Vijay Kumar Gaba

Tuesday, February 11, 2014

Need ≠ Demand

Thought for the day

“They must often change, who would be constant in happiness or wisdom.”

- Confucius (Chinese, 551-479BC)

Word for the day

Dulcify (v)

To make more agreeable; mollify; appease.
(Source: Dictionary.com)

Teaser for the day

Who we want our next Prime Minister to be:

(a) A conformist

(b) A reformist

(c) An anarchist

(d) A contrarian

(e) A capitalist

(f) A socialist

(g) A secularist

(h) A nationalist

(i) A superman

(j) Can’t say

Need ≠ Demand

Yesterday, I received overwhelming criticism for my suggestion to avoid large gestation infrastructure projects (e.g., power, roads etc.) and financials for investment purposes.

Much of the criticism is driven by the assumption that these sectors have seriously underperformed for some years and offer good value at current prices. Most critiques assumed that with new government in saddle, the infrastructure sector should in particular be in focus of investors.

My attempts to argue with some of the critics however exposed the tremulous foundation their arguments stand on. The following two examples are worth taking note of, in my view.

(a) One common highlight of the criticism was enormous physical infrastructure deficit that needs to be filled almost immediately to achieve the potential growth rate.

In my view, in this context it is critical to make a distinction between the “need” and “demand” for infrastructure. There is no denying that the need for infrastructure is colossal. To meet the ends of social justice, economic equality, sustainable economic growth and regional balance, development of social (e.g., education and health) and physical infrastructure (roads, communication, power etc.) is imperative. But at the stage of development where India stands today, the demand (ability to pay to fulfill one’s needs) for infrastructure is abysmally low.

The infrastructure development therefore needs to be mostly socio-political effort rather than an economic proposition.

The efforts to make roads, power and airports projects economically viable by bundling land and coal resources in past 15years have proved rather counterproductive. The evolving socio-political paradigm indicates that in foreseeable future it would not be possible to masquerade land and mining mafia deals as infrastructure development projects.

Besides, even if we accept the all hunky dowry scenario post election, where are the balance sheets worthy of undertaking new large projects? The only way existing infra developers could be viable is by way of transmitting a large part of stress to lenders and equity holders and offloading cash generating assets. Considering this, in my view, we are at least two years away from making an investment theme out of infra developers and financiers. For keeps sake odd L&T is fine with me.

(b) The other subtle hint in most critiques was Narendra Modi. The subterranean hope that messiah will come on a white horse holding a magic wand in his hand and all problems will vanish in a poof seems to be driving investment strategies.

I am also hopeful. I believe Modi led BJP will cross 250 mark on its own. But that is a bad news for equity investors in the short term. Most of the potential steps that the new government will likely take to set the economy in order would only cause pain in the short term….more on this tomorrow.

Monday, February 10, 2014

What to do? - III

Thought for the day

“There is nothing so strong or safe in an emergency of life as the simple truth.”

- Charles Dickens (English, 1812-1870)

Word for the day

Schuss (n)

A straight downhill run at high speed.

(Source: Dictionary.com)

Teaser for the day

RIP Maruti800 - a metaphor for Indian middle class rising.

What to do? - III

After two days of dithering and side stepping, I would like to tackle the real question, viz., “What to do?” To borrow a leaf from RBI governor’s book, it may not earn me many “likes” on social media. But, I guess even in these times you have to do few things which are beyond the realm of “likes” and “dislikes”.

At the outset, I would like to make it clear that I expect Most Indian equities should correct significantly (10% or more) from the current level in next 12months. Though is possible that benchmark Nifty does not correct to that extent due to its skewed construction but beyond Nifty correction could be serious. The correction in my view would be led by the stressed sectors like financials, realty and leveraged infrastructure builders.

What to do?

1. Equal weight in equity, hold 25% tactical cash at present. In debt only accrual products, no duration play. 10% precious metals in portfolio. In commodities – prefer agri commodities vs. industrial commodities. In real estate prefer land vs. apartments.

2. For equities, 2014 to be portfolio construction phase. Plan low to no return in next 12months.

3. Overweight domestic compulsions (staples, financials, higher productivity, low cost, low price discretionary, two wheelers etc.).Avoid aspiration stories and high gestation infrastructure projects, leverage.

4. Overweight global compulsions (highly skilled workers, low cost). Avoid consumers.

5. Global deflationary trends appear real. Avoid global commodities, including energy.

6. PSU stocks are completely avoidable, except may be for a small trade with a time horizon of less than 2months.

When to do?

Currently remain parked in select Index heavyweights and niche midcaps.

As usual, at some point in time over next few months the correction will be overdone and a good opportunity to buy will emerge. Mark the stocks you like based on quality of assets, strengths of the management, market leadership, execution skills and buy slowly at each dip over next 6months.

In case 2014 elections provide an undesirable outcome, the market may correct substantially. That in my mind would be an opportunity to go overweight in equities. However, if as expected Narendra Modi is able to form a stable government and market become euphoric, I would suggest “sit back and relax”.

How to do?

InvestTrekk model portfolio is mostly designed to reflect this strategy. Use the template and design the one to your liking.

Friday, February 7, 2014

What to do? - II

Thought for the day

“Men in general are quick to believe that which they wish to be true.”

- Julius Caesar (Roman,100-44BC)

Word for the day

Farceur (n)

A joker; Wag

(Source: Dictionary.com)

Teaser for the day

We all know that it’s anarchy when AK does it.

Will Kapil Sibal tell us what it is when KKR does it?

What to do? - II

The bad things are easier to believe. Haven’t you noticed that?

- Vivian to Edward in movie Pretty Woman

Continuing from yesterday, I would like to admit that answering the real question honestly is extremely difficult, especially knowing that I will be judged every day for my answer.

It is much easier and convenient to use the jargon like “long term”, “bottom up”, “stock-picking”, “value investing”, etc. and have a rather simplistic large cap defensive portfolio. However, given that ‑

(a) we are at junction where 5yr normalized CAGR of Sensex is close to peak of 16% and appears as a warning if you juxtapose it to declining real growth and elevated inflation and hence interest rate levels;

(b) we had one of the best year in 2013, in terms of foreign flows (both FII and FDI), a scenario that may likely not repeat itself considering the US tightening its monetary policy and conditions in Europe again taking a turn for the worst;

(c) the “high quality” and “global stability” (read exporters) trade is so crowded and exploited that the risk-reward in this sphere might have turned negative;

(d) the optical “deep value” in “financial” and “domestic investment pick-up” may not be deep enough to warrant a jump as of now;

applying most of these principles may not actually be gratifying for most investors.

The positives at this stage are all derivatives of hope, compulsion and continuity. Rationally, it is difficult to find some positives which are self sustained, definitive and confirmatory. For example, consider the following rays of hope.

· The domestic inflation and therefore rates have peaked as the vegetable prices have fallen. Core inflation rise despite lower capacity utilization is seasonal.

· CAD is now under control (<2.5% of GDP), as gold demand has been successfully curbed; exports to developed countries have picked up; NRI flows are strong; Fx reserves have been augmented to US$295bn from a low of US$274bn; imports have fallen; fuel demand has slowed due to higher prices.

· Fiscal deficit is under control (<5% of GDP) as government expenditure is cut; subsidy payments have been successfully rolled over; disinvestment targets have been accomplished through cross sale; service tax amnesty.

· China is just soft landing. The concerns over the stress in financial system are overblown to mythical proportions.

· ECB’s “whatever it takes” commitment will continue to be an effective back stop for all concerns, including France falling into recession.

· Fed’s QE tapering underscores the strength of US economy. EM collapse will not impact US and Japan. Tighter liquidity will not strengthen the deflationary trend rather lower commodity prices will aid the growth.

…to continue on Monday

Thursday, February 6, 2014

What to do?

Thought for the day

“If you can talk brilliantly about a problem, it can create the consoling illusion that it has been mastered.”

- Stanley Kubrick (American, 1928-1999)

Word for the day

Inglenook (n)

A corner or nook near a fireplace

(Source: Dictionary.com)

Teaser for the day

Mr. Murthy, please be informed that politicians, bureaucracy and police in India do work on corporate compensation structure. Low fixed – high variable.

Stock options are encashed by selling coal, spectrum, jobs, roads, Apartments etc.

What to do?

The bad things are easier to believe. Haven’t you noticed that?

- Vivian to Edward in movie Pretty Woman

In past few trading sessions Indian equities appeared to have lost the momentum seen since November 2013. Renewed concerns over sustainability of global economic growth seen in 2013, QE tapering, further worsening of domestic macro data, and rising stress in financial sector are some of the factors prima facie responsible for current round of sell off. A good (so far) earnings show by companies, perhaps the best in many years, is a consolation.

The mute question now is what should investors be doing in under the current circumstances? Should they be cutting their exposure to risk assets, like equity, and sit on cash or they should use this opportunity to build a risk portfolio keeping the next growth cycle in mind?

I feel before we devise an appropriate investment strategy and asset allocation plan, it is important to comprehend what exactly is bothering the markets and what are the likely scenarios that may evolve during the course of next few months.

In my view, broadly the following three factors are likely to impact our financial markets, especially equities, in next few months:

Domestic macro deterioration

The fiscal slippages ahead of elections, accelerated liquidity tightening, persistent high inflation and therefore pressure on rates, higher credit costs and slower consumer demand are some notable macro headwinds impacting the investors’ sentiments.

Besides, new RBI norms on provisioning (if implemented) might lead to accelerated recognition of NPAs and therefore further tightening of already constricted credit market. This comes at a time when fiscal constraints are anyways limiting the capital infusion in PSU banks.

Political uncertainty

As I expected, the prospects of Modi led BJP getting close to 225 is already causing panic amongst most regional and smaller national parties. This shall lead to united opposition and hence even higher uncertainty about election outcome. If AIDMK, BJD, JDU and SP, etc. join hands, and TMC, BSP, RJD etc. come closer to Congress, NDA would be seen falling short by30-40 seats even if BJP gets 210 seats on its own.

This should keep investors guessing till the results are announced in middle of May 2014.

Global economic conditions0

The global deflationary pressures have risen significantly in past two months. Historically, QE withdrawals have usually led to accentuated deflationary pressures and substantial fall in risk asset prices across the board. EU, China, Australia, LatAM, Russia, South Africa are all giving some worrisome signals. US yields, gold, copper, JPY indicate that perhaps a massive risk off is building.

To my mind, the unusual strength shown by Indian equities post Fed withdrawal is exactly that – UNUSUAL. At some point in time in next few months, the market needs to normalize by showing some fear…to continue

Wednesday, February 5, 2014

Economics, accounting and morality - III

Thought for the day

“As a rule, anything that is pretty you avoid when on an expedition in the polar extremes. Normally anything other than white means a hazard such as a crevasse.”

- Ranulph Fiennes (British, 1944 -)

Word for the day

Crevasse (n)

A fissure, or deep cleft, in glacial ice, the earth's surface, etc.

(Source: Dictionary.com)

Teaser for the day

Is poverty really a function of nominal monthly earnings?

Economics, accounting and morality - III

The reversal of previous government’s policy stance on FDI in multi brand retail trade (MBRT) by new governments in the states of Delhi and Rajasthan has evoked sharp criticism from many quarters.

Investors have criticized it as a negative for investment climate. Analysts have termed it as retrograde. The union commerce minister has termed it as irresponsible act that would present India in bad light amongst global investor community. He even thought that it could be unconstitutional as under the enabling law passed by the Parliament, states were only given the power to permit FDI in MBRT. However, once permitted, the states have no power to withdraw such permission.

I find nothing new in the decision of Delhi and Rajasthan governments. There have been numerous instances of various governments not sticking to policy decisions. In fact, if we consider some policy flip flops of the incumbent UPA government, the latest episode would look totally innocuous.

For example, when NDA government dismantled the administered pricing mechanism for transportation fuel, many investors had invested in the sector. Private sectors and foreign companies invested in setting up retail fuel distribution network (Petrol Pumps); E&P assets and even in stock of public sector OMCs and upstream companies. UPA government reversed the policy causing huge losses to investors. UPA government followed a particular policy on telecom spectrum auction. When the Supreme Court held the policy inappropriate and canceled the 22 telecom licenses, the government decided not to defend its policy by enacting appropriate legislation. Similar outcome is likely in coal block allocation policy also. Remember, in political sensitive instances of Delhi unauthorized business establishment ceiling, and ban on convicted politicians for contesting elections by the apex court, the UPA government had sought to reverse the court rulings through legislative means. Seeking to retroactively implement GAAR was also an instance of investor unfriendliness. In fact since the infamous Vodafone penalty case, India has not seen any big ticket FDI, except for MNCs raising stakes in their local ventures.

Whereas thankfully neither investment has actually taken place in pursuance of the policy to allow FDI in MBRT, nor many people seem interested.

In my view, it is not a simple issue of political morality or protection of free market economy. It goes much beyond that. It involves the question of:

(a) legitimizing private lobbying with legislators;

(b) evolving a code of conduct for all politicians with regard to exploiting the work done (or not done) in performance of their constitutional duties for electoral purposes; for example, it is not uncommon to see politicians claiming credit (through big and ugly banners) for building pavements, drains, etc.;

(c) evolving a consensus that no political party should claim credit for b-partisan legislations; UPA could not have passed any bill without the support of “constructive opposition” or “CBI friendly outside supporters”.

Remember, in accounting every “credit” need to have an equal “debit”; bad politics can never be good economics; why bother about “Morality”.

Tuesday, February 4, 2014

Economics, accounting and morality - II

Thought for the day

“Morality is simply the attitude we adopt towards people whom we personally dislike.”

- Oscar Wilde (Irish, 1854-1900)

Word for the day

Slake (v)

To allay (thirst, desire, wrath, etc.) by satisfying.

(Source: Dictionary.com)

Teaser for the day

In AAP wherein lies the problem – the Idea itself; implementation; or the current leadership?

If it is the Idea, scrap it. If it is implementation fix it. If it is leadership change it.

Economics, accounting and morality - II

Continuing from yesterday (see here), I would like to humbly submit to the finance minister that even small investment in a tiny business usually takes 3-5years to show results. The higher growth during FY04-FY08 was certainly the outcome of reforms and investments that took place in the preceding decade. The credit therefore does not belong exclusively to Congress (or UPA for that matter). Similarly, the downtrend seen since FY08 may not be entirely a folly of UPA government.

However, if you want to take credit for higher growth, for which you did nothing to achieve, you cannot escape the blame for the current disastrous state of the economy.

The fact of the matter is that the long term growth is trending down since FY08 and UPA–II has done little to stem the fall till recently. Few concrete steps have been finally taken during FY14 which will yield results in next 4-5years.

If you claim credit for NDA initiated projects like Delhi Metro, highway projects, etc. you should be prepared to see someone else claiming credit for nuclear power, GST, DTC and FDI in retail trade.

This is the feudal brand of democracy, where the ruling party claims credit for all good that takes place during its tenure. Congress claiming credit for Delhi Metro is a classic example. It’s like a landlord claiming credit for a good crop, even though he has not even seen the field from which that crop was harvested.

As I said yesterday, it is the accounting of economics, not the economics itself. And morality does not have even a remote connection to it.

Monday, February 3, 2014

Economics, accounting and morality

Thought for the day

“Where there is politics or economics, there is no morality.”

- Karl Wilhelm Friedrich Schlegel (German, 1772-1829)

Word for the day

Tittup (v)

To move, especially to walk, in an exaggerated prancing or bouncing way, as a spirited horse.

(Source: Dictionary.com)

Teaser for the day

Nitish Kumar believes that he could be the beneficiary of Congress benevolence, post election á la AAP in Delhi, should NDA fail to cross the 272 mark!

Are you ready for PM sitting on Dharna in front of Parliament for special status to Bihar?

Economics, accounting and morality

The finance minister P. Chidambaram has raised serious doubts about competence of the aspiring PM Narendra Modi in the field of economics.

This criticism coming on the back of universally acknowledged disastrous performance of his “economist” prime minister naturally raises some issues of morality.

I appreciate that given the “do or die” nature of 2014 general election for both Congress and BJP, and most other parties on the fringes, morality is something which may not prominently figure on lists of priorities (including the self proclaimed flag bearer of morality AAP).

Nonetheless, it may not be completely out of place to highlight the following points to Mr. Chidambaram:

(a) The macro economic conditions could be improved by anything but accounting. Managing fiscal deficit by accounting jugglery, e.g., by holding income tax refunds, deferring payment of subsidies and other payments to next fiscal year, effecting disinvestment by accounting entries (cross sale of equities between PSUs); extracting special dividend from PSUs even at the cost of their future growth plans; harassing government vendors and contractors by unusually delaying payments due to them; and cutting vital plan expenditure is something which only an account think of. Even a thoroughly incompetent economist would not like to do indulge in this trivial gimmickry that could only worsen the conditions.

(b) Managing current account and currency deficit by effectively transferring a large part of gold trade to parallel market; borrowing short term Fx at exorbitant rate of 9.5% from NRIs; force oil companies out of currency market; and distorting the debt profile of the economy in favor of short term instable source of funds is also not sound economics. At best it is immoral trafficking.

(c) Basing your consumer price management strategy on the vagaries of monsoon is also not economics. A common FM radio listener will tell you that American companies are advertising not Facebook or Twitter. They are propagating California apples, almonds, walnuts, and peers amongst Indian masses. That should be cause of serious worry for those responsible for managing trade balance and consumer prices. Please understand doing Yagna for good monsoon every year will not bring food prices down.

(d) Good politics is quintessentially good economics. Politics for immediate electoral gains is not economics it is immorality. It is robbing future generation to get few votes. If LPG subsidy was bad two years back, it is criminal today.

(e) Accelerated environmental clearance to US$40bn worth of projects may also not be good economics, if it makes growth unsustainable and inequitable. I feel Niyamgiri will not remain an exception. It will become a rule if the government fails to protect people’s interest.

…to continue tomorrow