Vijay Kumar Gaba

Wednesday, June 11, 2014

Make a beginning

Thought for the day

“We shall not cease from exploration, and the end of all our exploring will be to arrive where we started and know the place for the first time.”

- T. S. Eliot (American, 1888-1965)

Word for the day

Prevaricator (n)

A person who speaks falsely; liar.

(Source: Dictionary.com)

Teaser for the day

The government need to choose between 6,50,000 smart villages and 100 smart cities.

If you say we need both – tell me what should happen first?

If you say both should happen together – show me the money.

Make a beginning

The political events in couple of weeks and subsequent up move in equity stock prices have reignited interest of many savers. Many people who drastically reduced weight of listed equities in their wealth portfolio are also showing keen interest in rebalancing of their risk profile by increasing weight of listed equities. I have received many requests for suggestions as to what should be the approach for rebalancing the portfolios.

While I have been replying to individual queries, I find it appropriate to present a general approach for the benefit of broader readership of this column.

The most common question I get is “What would you do if you have to invest fresh Rs___ in equity market?”

To this, my answer is usually as follows.

Make a diversified portfolio, which captures the current environment and likely trend in economic hence business cycle. The portfolio should be focused and not too diversified. It should largely contain leaders in terms of market, product, technology, and pricing power. It would however not be completely inappropriate to include couple of new kids on the block who are clearly demonstrating the potential to become leaders in their respective spheres.

The basis of diversification could be as follows:

Basket 1 - Broader economic growth (25%): This will be a basket of leading corporates of India which would lead and equally participate in the revival of economic growth in India and than elsewhere. A focused large cap fund that picks up from top 100-150 stocks will be optimal for this purpose. A passive index fund can also serve the purpose, but I would prefer an actively managed fund at this stage, given that the economy is still not likely to get out of woods in next 2-3 quarters at the least and currency could be a major play impacting the performance of a large number of Nifty constituents.

Basket 2 - Cycle leaders (25%): As the economy revives, some sectors will do better than the others. Companies in sectors will obviously give more return than benchmark indices. In my view, early cycle plays (large operating leverage, faster demand pick up) with market leadership should be considered for this. A sectoral fund (banking and power for domestic and IT and Pharma for global) could be a good way to participate in this segment.

Basket 3 - Growth vs. value (20%): Being convinced that we are embarking on a long journey of faster and sustainable growth we need to identify and invest in few high growth potential companies that have demonstrated strong potential to become market leaders in future. We could consider a basket (specialized funds) or not more than 5 direct stocks.

Basket 4 - Secular growth (30%): About two fifth of our portfolio must be secured in secular non-cyclical growth stories like consumption and generic pharma. Assuming that other three buckets will capture some exposure in this segment, I suggest 30% direct exposure to this segment through quality stocks.

Based on the latest socio-economic vision statement of the government, as enunciated in the President’s address to the Parliament on Monday, I find the following investment themes that may be relevant in the next few years.

Investment themes

Professionalization of PSU. Select PSU’s that are doing well and are least affected by policy decisions. Nevertheless, the current positive policy cycle may favor energy and banking.

Railways could be to 2015-2020 what roads were to 2003-2007. Focus on technology leaders rather than generic stock (wagons and wheels) suppliers.

Agri productivity as an economic activity will likely enjoy highest priority for the incumbent administration. Focus should again be on technology innovators and market leaders rather than generic fertilizer producers.

Cyclicals. Buy cyclicals and industrials with god balance sheet and decent operating leverage (cement, capital goods, auto and construction).

Commodities: Buy global commodities which are on the cusp of reversing demand-supply cycle (Aluminum, Zinc and Lead).

Global businesses (IT, pharma, auto ancillaries) as INR completes its correction over next 2-3months

Consumers (FMCG, 2wheelers, telecom, pharma, textile, finance, media) for demand pick up on fiscal and monetary stimulus.

Illustrative list of stocks (Not be considered as recommendations)

1. Bharat Forge (Undisputed global leadership, strong B/S, operating leverage, CV cycle upturn, higher railway and defence demand)

2. Bosch (Technology leadership, operating leverage, CV cycle upturn)

3. HCL Tech (Cheaper valuation, better margins, new business traction, management transition to high degree of professionalism, large size)

4. HDFC Bank (Undisputed market leadership in retail banking)

5. HUL (Undisputed leadership, strong product profile, margin bottoming)

6. Idea (Strong growth in data business, best cost management)

7. Kaveri Seeds (Strong market leadership in hybrid seeds, strong B/S)

8. L&T (Undisputed market leadership, operating leverage, cyclical upturn)

9. Mahindra and Mahindra (Cyclical upturn, diversified)

10. Motherson Sumi (Technology & product leadership, operating leverage)

11. PVR (Strong market and brand leadership, high growth, operating leverage, top play on consumer discretionary, early stage business)

12. Reliance Industries (Cyclical upturn, strong product leadership and B/S)

13. Sun Pharma (Strong leadership, consistent premium valuation, high growth and margins)

14. Tata Motors (Cyclical upturn, Global leadership (JLR)

15. Ultra Tech Cement (Market leadership, cyclical upturn, operating leverage )

Tuesday, June 10, 2014

I’m lovin’ it

Thought for the day

“Once we have a war there is only one thing to do. It must be won. For defeat brings worse things than any that can ever happen in war.”

- Earnest Hemingway (American, 1899-1961)

Word for the day

Prate (v)

To talk excessively and pointlessly.

(Source: Dictionary.com)

Teaser for the day

If Narendra Modi is successful in his endeavor to bring good governance – do we need an alternative like AAP?

I’m lovin’ it

Since past couple of days the new government had been giving signals regarding its priorities, style of functioning, targets and above all their vision of India’s future. However, the broader view was fragmented and critics’ opinions divided. A section of society still had misgivings about the intentions and agenda.

The President’s address to the joint session of the Parliament, in my view, has defined the intentions, vision, mission and agenda of the government unambiguously. I am particularly delighted as the government’s agenda incorporates most of my suggestions presented through this column.

I know that by now the readers of this column must have been overwhelmed by the threadbare, between the lines and behind the hand analysis of the vision statement of the government. However, I would still take risk of offering my two paisa. In my view, the key highlights of the vision statement of the government made through President of India are as follows:

Strong and firm leadership

The best way to find out if you can trust somebody is to trust them. (Ernest Hemingway)

From the address it is clear beyond doubt that the country has a strong and firm leadership. The prime minister is in full control of the situation. The conventional wisdom suggests absolute power in one hand is worrisome. But so far we do not have evidence to suggest that the present leadership is corruptible. The statement goes a long way in addressing the fears of the traditional detractors of the Prime Minister, by remaining strictly within the contours of constitution.

Conceptual clarity

The best part of the statement is the conceptual clarity on various issues, especially structural imbalances faced by the economy and imperative to correct these imbalances in right earnest.

For example, the statement lays strong emphasis on skill deficit, agriculture productivity, skewed sex ratio, rural-urban divide, state – center strife, sustainability of growth especially ecology-economy balance and foreign policy – economic policy imbalance.

Most important aspect is that without offering and platitudes about the global economic conditions, it straight away focuses on the internal strengths like demographics, traditions, culture, technology and presents simple programs to harness these strengths.

Alternative governance structure

Departing from the popular view of being other side of the Congress Coin, BJP leadership has shown strong commitment to a transparent, predictable, fair and accountable policy regime and governance structure. The indications so far are that the government is “running the talk”.

Promising to do away with administrative discretions that have traditionally been source of many corrupt practices is for example a welcome departure.

Tomorrow I shall present my views on market implications of the policy outline.

Saturday, June 7, 2014

Few words of caution

Thought for the day

“Inferiors revolt in order that they may be equal, and equals that they may be superior. Such is the state of mind which creates revolutions.”

- Aristotle (Greek, 384-322BC)

Word for the day

Sparge (v)

To scatter or sprinkle.

(Source: Dictionary.com)

Teaser for the day

Post Delhi election last winter, RaGa said Congress needs to learn lot from AAP.

It indeed does need to learn what not to do?

Few words of caution

Investor’s confidence has definitely taken a rocket flight in past two weeks. People who were not even willing to talk about investing in Indian equities are now desperate to listen to “multi bagger” ideas. Analysts and strategists like me have also changed their tune. While this is a welcome change from the extreme pessimism seen during past three years, I feel some words of caution would be useful.

Reproduced below is an interesting discourse from Unlearning Economics, I find extremely relevant to the current circumstances.

First, something which is expected to do a certain job - whether it's an economic system or the economists who study it - is expected to do this job all the time. If an engineer designs a bridge, you don't expect it to stand up most of the time. If your partner promises to be faithful, you don't expect them to do so most of the time. If your stock broker promises to make money but loses it after an asset bubble bursts, you won't be comforted by the fact that they were making money before the bubble burst. And if an economic system, or set of policies, promise to deliver stability, employment and growth, then the fact that it fails to do so every 7 years means that it is not achieving its stated objectives. In other words, the "invisible hand" cannot be acquitted of the charge of failing to do its job by arguing it only fails to do its job every so often.

Second, the argument implies there was no causal link between the boom and the bust, so the stable period can be understood as separate from the unstable period. Yet if the boom and the bust are caused by the same process, then understanding one entails understanding the other. In this case, the same webs of credit which fuelled the boom created enormous problems once the bubble burst and people found their incomes scarce relative to their accumulated debts. Models which failed to spot this process in its first phase inevitably missed (and misdiagnosed) the second phase. As above, the job of macroeconomic models is to understand the economy, which entails understanding it at all times, not just when nothing is going wrong - which is when we need them least.

As a final note, I can't help but wonder if this argument, even in its general political form, has roots in economic theory. Economic models (such as the Solow Growth Model) often treat the boom as the 'underlying' trend, buffeted only by exogenous shocks or slowed/stopped by frictions. A lot of the major macroeconomic frameworks (such as Infinite Horizons or Overlapping Generations models) have two main possibilities: a steady-state equilibrium path, or complete breakdown. In other words, either things are going well or they aren't - and if they aren't, it's usually because of an easily identifiable mechanism, one which constitutes a "notably rare exception" to the underlying mechanics of the model. Such a mentality implies problems, including recessions, are not of major analytical interest, or are at least easily diagnosed and remedied by a well-targeted policy. Subsequently, those versed in economic theory may have trouble envisaging a more complex process, whereby a seemingly tranquil period can contain the seeds of its own demise. This causes a mental separation of the boom and the bust periods, resulting in a failure to deal with either.”

Thursday, June 5, 2014

Optimistic – absolutely, unconditionally

Thought for the day

“The weak can never forgive. Forgiveness is the attribute of the strong.”

- Mahatma Gandhi (Indian, 1869-1948)

Word for the day

Embroil (v)

To bring into discord or conflict; involve in contention or strife.

(Source: Dictionary.com)

Teaser for the day

Will Arun Jaitley present “dream Budget” in July?

After all he has much stronger support than what MMS and PC had in 1990’s.

Even more important – will Congress openly support the reforms which UPA failed to implement supposedly due to inadequate numbers?

Optimistic – absolutely, unconditionally

In early 2011, while serving as a strategist with a large wealth management firm in Mumbai, I accompanied a senior relationship manager to his client. The client had just sold off his business and was flush with liquidity. The relationship manager wanted to capture a pie of the booty.

This was the time when markets had just completed their massive up move from March 2009 lows, and were struggling with European crisis. Macro indicators were deteriorating. Government appeared clueless and FIIs were saying good night and logging out of the “India Story”.

We were hugely underweight on equity and advising only high quality short term debt to our clients. I had no fascinating “buy” ideas as my model portfolio was full of boring consumers and IT names.

On our way to client’s office in suburban Mumbai, the Relationship Manager suggested – please do not give him any bearish views. We will get money only if we present an optimistic outlook and convince him to take market and credit risk. He gave me precisely 40minutes to redefine my strategy in which I had strong conviction. Subsequent events are not relevant here.

I remembered the cited instance as I read the latest RBI policy statement for the third time late evening yesterday. I could see him obliging a request from the finance minister – “I understand there is little economic rationale for cutting rates at this point in time, but at least sound bullish”.

The discomfort of the governor in sounding conspicuously dovish could be gauged from the following two paragraphs in the statement.

“Lead indicators point to continuing sluggishness in domestic economic activity in the first quarter of 2014-15. The outlook for agriculture is clouded by the meteorological department’s forecasts of a delay in the onset of the south-west monsoon with a 60 per cent chance of the occurrence of El Nino. The ongoing contraction in the production of consumer durables and capital goods, coupled with moderation in corporate sales and non-oil non-gold imports, is indicative of continuing weakness in both consumption and investment demand. The decisive election result, together with improved sentiment should, however, create a conducive environment for comprehensive policy actions and a revival in aggregate demand as well as a gradual recovery of growth during the course of the year.”

“The risks to the central forecast of 8 per cent CPI inflation by January 2015 remain broadly balanced. Upside risks in the form of a sub-normal/delayed monsoon on account of possible El Nino effects, geo-political tensions and their impact on fuel prices, and uncertainties surrounding the setting of administered prices appear at this stage to be balanced by the possibility of stronger Government action on food supply and better fiscal consolidation as well as the pass through of recent exchange rate appreciation. Accordingly, at this juncture, it is appropriate to leave the policy rate unchanged, and to allow the disinflationary effects of rate increases undertaken during September 2013-January 2014 to mitigate inflationary pressures in the economy.”

It is however pertinent to note that on my part I am genuinely optimistic about FY16-FY18 macro outlook; though not euphoric as yet.

Wednesday, June 4, 2014

Firmly consistent

Thought for the day

“A wise and frugal Government, which shall restrain men from injuring one another, which shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned. This is the sum of good government, and this is necessary to close the circuli of our felicities.”

- Thomas Jefferson (American, 1743-1926)

Word for the day

Gnomist (n)

A writer of aphorisms.

(Source: Dictionary.com)

Teaser for the day

Should Congress hold a free and fair organizational poll to save herself?

Firmly consistent

· No change in Repo (8%), Reverse Repo (7%), MSF (9%) and CRR (4%).

· 50bps cut in SLR to22.5%.

· FIIs allowed additional US$10mn limit in currency derivative market over and above their normal hedging requirements.

· Remittance limit under LRS increased to US$1,25,000 from present US$75,000.

· CPI target 8% FY15 and 6% FY16

· Growth target for FY15 5 to 6%. 1QFY15 growth to remain sluggish.

· Inflationary risk at balance despite expected sub-normal monsoon.

The policy stance of RBI, as reiterated in Tuesday’s bi-monthly review statement, is firmly consistent, in my view.

Through his statement, Governor Rajan not only successfully alleviated the concerns about change in policy trajectory due to change in government in New Delhi, he also demonstrated remarkable resolve in achieving the objective of greater predictability and consistency of policy.

The key highlights of latest policy statement are as follows:

· Inflation targeting is now definitely the primary driver of monetary policy. This not only brings objectivity to policy formulation but also add fair degree of predictability to it. The chances of speculation around the policy and undue political intervention are thus minimized.

The latest statement in this regard reads “The Reserve Bank remains committed to keeping the economy on a disinflationary course, taking CPI inflation to 8 per cent by January 2015 and 6 per cent by January 2016. If the economy stays on this course, further policy tightening will not be warranted. On the other hand, if disinflation, adjusting for base effects, is faster than currently anticipated, it will provide headroom for an easing of the policy stance.”

· RBI is also consistent in its move to bring about some structural reforms in monetary policy and stability in money market.

I view reduction in SLR and small opening of currency derivative to foreign investors from this angle. In short term SLR reduction may not have any material impact as most banks are already running a high SLR deposit. However, a structural decline in SLR is desirable from prudent financial management angle and driving government borrowing closer to market rate. Moreover, this will prepare banks for the expected pickup in credit demand later this fiscal.

Gradually opening currency derivative market to foreign investors will help relocating large offshore INR derivative market to Indian shores, thus providing RBI better control over currency volatility.

· In its last policy review RBI had begun to unwind some of the measures taken last summer to check excessive volatility in Fx market. Further in this direction RBI has relaxed US$75000 remittance limit under LRS to US$1,25,000.

In pursuance of the Dr. Urjit R. Patel Committee’s recommendation to move away from sector-specific refinance towards a more generalised provision of system liquidity without preferential access to any particular sector or entity, the Reserve Bank has decided to limit access to export credit refinance while compensating fully with a commensurate expansion of the market’s access to liquidity through a special term repo facility from the Reserve Bank (equivalent to 0.25 per cent of NDTL). This should improve access to liquidity from the Reserve Bank for the system as a whole without the procedural formalities relating to documentary evidence, authorisation and verification associated with the ECR. This should also improve the transmission of policy impulses across the interest rate spectrum and engender efficiency in cash/treasury management.

Tuesday, June 3, 2014

Return of good times!

Thought for the day

“Caesar's wife must be above suspicion.”

- Julius Caesar (Roman, 100-44BC)

Word for the day

Braggart (n)

A person who does a lot of bragging.

(Source: Dictionary.com)

Teaser for the day

What should be the role of Modi government – (a) Driver or (b) Engine or (c) Wheels?

Or do we need a robotic engine that can fly Indian economy without a driver?

Return of good times!

Latest round of economic data from major global economies indicates towards three notable trends – (a) Large commodity producers like Canada, Brazil, Australia and Russia are materially lagging behind the commodity consumers indicating persistent deflationary pressures on commodity prices; (b) Yields have fallen sharply both in safe haven like US and German treasuries as well as weaker economies like in peripheral Europe; and (c) despite moderation in US Fed bond buying program and reluctance of ECB, BoE, BoJ and PoBC in adding fresh monetary stimulus liquidity conditions remain easy fueling risk appetite of global investors.

India appears to be benefiting from all three cited trends.

Subdued commodity prices, coupled with subdued demand and import restrictions on gold import, have completely alleviated the payment default risk, which were weighing heavy as foremost concern on the investors’ mind till at least September 2013.

Lower yields on safe haven assets have once again triggered carry trade that helped bubble building in EM assets in late 1990s and during 2004-2008. Massive inflows YTD have not only eased pressure on INR, but also made Indian debt look relatively attractive.

As the fears of liquidity squeeze have not come true despite “taper” and global financial markets are back to their euphoric best, appetite for Indian equities are at a high, despite not so encouraging growth and inflation numbers.

Incidentally, these trends are occurring when a new government is taking shape in New Delhi. Given the staggering hopes raised by Mr. Narendra Modi during his campaign, the business confidence appears at a new high. Consumers also look positive in their expectations. It is therefore natural to see the stock market rally in association with the new administration.

Though we are yet to see any concrete evidence of increased consumer spending, new investment proposals, or any indication of higher government spending, there are strong expectations that 3QFY15 data will likely show a definite uptick in consumption as well as investment demand.

Remember 1QFY15 is virtually over without any positive data improvement. The government is in the process of formulating the reviewing extant policy framework and will likely announce corrective steps only by the middle of July as part of routine budget exercise. Actual implementation may begin only by the end of 2QFY15 which may also suffer due to inadequate monsoon as predicted.

The 4QFY14 results for larger companies have been encouraging, showing a sign of demand and margins bottoming out. Most of the improvement however might be coming from massive cost rationalization programs undertaken by various companies and not necessarily due to return of pricing power. Inventories appear to have been run down materially. SME segment though has not shown any sign of improvement. Finance cost and revenue pressure are conspicuous in this arena.

I am looking at cement sector for some aggressive bets as an early cycle investment.

Monday, June 2, 2014

Early cycle industrial, consumers and exporters

Thought for the day

“All differences in this world are of degree, and not of kind, because oneness is the secret of everything.”

- Swami Vivekananda (Indian,1863-1902)

Word for the day

Xyst (n)

A garden walk planted with trees.

(Source: Dictionary.com)

Teaser for the day

Is UP Chief Minister is guilty of constitutional impropriety by –

(a) allowing discrimination on the basis of voting patterns; and

(b) failing to establish rule of law.

If yes, should he be sacked immediately?

Early cycle industrial, consumers and exporters

The GDP growth for FY14 came below 5%, mostly in line with expectations. This marks a phase of worst slow down in almost three decades.

I am not worried about the slower growth in a year or two. The worrisome part is that long term trajectory of growth (defined by 5yr CAGR of GDP) that motivates fresh large investments and thereby creates sustainable employment opportunities has now slid below 6% mark and not likely to rise above it at least FY18.

Insofar as the current year is concerned, I expect first two quarters not to show much improvement, as the efforts of new government will start showing results only from August onwards. Moreover, expected poor monsoon may actually delay the recovery by another quarter. I expect FY15 growth to be 50bps higher primarily on pick up in mining and construction activities in second half.

The private consumption demand has shown some encouraging revival in 4QFY14. I would like to wait till 1QFY15 data release to assess how much of this was due to election related expenditure. Government consumption may pick up only from August onwards, after final budget is passed.

At this point in time I do not see any need to modify my investment strategy. I feel we should stick to early cycle industrial plays, along with consumers and exporters.

On debt side however post RBI comments later this week I would like to consider whether the time to consider playing duration in fixed is approaching faster than earlier anticipated. My sense, a below 4.75% print on 1QFY15 GDP may precipitate rate cuts to September 2014 from March 2015. Excessive volatility in Fx market due to heavy inflows in short time may also prompt some easing even earlier.