Vijay Kumar Gaba

Wednesday, February 18, 2015

Till it happens, I'm staying put

Thought for the day

"The whole difference between construction and creation is exactly this: that a thing constructed can only be loved after it is constructed; but a thing created is loved before it exists."

- Charles Dickens (English, 1812-1870)

Word for the day

Canard (n)

An unfounded, false, or fabricated report or story.

(Source: Dictionary.com)

Teaser for the day

Over to Patna, via Perth.

Till it happens, I'm staying put

Analyzing the current market trends I get few signals that suggest that a major correction (10% or more) though not imminent is certainly on its way.

I say not imminent, because, the sectors that could have caused a slump have already corrected sharply.

From their recent highs (which incidentally happen to be 52w high levels also) CNX Metal Index is down ~30%, CNX Energy Index is down ~20%, CNX Realty Index is down ~25% and CNX PSU Bank Index is down ~18%. These sectors are representative of the poor demand environment, elevated stress in the financial system, global deflationary conditions and poor risk appetite.

Besides, The implied volatility of Indian equities, as represented by India VIX, has almost doubled in past couple of months, with material pick up in option volumes. The cash volumes though remain to their yearly average.

Going by the current trends, a further correction of 10% in the mentioned sectors may cause not more than 3-4% correction in benchmark indices. To the contrary, in strict technical terms, these sectors in fact appear deeply oversold and ready for a bounce back.

It would therefore be not unreasonable to say that the technically market is close to bottom and may stage a traditional pre-budget rally in next two weeks. The traders may however would need to keep a close watch on the development in Europe for any sudden shock.

I also feel that a deeper and more meaningful correction is on its way and may occur in historically weak market period of May and June. I say so for five simple reasons.

(a) The number of large daily movement in benchmark indices on closing as well as intraday basis has increased substantially in past three months.

(Please note large inter/intraday movements of 3-5% preceded the 1991-1992, 2000-2001, 2007-2009 market collapse.)

(b) There are clear category preferences visible in investors' activities along with unreasonably higher valuation in preferred categories. Normally a sign of bubble in the market.

(c) Policy focus is driven by market and market is obsessed with policy focus. Usually this harmony of market and policy is unsustainable - because it leads to misallocation of resources and higher volatility due to political events.

(d) Lower interest rates are driving retail investors to equities. Traditionally a sign of market peaking.

(e) US rate hike discussion will intensify in April-May period causing accelerated reversal in USD carry trade.

I will be happiest person on this earth to be proven thoroughly wrong on this count. But till it happens, I shall hold this view.

Flipping the kart

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

Sinecure (n)

An office or position that requires or involves little or no responsibility, work, or active service.

(Source: Dictionary.com)

Teaser for the day

For those who are overexcited about Delhi results - please note that BJP did not get simple majority on his own in Maharashtra, Jharkhand and J&K.

So what's the big deal!

Flipping the kart

While assessing the political mood of Delhi post exit polls I had a chance to meet group of traders in Delhi. Though mostly in their 30s and 40s, almost all these traders belonged to families which have been engaged in trading business for more than two generations.

Though the subject of discussion was Delhi politics, it somehow took a turn towards the existential threat this group perceives from the phenomenal growth recorded by e-retailing business in India.

All the members of the group felt that the core of the e-retailing business in India lies is the ability to sell cheaper than traditional retail. Convenience, more choice and greater accessibility are supporting factor, but "price" remains the key factor. Nonetheless, most of them have joined the bandwagon as supplier.

I am no expert of retail business in the country. But if the views of these experienced traders are any indication - e-retailing is fast turning India into a traders' and arbitrageur's economy. This is not congruous with the objective of the government to promote manufacturing in the country.

From my little knowledge I understand that e-market places would continue to need huge capital for investing in technology and delivery infrastructure. Given their business model of negative operating cash flows for a considerable period of time, debt may not be a viable option. So these ventures will obviously be high equity and low RoE models. Moreover, the business model is also shifting towards independent logistic support and non-exclusive suppliers, lowering the entry barriers.

The current trends suggest that initial investors may have multiplied their investments already, but eventual investor might be stuck with a business that (a) yields less than bank fixed deposit; (b) has low or no entry barrier; (c) owns little in terms of tangible assets; and (d) remains capital intensive forever.

Stretching the logic a little further - as a high volume but low (presently negative) margin business e-retailing shall keep the manufacturers margin under stress. Unless we have huge factories that can produce good quality stuff at really low cost (an advantage enjoyed by Alibaba in China) e-market places would continue to burn cash and keep economy under pressure.

I am trying to understand the "consumer is winner" notion of e-retailing also. If this business model subsidizes the "product prices" through lower wages, rentals, return on equity, quality of product, & traders' margin, with consistently higher viability risk, on the whole consumer may not be a winner.

Though not strictly comparable, we have seen this in power sector. Unviable price bidding for power projects has not benefitted consumers eventually.

I guess, the business so far has grown in a very localized way, without any holistic planning. This is a brilliant tool to handle the problems of accessibility, congestion, competiveness, logistic inadequacies, supply chain optimization etc. But unless it is fully integrated with town planning, manufacturing, Exim trade policy and taxation regime - the outcome may not be optimum.

Get an idea, Sir

Thought for the day

"It was one of those March days when the sun shines hot and the wind blows cold: when it is summer in the light, and winter in the shade."

- Charles Dickens (English, 1812-1870)

Word for the day

Voluble (adj)

Characterized by a ready flow of speech.

(Source: Dictionary.com)

Teaser for the day

Tell me why Delhi assembly election results should reverberate in Bihar election later this year?

Get an idea, Sir

A friend posted me a recording of December 2012 Lok Sabha debate on the issue of allowing 100% FDI in multi brand retail trade. It is still amusing to see the tears the Members of Parliament shed for the poor street vendors and local grocery stores.

Having switch the sides to the other side of aisle in the Parliament, many who vehemently opposed Wal-Mart et. al., are proud to welcome Alibaba and boast about the success of local Snapdeal and Flipkart (who by the way are mostly funded by foreigners). A multitude of online grocery stores has also mushroomed threatening the business of local grocery store and vegetable vendor. These too are funded materially by foreign funds.

It is widely acknowledged that in India e-retailing is becoming the next big thing after Maruti 800 and mobile telephony. The idea has been embraced by the people at large. There is no political or civil society or popular opposition to the idea. Even though the outcome is not materially different from the likely outcome of allowing 100% FDI in multi brand retail trade.

The point being that the idea whose time has come always drives the policy. The vice versa is seldom true. There are few examples where an idea driven by policy has attained success before its due time.

Those watching the Union budget too closely for "idea driving policies" may note that it is only a matter of time when the government of day will roll out red carpet for Wal-Mart et. al. We have done that in automobile and telecommunication. We shall do that in Insurance, banking, healthcare, transportation, and education also in due course - not because the government wants to drive this idea, but because people would have embraced the idea.

Non-conventional power is one idea that is catching up fast with the people. A road trip across villages of UP and Bihar would show you that "Chinese Power Bank" are the hottest FMCG products for the power starved. These power banks are used to keep mobile phone operational during regular long power cuts.

Small roof top and portable solar panels is one idea whose time has come, in my view. Rising cost of regular electricity and poor availability will continue driving consumers in smaller towns and villages towards this renewable source. I believe this certainly has the potential to become even a bigger market than mobile telephony and Maruti 800.

In my view, instead of bothering too much about fiscal deficit, if the government invests the current savings in fossil fuel subsidies in developing the solar user base on mission basis, it could materially enhance our country's energy security and energy efficiency on sustainable basis.

On Delhi election, I feel - (a) If AAP wins, Congress may lose another state forever like UP and Bihar; (b) If BJP wins, with no power and money AAP will become irrelevant in five years. Delhi elections therefore have been a fight for survival between AAP and Delhi Pradesh Congress. For extrapolating the Delhi results to Bihar and UP, a study of BSP history is suggested.

"Pre-requisites" vs. "perquisites"

Thought for the day

"For one swallow does not make a summer, nor does one day; and so too one day, or a short time, does not make a man blessed and happy."

- Aristotle (Greek, 384-322BC)

Word for the day

Winnow (v)

To separate or distinguish (valuable from worthless parts)

(Source: Dictionary.com)

Teaser for the day

Just as a matter of curiosity, would like to know from AAP - "Is there any political outfit in the country, besides AAP, which is honest and works for common people?" or is it "AAP vs. ALL?"

"Pre-requisites" vs. "perquisites"

The primary lesson of economics is that at any given point of time Price of any object having any economic value is determined by the equilibrium of Demand for and Supply of that object at that point of time.

The incumbent government has shown vision to accelerate India's economic growth by encouraging substantial rise in capital investment. Execution of projects like "Make in India", "24*7 Electricity for all", "Railway Modernization", "Smart Cities", "Rapid Expansion of Expressways", "Development of Waterways", "Development of Coastal Transport Corridor", "River Linking" etc., would need capital investment at a scale not seen so far.

The problem is such capital is not available within the country. Moreover, whatever capital is available, it has (a) low risk appetite and/or (b) better alternatives like buying existing stressed assets in India or outside at a bargain price. The required capital therefore has to come from outside.

Here we need to differentiate between the abundant "global liquidity" due to unprecedented QE by central bankers and "global capital".

The global liquidity is intangible, mostly represented by book entries. It could be used to take advantage of temporary arbitrage opportunities available in global currencies and resources trades in dematerialized form. This liquidity can hardly be invested for 20-30yrs in a infrastructure project in a developing country like India where flows of capital are still controlled by the government and currency is still not fully convertible.

The global capital on the other hand is scarce with very low risk appetite. Apparently, the oppressed savers in Japan & EU, and US corporates flush with cash are the only source of risk capital at present. The sovereign wealth funds of Arab nations which have supplied capital to the troubled world in past decade may not be that potent given the energy price outlook.

Given that in India (a) the demand for capital shall remain materially higher than supply and (b) the risk appetite of global capital may continue to remain low - the price of the capital shall most likely find equilibrium at a much higher level.

The government will have to ensure a higher RoE for equity investment through cheaper resources, lower taxes, and stable currency and/or a higher rate of interest on debt capital. It should also be noted that the ease of doing business and higher capital account convertibility would be "pre-requisites" and not "perquisites".

The RBI governor recently suggested in an interview that domestic interest rates are not likely to rise in next 3-4years. He has also made it amply clear that he is looking for a slightly depreciating currency rather than a stronger currency.

There is still no wider consensus within the government to invite foreign capital at investors' conditions and in sectors they are interested to invest in.

Under the circumstances, in my view, the profitable trade is still on Indian consumer. I am happy to note market is with me on this.

"Good" as a noun

Thought for the day

"It is clearly better that property should be private, but the use of it common; and the special business of the legislator is to create in men this benevolent disposition."

- Aristotle (Greek, 384-322BC)

Word for the day

Contrite (adj)

Deeply affected with grief and regret for having done wrong; Penitent.

(Source: Dictionary.com)

Teaser for the day

AIB Roast - is unacceptable because (a) it hits where it hurts most, at the core of our Hippocratic morality; and (b) it is truly f****g s**t.

"Good" as a noun

I often wonder how many of us usually rely on IMD weather forecasts to plan our day? and how many of us judge the winter cold by the minimum temperature and summer heat by the maximum temperature recorded on a given day?

Hand on my heart - I could not care less for IMD forecast in planning for my daily schedule; a tiny shiver does travel up my spine when I hear about day's minimum temperature in winters and few droplets of sweat do appear on my temple when I hear about day's maximum temperature in summers. It is also true that it makes absolutely no difference to my life beyond these ephemeral feelings.

I know, till this point there would be little disagreement. Even those disagreeing may want to nod in agreement just to keep me in good humor.

But I do not want to stop here. I want to apply this ratio to the macro economic data issued by the government other agencies! This would certainly ruffle some feathers. A large majority of economist and analyst community who rely heavily on the "periodic official data" for their livelihood would strongly resent any attempt to trivialize the importance of such data.

To test my hypothesis I discussed the issue with some consumers, producers and investors. The key take away are follows:

(a) An executive with a midsized cement producers suggested that they do use GDP multiplier to forecast the cement demand for their investor presentations, but in real life the decision to increase/curtail production and add/reduce production capacities are strictly based on actual sales and feedback from dealers. GDP multiplier for demand forecast is mostly a post facto decision justification tool.

(b) A middle class home maker tells me that inflation number you people discuss on television and newspapers means nothing to her. It is monthly outgo from her purse that matters and that amount is rising consistently for past one decade.

(c) The sweet shop owner in my neighborhood market says that his sales are growing much faster as compared to 2003-2007 period. GDP growth deceleration from 9% to 5% does not matter to him. The inflation inside his shop has recorded over 15% CAGR in past five years. The wages though are stagnating for past couple of years.

(d) "The change of GDP growth rate by changing the methodology does not get my engineer daughter a decent job", is what an investor had to say.

Trust me, I am not at all cynical. I fully understand and appreciate the importance of empirical data as a critical input in future planning. But I suspect the utility of forecasts based on extrapolation of empirical data using the great gift of Bill Gates to mankind (MS Excel) for my investment decisions.

My favorite Robert Pirsig noted in Lila "Quality is Good as a Noun". I agree.

PSBs - trade - ok, investment "no-go"

Thought for the day

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

- Aristotle (Greek, 384-322BC)

Word for the day

Obviate (v, trn)

To prevent by interception; to anticipate and dispose of or make unnecessary.

(Source: Dictionary.com)

Teaser for the day

Stakes put on Delhi election:

AAP - 100%, its "double or quit" for them.

Cong - 0%. Even a win here does not help them nationally.

BJP - 5%. Does not matter much in national picture. However if they lose, the PM gets a monkey on his back for 5yrs.

PSBs - trade - ok, investment "no-go"

From the periodic monetary policy statement of RBI governor and views expressed by him in customary press conference post policy statement four things stand out, in my view:

(a) The policy making at RBI has definitely moved to global standards. It is purely data driven and no longer rely on the subjective assessment of RBI and political expediency. The governor made it amply clear that if the GDP data to be announced on 9th February and the budget provisions warrant a change in rates he is willing to do it outside periodic policy reviews.

(b) Doubling the remittance limit under LSR (Liberalized Remittance Scheme) from USD1,25,000 to USD2,50,000 marks the end of emergency measures taken to protect BoP in summer of 2013. The limit was reduced from USD2,00,000 to USD75,000 and later enhanced to USD1,25,000.

This comes after lifting most restriction on gold imports applied in 2013.

In my view this has three implications:

(i) Many had interpreted the move back then as return of capital controls. The governor has addressed all those concerns in definite terms.

(ii) This demonstrate the confidence of RBI in BoP situation.

(iii) It clearly highlights the intention of RBI to maintain INR/USD at current or slightly higher level. It is therefore clear that RBI has reconsidered its earlier bias towards importing deflation. This measure when read along with inflation outlook (6% in Jan' 2016) makes it amply clear.

(c) By allowing banks to offer differential interest rates on term deposits based on the callability feature (meaning locked in fixed deposits can be offered higher rate of interest), the pitch has been further queered from FMP business of mutual funds. If, as expected, the finance minister also removes the tax arbitrage between FMP and bank deposits, the banks may gain substantial cost advantage over mutual funds insofar as the cost of funds is concerned.

The idea seems to make market efficient by removing apparent inefficiencies.

(d) RBI wants banks to play a more active role in restructuring of bad assets - through change of management or otherwise.

The governor admitted that a fair bit of stress still remain in asset quality and banks are not willing to cut lending rates as yet.

The market reaction to the policy statement in my view was more of a correction of huge build up in the preceding sessions, rather than any reflection on the policy stance itself.

I guess, we are reaching that point faster where PSU banks will become a "good trade". However, as a matter of policy I would maintain "no go" policy for investment in any PSU stocks.

Toffees on trees and fish on streets

Thought for the day

"It is the mark of an educated mind to be able to entertain a thought without accepting it."

- Aristotle (Greek, 384-322BC)

Word for the day

Celerity (n)

Rapidity of motion or action; quickness; swiftness.

(Source: Dictionary.com)

Teaser for the day

In Indian politics, last week who said to whom: "Revenge is a dish that tastes best when served cold!"

Toffees on trees and fish on streets

A popular Gulzar song from 1980 Hindi film Khoobsurat, coaxed people to break rules and think out of box. The current popular market sentiment seems to have taken the cajoling far too seriously. Investors are actually looking for toffees on trees and expecting to find fish running on streets.

Speaking to some large investors/traders, businessmen and analysts in Mumbai last weekend, I discovered the following:

(a) There is an absolute consensus that USD shall gain further strength from here. However, the opinion is divided on INRUSD trends. The estimate vary from (a) Stronger INR vs. USD; to (b) a materially weaker INR vs. USD to (c) a gradually depreciating INR vs. USD.

Most opinions are based on the premise that current account gains are structural due to medium to long term shift in energy price equilibrium.

Most believe that there is strong, almost unchallenged TINA factor behind FII flows to India.

Many believe the weakness in oil based middle east economies and strength in US economy will accelerate remittances - in former case due to fear and in latter case due to abundance.

(b) There is a conspicuous race to offer innovative arguments in support of higher valuations - much like 1999-2000 when obscene ICE valuations were justified using "differentiating" valuation techniques.

(c) Lower inflation, higher growth and falling rates is an overwhelming consensus. No one is willing to account for a Lehman type collapse.

Only a couple of people accepted my argument that it is not only about "inflation", i.e., rate of change. It is also about the price levels which are becoming unaffordable for lower middle class in most cases, especially when wages are stagnating and employment market is intensely competitive.

Higher prices and stagnate or slowly rising wages do not support the higher saving higher investment matrix.

(d) Most concerns were expressed in feeble voices, clearly emitting fear of being singled out or losing on the market rally.

(e) The hope is seen driven by vision statements like "Make in India", "Clean India", "Ease of Business", "Red Carpet for Red Tape" etc.

Paradoxically, positioning is similar to 1980's era of pseudo socialism and no growth. MNCs and domestic oligarchs (holding myriads of licenses) did well and commanded higher popularity amongst investors and therefore higher valuations. Similar is the situation today.

The underlying trade, as someone beautifully put it, is entirely on the small luxuries that large masses are now enjoying - biscuit, noodles, tampons, motor cycles, dental cream, watches, shoes, fans & coolers, etc. The "Growth" is just driver of hope; far from converting into a trade.

Top right corner

Thought for the day

"How did it get so late so soon? Its night before its afternoon. December is here before its June. My goodness how the time has flown. How did it get so late so soon?"

- Dr. Seuss (American,1904-1991)

Word for the day

Rapacious (adj)

Given to plunder; Seizing by force; Grasping; Greedy.

(Source: Dictionary.com)

Teaser for the day

Should Congress Party make up with Anna by agreeing to his agenda?

What is there for it to lose?

Top right corner

The recent India trip of US president Barack Obama may or may not be important from economic standpoint; but it may most likely mark a watershed in India's foreign policy and could have far reaching implications for global strategic balance.

The expert may differ, but I clearly saw an eagerness on Indian side to cross over to US camp or if I may use cold war jargon from Soviet Bloc to NATO Bloc. In the process, India could have given formal burial to the NAM movement it co-founded six decades ago.

In words of Geeta Anand (WSJ) "India finally came out this week after years in the closet, declaring itself a firm friend of America.

The country’s Cold War commitment to non-alignment died long ago as the guiding foreign-policy principle for the world’s second-most-populous nation. But its obituary wasn’t written until this week."

The widespread economic cooperation that developed seen post Lehman collapse is no longer visible. EU and US monetary policies are diverging far apart.

If we juxtapose this event to the series of events that have taken place in past few months, e.g., isolation of Russia and Pakistan by western countries, China coming closer to Russia by extending financial help and escalating tension with Japan and South Korea, US re-establishing relations with Cuba, and OPEC virtually disintegrating, the world is heading towards polarization, not seen since end of cold war.

In my view, it is for Germany to decide whether it will be a bi-polar or a tri-polar world.

Insofar as India is concerned, I believe that in the emerging global scenario, her economic and strategic interest are better aligned with US and its allies. In past 'pseudo neutrality' and tactical alignment with Russia and has not helped much.

It would be interesting to watch, how much integration of India's economic and strategic interests the USA accepts and allows. A deeper cooperation would allow India (a) to overcome its capital & technology inadequacies; and (b) greater access to developed markets in west.

The downside could be elevated threat perception at borders on all the side. (Sri Lanka is showing little hesitation in standing next to China). It would also be challenging to bring around the sizable population that still harbors anti-USA sentiments.

However, since the government has already decided to move ahead whole heartedly, it is for USA to reciprocate with some tangibles, before we build some investment themes on these developments.

Today, there is no hurry and no worry. If I am thinking in right direction, we will have enough time and space to move on the top right corner of the Sensex graph.