Vijay Kumar Gaba

Tuesday, September 29, 2015

Mind your expectations

Thought for the day

"Corpses are more fit to be thrown out than is dung."

—Heraclitus (Greek, 544-483BC)

Word for the day

Minimax (n)

A strategy of game theory employed to minimize a player's maximum possible loss.

(Source: Dictionary.com)

Malice towards none

PM Modi is able to inspire all but Congress and her associates!

Mind your expectations

If one were to go by media reports - (a) all the market participants are keenly waiting to hear RBI governor this morning; (b) a large majority has already assumed and assimilated a 25bps cut in policy repo rate; (c) a more aggressive easing will catalyze a sharp rally in Indian equities led by rate sensitive financials, realty, auto and infra sectors; and (d) a 25bps cut with no clear promise for more cuts will disappoint the markets and a sell off will follow almost immediately.

All seems so simple and well settled. Life cannot be easier than that!

Without speculating over Governor Rajan what may or may not do later today, I find it pertinent to note that global markets, including India and US, are almost there, where these were before US FOMC met earlier this month with much anticipation and expectations.

There are many more incidental data point that need to be considered while forecasting market direction on the basis of what RBI governor does or omits to do. For example, consider the following:

(a) In the previous RBI rate cycle (Jan 1998- Apr 2003), RBI's primary policy rate fell 500bps from 11% to 6%. In this period SBI prime lending rate fell 375bps from 14% to 10.25%.

The current cycle began at RBI policy rates 8% and SBI prime lending or base rate at 10%. Obviously this cycle will be much smaller as compared to the previous one.

(b) The previous cycle saw cash reserve ratio (CRR) falling 650bps from 11% to 4.5%. This cycle is beginning with CRR at 4%. This move along with material re-capitalization of banks catalyzed a super cycle in Indian banking stocks.

(c) The previous rate cut cycle (FY1998-FY2003) saw economy growing at 5.4% CAGR. The growth accelerated with a lag from FY04 onward and averaged over 8% in next five years.

The accelerated global demand catapulted by huge infusion of liquidity by central banks was one of the reasons responsible for acceleration in growth. This time global liquidity is almost redundant to global demand.

(d) The producers price inflation averaged around 4% during FY1998-FY2003, incentivizing investment in capacity building. This time inflation expectations are much lower, at least for next 2yrs.

(e) Indian equities yielded NIL return during 5yr period FY1998-FY2003. The following five years (2003-2007) yielded over 40% CAGR.

However, in past five years, Indian equities have already yielded in excess of 5% CAGR. So the returns in this cycle may be much lower as compared to the previous bull market.

What I infer from these and many such data points is that this cycle is nothing like the previous one. The cycle may be short and not that sweet. Neither leveraging nor de-leveraging will be an umbrella theme. Cheaper credit may not propel consumption or investment like before.

I am therefore keeping my return expectations for next couple of years very low.

Monday, September 28, 2015

Bank Nifty: Treading dangerous waters

Thought for the day

"No man ever steps in the same river twice, for it's not the same river and he's not the same man."

—Heraclitus (Greek, 544-483BC))

Word for the day

Donnybrook (n)

An inordinately wild fight or contentious dispute; brawl; free-for-all

(Source: Dictionary.com)

Malice towards none

What would change if India gets a permanent seat in UNSC?

Bank Nifty: Treading dangerous waters

Bank Nifty has is trading 70% higher than the peak registered in January 2008. It has gained more than 90% since the bottom of 2013.

Fundamentally the returns given by banking stocks could be matter of interesting debate. Since 2013 the banking sector has seen consistent decline in credit growth.

A large part of this decline could be structural as (a) the fuel price subsidy reforms and deregulation of petrol and diesel prices has drastically reduced the funding requirements; (b) the change in taxation norms for debt oriented mutual funds has moved the short term credit market away from banks to bond market; and (c) lending against gold and shares has also fallen.

The cyclical part of decline especially in housing, commercial vehicles and infrastructure projects has also worsened in past three years.

The capital inadequacy of PSU banks has risen with worsening NPA cycle.

These factors make it difficult to expalin this bull market in banking sector.

In strict technical sense, Bank Nifty broke down on daily charts last month. This month it has shown distinct signs of breaking on Weekly charts. A fall below 16200 level may open the flood gates.

Fall below 970 for HDFC Bank and 644 for Yes Bank could be two pointers to the bad times coming in Bank Nifty.

Thursday, September 24, 2015

Sitting tight and liquid, and praying

Thought for the day

"Youth is easily deceived because it is quick to hope."

—Aristotle (Greek, 384-322BC)

Word for the day

Penitent (adj)

Feeling or expressing sorrow for sin or wrongdoing and disposed to atonement and amendment; repentant; contrite

(Source: Dictionary.com)

Malice towards none

Well done Mr. Fadnavis!

Now please also tell us whatever the previous government did to suppress the freedom of expression and appease religious minorities was right and you see nothing wrong in continuing with those practices.

Sitting tight and liquid, and praying

Past few months have been tough on both investors and investment experts. The rise in uncertainty and consequent rise in volatility in asset prices and returns has made the task of asset allocation tougher. Traders appear even more exasperated.

Under the circumstances you cannot find fault with me, if I pray, totally with selfish motive and all my sincerity — "May RBI governor please (a) not effect any change in the monetary policy stance and key rates; and (b) make a strong commentary on the inadequacy of government's efforts in reviving economic growth and preparing for a potential 2008-09 like global contagion."

This coming on the back of a spate of growth downgrades and global risk-off trade, may lead to material correction in Indian equity and bond prices. The assets which are quoting at "middle of the channel prices" may correct sharply to the lower bound of the channel and provide an entry point where I do not have jostle with too many other buyers.

I firmly believe that:

(a) We have already entered the phase of low inflation and lower growth. With most extant drivers of growth (US, EU, China, Commodity producers) throttled by sluggish demand and excessive debt, it is highly unlikely that we may see any meaningful recovery in wages and industrial commodities, energy & food prices for next few years.

This phase may last at least for next 3years. The interest rates in India are definitely not rising from the current levels in this period. They may in fact be cut materially once the liquidity conditions improve.

Given the relatively strong macro fundamentals, the government of India securities (Gilts) therefore would make an attractive low risk investment.

My simple calculation suggests if I can get an entry when benchmark 10yr trades at 7.9% yield, I may be able to get ~9% CAGR for next 3yrs, assuming the benchmark yields correct by 65-70bps over this period.

Not at all bad when the nominal growth is expected to be close to 10%.

(b) The convergence of equity yields and bond yields has historically led to beginning of most bull markets in Indian equities.

A sharp correction in equity prices, alongside bond price correction courtesy Governor Rajan and Chairperson Yellen will also provide a hassle free entry point in Indian equities.

As indicated this Monday (see here) the market internals are weakening with each passing day. In past two days, the cracks in Nifty have widened further.

I do not know what would be the immediate trigger, but ~7K on Nifty appears quite plausible from here.

In the meanwhile, I am sitting tight and liquid.

Wednesday, September 23, 2015

Clear majority for NDA in Bihar!

Thought for the day

"What it lies in our power to do, it lies in our power not to do."

—Aristotle (Greek, 384-322BC)

Word for the day

Enervate (v)

To deprive of force or strength; destroy the vigor of; weaken; enfeeble, debilitate, Sap.

(Source: Dictionary.com)

Malice towards none

Congress and Apple Inc. ......hmm........hmmm........hmmmmmm.

Clear majority for NDA in Bihar!

Somehow the Bihar election has become a major event for the markets. Many financials experts have reported on the probable outcome of the elections and subsequent impact on the Indian politics and economy.

Reading many of these lengthy report, I am reminded of the song Eer Bir Phatte made popular by Amitabh Bachchan in 1996 (see here). The song depicts a poor guy who always tries to imitate his smarter friends but never succeeds. Regardless, I am also trying to present my report on the Bihar elections.

Speaking to many people living across Bihar, people from Bihar now living in Delhi and Mumbai having close ties with the people back home, and trustworthy political activists, political workers, NGO operators & my colleagues who have travelled to the state extensively in the recent times I have concluded as follows:

The election

(a) BJP led NDA may emerge as a clear winner in the State. Except for a few pockets in South Central Bihar, the alliance may dominate the entire State.

(b) Like 2010 and in line with the national trend of past 4 years, the winning alliance will get a clear majority. (170-210 seats out of 243)

(d) Nitish Kumar led JDU will be a major loser in this election, but will retain the principal opposition roll.

(e) RJD will be the biggest loser in the election in terms of credibility and sustainability.

Political fallout

(1) The non-Congress ruling parties in Odisha, West Bengal and Tamil Nadu will become more cautious of BJP and may become reluctant to cooperate too much at the center.

(2) The Congress with its back firmly stuck in the wall, may become more belligerent in the Parliament. It may also see acceleration in exodus in poll bound states of UP, West Bengal, Assam, etc.

(3) PM Narendra Modi and BJP President Amit Shah will be able to silence the isolated voices of dissention within the party.

Economic consequences

(A) Expect almost immediate acceleration in public spending on infrastructure development.

(B) The improved law & order conditions may stem the exodus of talented, wealth and wealthy from the state.

My team is planning an extensive 10day trip to the State. Shall get back with first hand assessment by middle of next month.

Tuesday, September 22, 2015

Staying put for good times

Thought for the day

"All paid jobs absorb and degrade the mind."

—Aristotle (Greek, 384-322BC)

Word for the day

Timocracy (n)

A form of government in which love of honor is the dominant motive of the rulers.

(Source: Dictionary.com)

Malice towards none

RSS chief is addressing investors' conferences in Mumbai, calling for end to redundant traditions and religious practices, wants review of reservation practices - change is in the air! or is it?

Staying put for good times

The narrative of Bihar election makes one thing clear — "Dynasty" as an electoral plank has been rendered completely redundant. No one has ever uttered this word in the campaign so far.

Though Mulayam Singh Yadav has entered the fray with much fanfare, Mayawati is conspicuous by her complete absence in a rather prominent dalit battle. Is she strategically saving her resources for UP battle due in March 2017, or ....?

An Investor's Diary

All those busy writing epitaph of Chinese economy may note that the colossal manufacturing infrastructure and skill set China has created over past two decade is for real. As in India, the people who have been lifted out of abysmal poverty are real. The banks may fail. Large corporations may go bankrupt and wound up. But roads, railways, power plants, factories, houses, ports would remain.

In India, today investors may not wish to invest in equity of troubled companies like JPA, GMR, GVK, Lanco, etc, but there are buyers of the assets created by these company. Likewise, the Chinese equities may be going out of favor but Chinese assets are not.

So, as a financial investor I may be feeling the pain as the bubble completes the burst and valuations correct to more realistic levels, I am certainly staying put for good times that would inevitably follow.

Events in our backyard

FM exudes confidence on growth, GST roll out as government rolls out 24X7 power for all in 3 states.

Morning walk through the woods

Oil speculators bullish after 2months as supplies fall. Fed decision to postpone the "liftoff" raises global growth concerns afresh.

An Investor's Diary

In a recent interview to Indian media, the legendary Vinod Khosla expounded how reality sometimes diverges from stock market valuations.

He very rightly observed that "If you look at internet traffic through the bubble in the US dotcom bust, you can't tell where it is. Because internet usage kept going up. It didn't crash the day stock prices crashed. Because prices crashed, it doesn't mean people stop using Facebook. So how do you measure a bubble? Is it the reality of usage or that of valuation. In a valuation sense, you get lots of bubbles. In a real usage sense, you don't!"

I wrote a year ago (see here), bubbles occur when the stakeholders get tired, frustrated and exhausted from prolonged economic weakness. At that point in time, they muster all their courage and supported by the 'authority' do things they would never do in normal times. They do excessive and seemingly irrational borrowing, investing and spending. Capacities are built to the scale unfathomable during normal times.

The good that emerges from these bubbles is usually shared by many. However the bad that emerges out of bust of such bubbles is usually shared only by the financial investors who invariably end up poorer after every such burst.

To correlate with what I am saying - imagine would India be a ITeS superpower without Y2K or technology bubble during late 1990s! Would we build so many houses, roads, malls, power plants, cement plants etc. during last decade but for a credit bubble! Would capital be so easily and cheaply available to Indian entrepreneurs without the a QE bubble in the west!

The stock valuations of many real estate and infra developers, lenders and asset owners may not be fraction of what it was in late 2007, but all those assets created by them are there for us to use.

In my view, the valuation bubble in China (or bust of that) must be seen in this light.

These will not only support Chinese economy for decades but also support capital starved African, East European and Asian economies through leasing their manufacturing facilities to them.

In India, today investors may not wish to invest in equity of troubled companies like JPA, GMR, GVK, Lanco, etc, but there are buyers of the assets created by these company.

Likewise, the Chinese equities may be going out of favor but Chinese assets are not.

Monday, September 21, 2015

Nifty: Breakdown prevented but internals weaken further

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

Too-too (adj)

Excessively and tastelessly affected

(Source: Dictionary.com)

Malice towards none

Common youth of India who had zestfully come out of their comfort zones and took on streets just a couple of years ago - is again disenchanted by politics and politicians.

Who is to blame for this antipathy?

Nifty: Breakdown prevented but internals weaken further

As expected (see here) last week NIFTY mostly oscillated within the 7560-7940 range and successfully prevented a break down. Nifty also managed to close the week near 8000 mark, thus leaving chance of the pull back rally extended to 8240 this week.

The internals for the market though continue to weaken. Despite an eventful week the market completely lacked momentum. Institutional activity remained low. Market breadth remain almost even. Implied volatility fell materially.

The retail participation remained high. The small caps showed first sign of capitulation, though broader market continue to outperform.

As the comparison with November 2007-March 2009 period shows, this usually is the beginning of the last leg of a market cycle. Expect large cap to outperform in next 6-9 months as market searches for a bottom.

Friday, September 18, 2015

It's not about monetary policy alone

Thought for the day

"Whatever the tortures of hell, I think the boredom of heaven would be even worse."

- Isaac Asimov (American, 1920-1992)

Word for the day

Tommyrot (n)

Nonsense; utter foolishness.

(Source: Dictionary.com)

Malice towards none

Who has inched closer to UNSC permanent seat:

India

Germany

Japan

All of the above

None of the above

It's not about monetary policy alone

I am not sure how many people will agree with me on this. Regardless, I have an opinion - the autonomy and objectivity of central bankers is highly overrated. I find a variety of events (including politics and geo-politics) reflecting on the monetary policies of central bankers across the world - Our RBI and US Federal Reserve being no exception.

With this premise, I believe that the FOMC decision on reversing the rate cycle needs to be anticipated in the following light.

Post Lehman collapse, it appeared that the US is becoming a marginal force in the emerging global order. Emerging economies like BRIC, South Africa. Mexico, Indonesia etc. asserted themselves as leaders in a new multipolar world. G-20 was formed to undermine the supremacy of US led G-3, G-8 etc. The global multilateral financial and development institutions also saw rise in influence of these countries in their affairs.

However, the events of past one year are a clear subtle pointer to the fact that Uncle Sam may have lost a few battles, but it is close to winning the war. Consider this:

(a) Plagued by sub-prime crisis which crippled its financial institution, the US did not bow down. It successfully transmitted the disease to these resurgent emerging economies and rescued its financial institutions. Most emerging economies, especially India and China are now struggling with huge sub-prime assets with no clue as to how to get rid of these. US banks are now inarguably amongst the strongest global financial institutions.

(b) Many influential voices from the US have already suggested that the era of global economic cooperation and coordinated policy action is over. We will do only what is in the best interest of the US is the new mantra. No one is mentioning Plaza Accord of 1980s. If monetary tightening in the US disrupts common man’s life in over 100 countries - so be it.

(c) After becoming energy independent, the US does not bother about situation in Middle East or South Asia. Iraq was raided merely on the basis of unfounded doubts about weapons of mass destruction. Syria has actually used these weapons and no action is promised. The proposed Immigration Bill also indicates towards rising protectionism.

(d) US Federal Reserve, who bought all the bonds that came its way in past 3years has ended up making much more money than what people thought it would have sank in saving US financial markets. In past 10months, Fed has contracted its balance sheet and USD has seen its strongest rally since 1984 (see here).

In my view, at the most opportune time US will strike hard on the opponents. A swift reversal of rate cycle (and consequent stronger USD) may adversely impact exports and earnings of many large US corporations. It may also adversely impact housing market as the mortgage rate rise. This would all be temporary and manageable damage. However, it will inflict a material disaster on the competitors like Russia, China, and Arabs and at the same point cushion US against the contagion reaching her shores.

In simple terms, the rate hike is not about monetary policy alone.

Wednesday, September 16, 2015

2008 like panic selloff will be an opportunity

Thought for the day

"No sensible decision can be made any longer without taking into account not only the world as it is, but the world as it will be."

- Isaac Asimov (American, 1920-1992)

Word for the day

Mollify (v)

To soften in feeling or temper, as a person; pacify; appease; to mitigate or reduce;

(Source: Dictionary.com)

Malice towards none

Aug WPI down 4.95%. Will the Government come forward to claim credit for this fall in prices?

or will it accept it as a problem?

2008 like panic selloff (not likely) will certainly be an opportunity

The economists and strategists worldwide are busy preparing for the first Fed rate hike ("the Lift") in over a decade.

The recent data has pushed the debate over "IF" to the fringes. The debate over "WHEN" is also no longer aggressive. The consensus is that it is certainly happening in calendar 2015.

Those whose strategy and portfolios are fully aligned are expecting the Fed to begin lifting in right earnest from 17th day of September 2015 and reach summit before summer of 2018. Simply, look for OW USD, UW Gold, UW EM Currencies & Equities to locate this group.

Those who are not fully prepared are hoping it to begin sometime in 2015 and then pause for a long time giving them time to prepare for the yet newer normal. To locate this group look for terms like "differentiated EM strategy", "bull market in bonds not over yet", "opportunities in peripheral European debt", "Chinese equities offer great value", etc.

There is a small group busy in overanalyzing China and the deflationary contagion it is exporting. The members in this group do not see much chances of the "Lift" anytime soon. They are obviously least prepared. Look for OW US Treasuries, OW EMs to locate this minority group.

The debate is mostly now focused on "WHAT" would be the likely consequences of the Fed rate hikes.

First where majority is in agreement - USD will strengthen in all likelihood against the EM currencies that have enjoyed weaker USD, near zero interest rates and higher commodity prices for over a decade.

The consensus however has yet not emerged on the extent disruption such rate rise will cause in the short to midterm. Many emerging markets, especially those driven by commodity boom, have accumulated debt in billions of USD debt that needs to be repaid at some point in time. The rise in their accumulated debt consequent to USD appreciation, along with higher debt servicing cost and lower commodity realization, will force dilution of huge USD reserves accumulated over years. Consequently the world will face tighter liquidity, demand contraction, asset price erosion and strengthening of deflationary pressures. These effects may however be mitigated materially if the "Lift" is accompanied by material liquidity infusion by US Fed (QE4!), ECB, BoJ and PoBC.

Second, where there is little agreement - how it will impact the US global corporations that drive a large part of their revenue from emerging markets, and the consequential impact on the US local job market.

Insofar as India is concerned, in my view, Fed rate hike would be relatively smaller part of the problem. The direct impact may be limited to the companies with unhedged exposure to USD debt. The impact on trade account may also not be materially disruptive.

The market disruption could be caused by tighter liquidity and consequent acceleration in FPI outflows.

A 2008 like panic selloff (not likely) will certainly be an opportunity here.

Tuesday, September 15, 2015

Fed hike: Sooner, faster

Thought for the day

"Life is pleasant. Death is peaceful. It's the transition that's troublesome."

- Isaac Asimov (American, 1920-1992)

Word for the day

Genesis (n)

An origin, creation, or beginning.

(Source: Dictionary.com)

Malice towards none

After KM Birla, now Cyrus Poonawala buys an expensive (Rs725cr) property to live.

What about investing in Make in India?

Ain't it more Italian or Greek than American?

Fed hike: Sooner, faster

David Rosenberg, chief economist and strategist at Gluskin Sheff, highlights, in one of his recent reports, that the US labor market is on the verge of becoming a sellers' market.

Rosenberg writes—

"The ratio of the unemployed to the level of job openings has decline to 1.43x, far below the near-7x peak at the worst part of the Great Recession and a place we have been at just two other times before (since the JOLTS data were first published.)

This may well be the most accurate measure of just how tight the labor market is - we are heading to an environment where we are down to one person competing for one job.

The sands have shifted towards this being a sellers' market for labour.

Wage acceleration either starts real soon or we can simply take the laws of supply and demand and throw them in the dustbin."

This essentially means two things:

(a) The wages in US are likely to begin their northward journey soon; and

(b) the US Fed may begin to hike soon and complete the task faster than most are expecting.

In an unrelated but still pertinent move the New York State has decided to raise minimum wage for fast-food workers to US$15. Political observers expect the move to reverberate in other States also.

The positive demand-supply gap in US labor market combined with (a) stronger USD; and (b) pressure on export prices due slower European and Chinese demand may be a good news for Indian technology services outsourcing companies.

Regardless of Trump's rhetoric, we may actually see relaxation in H1b quotas in next few years.

Good times may be round the corner for India IT, ITeS, and CRAMS companies. Just watch out for more competitive devaluation of CNY.