising. There are little signs of reversal of negative feedback loop of higher inflation – higher rates – lower growth – higher demand supply gap – higher inflation.

The governor will likely further strengthen this loop by raising rates on 29 October.

The CCI’s (mis!) achievement of clearing multi billion dollars worth of project has been touted so much that nobody even bothers to listen.

The reality is that the CBI’s latest FIR in coal scam will most likely result in (a) many more outward FDI proposals and (b) further delay in execution of projects stuck for want of administrative approvals. The already wide rift between politician bureaucracy chasm shall widen substantially in next few months.

With PM in direct firing line now, the winter session of the Parliament has been virtually killed. So the next meaningful legislative action is expected only in June-July 2014 when new Lok Sabha will assemble.

And insofar as the strength of INR is concerned, it is mostly an optical illusion. INR/USD averaged 39 in 2007, 48.5 in 2008, 46.5 in 2009, 44.7 in 2010, 53 in 2011, 55 in 2012 vs. the last closing of 61.85.