Vijay Kumar Gaba

Thursday, March 20, 2014

Markets still in twilight zone

Thought for the day

“In order to carry a positive action we must develop here a positive vision.”

-Dalai Lama (Tibetan, 1935-)

Word for the day

Venerable (adj)

Commanding respect because of great age or impressive dignity; worthy of veneration or reverence, as because of high office or noble character:

(Source: Dictionary.com)

Teaser for the day

What if B. S. Yeddyurappa and Pawan Bansal win top leaders of AAP lose the elections?

Would that mean victory of evil over good or just that the current movement against corruption is misdirected?

Markets still in twilight zone

I firmly believe that Indian equities completed a four and half year (July 2007 to December 2011) bear market in mid 2011.

The bear market was mostly led by slowing trend growth due to declining investment and consumption demand, steady deterioration in macro indicators like inflation, fiscal and current account deficit, exchange rate, rise in cost of capital and labor and derating of PE ratio of Indian equities.

The period was marked by negative real earnings and wage growth. The bear market witnessed couple of profound swings during June 2007 to January 2008 and September 2008 to May 2009 but mostly ended on a flat note in terms of the benchmark indices (Nifty 4500 level).

In the bear phase – the leaders of 2003-2007 bull market, i.e., credit and investment, were completely decimated with an overwhelmingly large number of stocks losing 75-90% of their peak market value. Defensive consumers, pharma and IT stocks gained in market value bringing the benchmark indices out from a deep abyss.

Global events like collapse of US investment bank Lehman brothers leading to freezing of global money and credit markets, fiscal crisis in Europe raising widespread concerns over feasibility of common currency area and substantial slowdown in consumption levels across the globe contributed to the bearish trend.

Since beginning of 2012 corporate earnings have bottomed out and showing a rising trend albeit at a slower rate. Macroeconomic indicators have begun the correction process and are forecast to show material improvement over next couple of years. Market volatility has bottomed at lower level and showing early signs of rising. The supporting global environment also appears relatively stable.

The benchmark indices have undoubtedly raced to their all time high levels. However it would be a mistake, in my firm opinion, to consider it as a bull market. There is little evidence to suggest that the current pace of gains in equity prices is enduring or we could see sustained up move from here over next 12-15 months.

The market internals suggest that (a) volumes are too low for a sustained bull market, (b) volatility is too low for a large push up; (c) market breadth continues to be disappointing indicating shallowness of up move; (d) expected risk adjusted return on equity alternatives like fixed income, gold etc. is still higher as compared to equities; (e) capital market appears ill prepared for capital raising plans; (f) the impact of inevitable reversal of global rate cycle is yet to be assessed.

The increased foreign participation could be entirely due to rebalancing of overweight debt portfolios ahead of rate cycle reversal expected in 2015. It may not be reflection of the attractiveness or otherwise of Indian equities.

The market therefore, in my view, continues to be in a neutral trajectory. The course will continued to be marked by frequent sectoral rotations giving trading opportunities and slower momentum in terms of volatility and volumes. The strategy here should be two pronged – (a) trade and (b) prepare for the next bull market to begin.

Wednesday, March 19, 2014

Setting the context for post election market perspective

Thought for the day

“Endorsing an idea doesn't mean you endorse any interpretation of it, or everything done in its name, under any circumstance.” -Unknown

Word for the day

Arraign (v)
To accuse or charge in general; criticize adversely; censure.
(Source: Dictionary.com)

Teaser for the day

My Mother India is the supreme deity. She is held on the highest pedestal of unquestionable extreme reverence & devotion by 1.3bn Indians and admired by many foreigners. She is above all respect, insult, criticism, attacks, insinuations, and malaise.

The one demeaned, smeared or insulted easily by mere pictorial depictions, refusal to sing her praise etc. is not my Mother. Is she yours’?

Setting the context for post election market perspective

2014 general elections in India are being seen as a watershed in the political history of India. There is near consensus, a rarity, amongst political analysts and commentators on this issue. The decisive change in the constitution of electorate in favor of under 25yrs voters; emergence of a larger than life personality (first in post Indira era) as key contender for the top post; and overwhelming disregard for established political ideologies in bargain for political power are the key contours defining the watershed.

With little ideological support to back, all political parties are scrambling to find issues. It has never occurred in my memory that less than one month for elections to begin, there is no clarity on “the key election issue”. As of now it is “undefined Gujarat model of governance” vs. “bickering over moral and legal accountability for 2002 riots” with Narendra Modi at center of debate.

Though occasionally parties try to obfuscate the public discourse with more pertinent issues like unemployment, inflation, and economic development; but these issues have so far mostly remained at the fringe in the election strategy. The issue of corruption that dominated the December assembly elections has been effectively sidelined by understandably united and concerted efforts of all parties to put “clouded” leaders back in fray.

It is in this context that we need to form post election market perspective for an appropriate investment strategy.

My thesis in this regard could be summarized as follows:

(a) Expect no radical change in the economic policies and program post elections, irrespective of the constitution (BJP led NDA, Congress led UPA or any other alliance) and form of the government (majority or minority).

(b) In past six months execution at policy level has improved dramatically. The incumbent Congress led UPA government has perhaps achieved more in past one year than it did in preceding nine years. I believe this trend is irreversible and will only accelerate post election, irrespective of the outcome of elections. Burdened by humongous expectations, a Narendra Modi led government will be obligated to perform much better in the short term.

(c) A Narendra Modi led government is likely to face stronger resistance from left leaning sustainability activists. We might therefore even higher judicial intervention in policy matters relating to environment, compensation for displacement & rehabilitation, and allocation of natural resources. The issue of probity may dominate the allocation of resources and process if licensing, unfavorably and sometimes unreasonably impacting businesses and people popularly perceived closer to the new administration. A third front government would be actually best placed in these terms.

(d) A continuation of effort seen in past 6months will be the best case scenario for markets in short term. A more “populist & Keynesian” (looser monetary & fiscal policy to stimulate economy) or fiscally tighter (higher taxes, lower government spending) could both be painful for markets in the short term.

…to continue tomorrow

Readers can send their views, comments, criticism to the author at vijaygaba.investrekk@gmail.com

Follow @VIJAYGABA

Tuesday, March 18, 2014

What the crystal ball says?

Thought for the day

“O wise man! Give your wealth only to the worthy and never to others. The water of the sea received by the clouds is always sweet.”

- -Chanakya (Indian, 350-275BC)

Word for the day

Solipsism (n)

Extreme preoccupation with and indulgence of one's feelings, desires, etc.; egoistic self-absorption.

(Source: Dictionary.com)

Teaser for the day

Paid media! AK is absolutely right.

Ashutosh, Manish Sisodia, Shazia Ilmi, Ashish Khaitan…

AAP has rewarded all journalists who unduly propagated AK & associates with election tickets.

What the crystal ball says?

In 2HFY14 Indian equity markets have been generally buoyant. Benchmark indices have gained ~24% from lows of September 2013. I find four notable elements in this rally.

First, during this period foreign investors have been more bullish on Indian equities, whereas domestic investors have generally preferred fixed income.

Second, four notable events triggered this rally – (a) appointment of Mr. Raghuram Rajan as RBI governor and some aggressive measure successfully taken by him to stem the slide in INR; (b) announcement of Narendra Modi as PMship candidate of BJP for forthcoming election (and subsequent opinion polls showing he having an edge over opponents) which stemmed the slide in business confidence to some extent; (c) improvement in macro indicators especially fiscal deficit, current account deficit and inflation due to a variety of measure taken by the government; and (d) encouraging 3QFY14 aggregate corporate performance, primarily led by large companies having global operations.

Third, the rally was initially led by the global businesses like IT, pharma, and duly supported by domestic consumption stories. However, lately the action has moved to the hopes of economic recovery and hence credit and investment themes are leading the bull charge while defensives IT, pharma and consumers have taken a back seat. Stocks from infrastructure, realty, energy and capital goods are more in demand these days. Moreover, the early part of the rally was confined to a handful of large cap stocks while the latest surge is little broad based; though the volumes have continued to remain dismal and overall market breadth mostly negative. Market volatility has also remained confined to lower range.

Four, the rally has occurred despite (a) US Federal Reserve moderating the pace of bond buying program (tapering); (b) global energy prices ruling at elevated level; (c) Chinese economy moderating triggering fears of reversal of nascent global economic recovery; (d) RBI refusing to signal any easing plans in near term; (e) early indications of El Nino returning this year; and (f) no signs of financial stress in the system dissipating.

Keeping these elements in context, I would like to answer the following queries frequently raised by our readers.

(a) Is it time to change asset allocation in favor of equities?

(b) Are we at the threshold of a new bull market? Or this is just another bear market rally extended a little far, just like October 2007 – January 2008?

(c) All new bull markets are usually led by a new leader. If we are entering a new bull market which sector(s) is/are going to lead the way?

(d) What will change if Narendra Modi indeed moves to 7RCR in May 2014? What if he fails?

(e) Is it possible for equity markets to rally hard from here even if interest rates do not fall materially, food inflation picks up again due to poor monsoon and global rate cycle begins to turn with Fed indicating a hike sometime in year 2015?

Readers can send their views, comments, criticism to the author at vijaygaba.investrekk@gmail.com

Follow @VIJAYGABA

Friday, March 14, 2014

We stay put with our strategy

Thought for the day

“Markets don’t exist simply to enrich people.”

- Seth Klarman (American, 1957 - )

Word for the day

Claptrap (n)

Any artifice or expedient for winning applause or impressing the public.

(Source: Dictionary.com)

Teaser for the day

Why dissent is always a “big deal” in India?

Are we more conformist, feudal or hypocrites?

We stay put with our strategy

The sound of an angry text message on my hand phone woke me up little early this morning. I knew it was angry because it was unusually long (split in 5 SMS’) and untimely. It was serious reprimand from a dear friend who is apparently feeling “left out”. The text shouted “while you were busy dreaming your Utopia markets have run up sharply to new all time high level”.

At first I found it particularly provocative and hence worthy of an immediate reply. An hour later, however, I am feeling empathetic and concerned. I feel my friend may not be alone in his restlessness. Traversing through some blogs, I find the feeling is all pervasive. Though thankfully, not many investors seems to have taken the plunge this time.

While, I do not deny that benchmark indices are ruling at their all time high levels in nominal terms, in real terms these are substantially lower. In real terms Sensex at 21K in 2007 (1yr forward EPS ~850) was much higher than Sensex at 22K in 2014 (1yr forward EPS~1500).

I believe that the de-rating of Indian equities is real and will likely sustain for couple of more years at the least. That is precisely the argument in support of InvesTrekk strategy of constructing a forward looking portfolio rather than trading short rallies.

Insofar as immediate skepticism is concerned, I would like to make just three small points.

(a) YTD gold has gained 14% and copper has lost 14%. Historically, in past four decades this kind of divergence has been invariably followed by serious correction in equity prices. For record, InvesTrekk strategy of accumulating gold at lower prices has returned more than equities since November. Our negative call on duration products and focus on accrual products has also served well.

(b) The primary function of capital market is to help businesses raise capital for implementing their business ideas and growth plans. I do not find an iota of evidence that would suggest that market is ready for IPOs as yet. In fact most attractively priced government IPOs have completely flopped in past few months. PE activity is focused mostly on e-commerce, part of a global trend. Some aggressively priced e-tailing IPOs would mark the end of current enthusiasm in market, in my view.

(c) I visited Delhi and NCR region early this week, searching for a home. I met a number of real estate developers, traders, investors and brokers. The only sense I got was that they all, without exception, are in deep distress. The situation in fact appears to be much worse than late 1990s’. Payment defaults are wide spread and deals elusive.

Thus, notwithstanding annoying messages that make me work harder early in the morning – I remain committed to my strategy of high quality, low beta, gradual construction of portfolio, no leverage and underweight investment and credit. Exception could be made for an L&T and HDFC Bank.

I also feel like sharing a recent blog post of my favorite central banker Bob McTeer a former member of US Fed, which I find quite relevant and soothing in the current context.

“The Federal Reserve recently reported that the net worth of American households grew by $9.8 trillion, or 14 percent, last year. $5.6 trillion of this increase came from the stock market and $2.3 trillion came from rising home prices. The increase in household net worth is also called an increase in household wealth.

This increase is a good thing. Individual households, on average, have a higher net worth or wealth, which, by spending it, can be realized in the form of more goods and services consumed. However, households as a group cannot realize more consumption of goods and services since the quantity of goods and services available does not rise with stock or house prices. The fallacy of composition is at work.

The most familiar example of the fallacy of composition is that you can see better at a football game if you stand up. However, it doesn’t work if everybody stands up. The advantage is real only if most people don’t try to realize it.

The fallacy of composition is fairly obvious in monetary economics. Give individuals more money and they are wealthier. They can buy more stuff. However, giving the economy more money doesn’t, per se, make an economy (all of us) wealthier. There is not immediately more stuff to be bought. More money involves money illusion, except for those that win the race to the store. The same is true of wealth that can easily be converted into money for spending.

Does counterfeiting, which creates more money, albeit fake, create wealth? Yes for the counterfeiters who get away with it. They can exchange their fake money for real goods and services. However, since there are not more goods and serves to be had, their benefit is at the expense of the rest of us, who have the same amount of money and other wealth, but fewer goods and services available to us.

There is a fundamental difference between income and wealth and between wealth created by higher real incomes and saving and wealth created by rising housing and equity prices. Higher income increases wealth both in money terms and in real terms. The additions to wealth through income are matched by an equal value of additional goods and/or services being produced.

I started by saying that the reported increase in household net worth or wealth was a good thing. By making us feel better about our finances, a “wealth effect” can increase our willingness to spend and thus create real wealth if we have sufficient slack in the economy. But, if you want to cash in some of that money wealth, you’d better beat your neighbors to the mall.”

For records, for the first time, I agree with Mr. Murthy. It would indeed be difficult for Infosys to regain the lost leadership status.

I wish all our readers a very Happy Holi. Shall be back with you coming Tuesday.

Thursday, March 13, 2014

Utopia: The economic solution-IV

Thought for the day

“Fame has also this great drawback, that if we pursue it, we must direct our lives so as to please the fancy of men.”

- Baruch Spinoza (Dutch, 1632-1677)

Word for the day

Fervent (adj)

Having or showing great warmth or intensity of spirit, feeling, enthusiasm, etc.; ardent.

(Source: Dictionary.com)

Teaser for the day

Disappearance of Malaysian aircraft highlights at least three things – (a) There are still many things that are not under US NSA watch; (b) possibilities of another 9/11 are not dead despite Osama’s elimination and (c) St. Google does not answer all your questions.

Utopia: The economic solution-IV

Focus on strengths

At the risk of sounding irritatingly repetitive, I would like reiterate that in past 6 decades we have focused too much on our weaknesses and tried hard to overcome by importing technology, energy, intellectual property, capital and consumption patterns. The root cause of many economic problems, e.g., current account deficit, fiscal deficit, energy deficiency, excessive dependence on external IPR & capital flows, etc. could be traced to this misplaced focus.

In my view, just by focusing on our intrinsic strengths, we can not only conveniently reverse the flow of trade to pre British era but also be successful in achieving our secular goals of sustainable and faster economic growth.

I have been suggesting that, for example, by implementing the following programs could improve the balance of payment substantially and structurally by 2025 by focusing on our intrinsic strengths like abundant sun shine, large number of middle class youth, amazing landscape, strong and rich tradition & culture:

(a) Energy deficiency had been one of the primary reasons for India’s fiscal and trade deficits. Failure in implementing an integrated energy policy has been a major failure of policy making. It is widely recognized that “roof top solar panel” has the potential greater than the one seen in mobile telephoney in past one decade. Reducing energy intensity of water and developing a world class public transport infrastructure on priority basis, especially in tier II and III cities, and strict legal enforcement of energy efficiency should be considered.

(b) Indians spend approx USD25bn annually on education and related overseas travel. Creating 5 Special Education Zones (SEZ) with liberal VISA, forex, taxation and real estate ownership rules, and allowing foreign institutions to freely set up campuses could reverse this flow. Students from India, far-east, middle-east and Africa who find it difficult to get VISA for US/UK etc. or find that expensive could also benefit from this. Our politicians have spoken about recreating Nalanda and Takshila. This in my view is the easiest way to do that.

(c) India holds tremendous potential for tourism. However lack of proper infrastructure had traditionally constricted the growth of this sector. On the other hand Indian outbound tourists flow is rising. Developing some world class self contained international tourism centers, e.g., on lines of Macau, Disney, Las Vegas, etc. with liberal VISA, Forex, taxation and real estate ownership rules could reverse these flows.

(d) Vindavan, Tirupati, Varanasi, Gaya, etc. all have potential to be as desirable, venerable and popular destinations as Mecca, Vatican and Jerusalem. Converting these centers of Indian religion and culture into self contained special zones with international airport and annual event calendar could get substantial forex revenue.

These projects also have the potential to generate large scale productive employment opportunity for local talent, besides contributing to economic growth and true globalization of Indian economy.

Readers can send their views, comments, criticism to the author at vijaygaba.investrekk@gmail.com

Earlier in this series:

The state of the Union

The political problem

The political solution

The economic problem-I

The economic problem-II

The economic problem-III

The Economic Solution

The Economic Solution - II

The Economic Solution - III

Wednesday, March 12, 2014

Utopia: The economic solution-III

Thought for the day

“The duty of youth is to challenge corruption.”

- Kurt Cobain (American, 1967-1994)

Word for the day

Fallacy (n)

A deceptive, misleading, or false notion, belief, etc.

(Source: Dictionary.com)

Teaser for the day

Salim - Javed seem to be official dialogue writers for AAP leadership.

The most often used dialogue by AAP – Pehle Uska sign lekar aao … phir main bhi sign karoonga. (First tell other parties to refrain from wrong doing, then we will also do the things right way.)

Utopia: The economic solution-III

Enable the youth

The young demography is famously the biggest strength of Indian economy at this point in time. However, if not managed properly this may as well prove to be the nemesis of the fabled India story, in our view.

The pertinent fact is that Indian growth in past decade or so has miserably failed in creation of adequate productive jobs for the burgeoning workforce of the country. MNREGA has helped to some extent, but it is bound by fiscal constraints, leakages and lower productivity. Disguised/ underemployment also continue to impact the productivity and earnings potential.

We have been highlighting that the vast reservoir of youth energy on which Indian economy is sitting presently, could potentially explode if not channelized appropriately. It is therefore extremely critical to evolve an integrated youth policy that include mission scale programs to educate and skill the youth, inculcate enterprise skills in them from early stages, enable them to engage in productive self employment, deal empathetically with their concerns, anguish, frustration and disillusionment.

In our view, the following is the minimum that needs to be urgently implemented:

(a) Overhaul education system to make it job oriented. Inculcate enterprising skills in students from primary level. It is high time that we do some zero base planning regarding our education rather than just incremental tinkering. Post middle (8^th standard) job oriented education, training and skilling programs should be made more popular with active participation of industry. RTE should be amended to provide for a uniform and standard education to all the children. Bringing social changes like “respect for work” and inclusion of “workers” in main stream would be quintessential to this.

(b) The trained and skilled youth should be adequately supported and enabled to engage in productive self employment. The present model of MSME promotion may not be adequate to create massive employment needed. This model may not be totally competitive in the emerging scenario where the Indian industry will have to increasingly compete with large global players. Co-operation movement in industry on the lines of AMUL where a large number of trained youth can create, own and profitably manage large globally competitive enterprise should be promoted and encouraged. Giving equity in natural resources to local population could be a great starting point.

(c) Agriculture and allied activities are still at the core of Indian socio-economic structure. Promoting collective and commercial farming may add significant employment opportunity with increased earnings potential.

(d) Success of IPL has suggested that sports can potentially generate large scale employment opportunity if managed in industry like manner.

(e) Last but not the least police reforms are absolutely necessary to manage the agitated & disillusioned youth compassionately and ensuring that they do not stray into prohibited territory of violence and sedition.

(f) Readers can send their views, comments, criticism to the author at vijaygaba.investrekk@gmail.com

Earlier in this series:

The state of the Union

The political problem

The political solution

The economic problem-I

The economic problem-II

The economic problem-III

The Economic Solution

The Economic Solution - II

Tuesday, March 11, 2014

Strategy update

We spoke to some farmers, farm produce traders, and agri scientists in Delhi, UP, Bihar and MP in past three days.

The feedback is as follows:

(a) The reported loss of crop due to freak weather is understated. Potato, Mustard, Channa, Moong, Wheat and green vegetable crops in particular have suffered substantial losses.

(b) Potato crop that is being warehoused suffers from disease and excess moisture. At least half of this stored quantity is expected to rot before it comes out. Expect sharp rise in potato prices in summer months.

(c) El Nino fears are real. Good storage levels in reservoirs should help the irrigated parts. The late rains should leave good moisture in land for early sowing of Kharif. But areas that have not received late rains and depend on monsoon should suffer.

(d) The expected boost to economy due to higher farm income from Rabi may not materialize.

(e) Edible oil seed crop should be poor. The rise in palm oil prices due to crop failure in Malaysia should keep the pressure high.

We expect the food inflation to resurface again in 3Q2014.

We expect the fiscal pressure to exacerbate post election as the new government tries to revive the public spending.

We also do not expect Ukraine controversy to subside in a hurry. The crude price therefore may not fall substantially from the current levels despite lower demand. Lower Chinese demand though will continue to push coal, Iron ore and other industrial metals down.

We do not see much probability of rates easing in next 12months. Talk of Fed’s next step (rate hike) in 2015 should further provide support to higher rates. It is therefore advisable to invest in accrual products only. Duration play at this stage could be very risky.

Stock markets appear to be running much ahead of fundamentals. The margin of error at this stage is close to NIL. Any material disappointment on macro factors, political front or reversal in global flows could cause substantial correction.

Technically, momentum has risen sharply in past one week. The market is in similar condition as it was in October 2007 or October 1999. Though this time retail participation is negligible hence panic reaction less likely; nevertheless a sharp correction in next couple of months cannot be ruled out. We advise (a) No leverage; (b) Low beta; (c) high quality; (d) 15-20% tactical cash.

Sector wise, we suggest overweight on reasonably valued companies with low financial leverage and high operating leverage. Cement, auto and select engineering companies will fall in this category. Maintain positive stance on exporters (IT and Pharma) and defensive large consumers. The current correction in these sectors could be an opportunity to buy.

We maintain our negative stance on commodities and PSUs.