Vijay Kumar Gaba

Wednesday, October 5, 2016

Accommodation is the word

Thought for the day

"The same ambition can destroy or save, and make a patriot as it makes a knave."

— Alexander Pope (English, 1688-1744)

Word for the day

Gale (n)

A very strong wind.

Malice towards none

Heard an IT Commissioner issuing an open challenge - 'Those who have avoided paying 45% will definitely end up paying 60% (30% tax and penalty @100%, i.e., another 30%)!

First random thought this morning

Why Arvind Kejriwal is important to Indian media?

He is obviously the least powerful, and therefore least important, of the 31 chief ministers in the country.

Why is it so that the national media, especially electronics, considers it important and necessary to highlight whatever he says or does?

In Delhi or Mumbai, did you bother to know what Pawan Chamling, Okram Ibobi Singh, Lal Thanhawla or Mukul Sangma have to say on the surgical strikes on Pakistan?

Accommodation is the word

The Monetary Policy Committee of RBI made its first policy statement yesterday. On the basis of an assessment of the current and evolving macroeconomic situation at its meeting today, the Monetary Policy Committee (MPC) decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 6.5 per cent to 6.25 per cent with immediate effect.

Overall the Committee sounded neutral on the macroeconomic and monetary conditions and very accommodative, as it expected the domestic momentum to get somewhat offset by the global slowdown.

The Committee said, "The momentum of growth is expected to quicken with a normal monsoon raising agricultural growth and rural demand, as well as by the stimulus to the urban consumption spending from the pay commission’s award. The accommodative stance of monetary policy and comfortable liquidity conditions should support a revival of credit to the productive sectors. The continuing sluggishness in world trade and smaller terms of trade gains than in the past point, however, to further slackening of external demand going forward. Accordingly, the projection of growth of real gross value added (GVA) for 2016-17 is retained at 7.6 per cent, with risks evenly balanced around it."

In this context it is pertinent to note that the rating agency CRISIL in its latest report has observed material improvement in the credit quality of Indian companies during 1HFY17. As per the rating agency, for the first time in the last 10 semi-annual periods, the number of debt upgrades outnumbered the number of debt downgrades. The ratio for 1HFY17 stood at 1.2 compared with 0.8 2HFY16.

The report highlights that there were 646 upgrades to 553 downgrades in the first half. Upgrades were concentrated in the domestic consumption-linked sectors such as auto ancillaries and packaging, and in the exports-linked pharmaceutical sector. On other hand, downgrades were mainly in the investment-linked sectors such as construction, industrial machinery, real estate and metals. Financial (capital structure, debt protection and liquidity) and business (demand, profitability and working capital cycle) reasons contributed equally to rating actions.

CRISIL forecasts the overall ratio to stay above 1 in the near term led by an expected rural leg-up to private consumption following a near-normal monsoon. However, the agency warns that the debt downgrades in value terms are expected to be more in the second half because of continuing pressure on the investment-linked sectors.

In view of the rating agency the investment cycle is yet to pick up, there hasn't been a material deleveraging in corporate balance sheets, and weak assets continue to mount in banking. The focus therefore has to be on the sustainability of this improvement in credit ratio.

Tuesday, October 4, 2016

Gather amunition before the war begins

Thought for the day

"And, after all, what is a lie? 'Tis but the truth in a masquerade."

— Alexander Pope (English, 1688-1744)

Word for the day

Knave (n)

An unprincipled, untrustworthy, or dishonest person.

Malice towards none

Is our fight with Pakistan or Pakistanis?

And have we already defined who is a Pakistani?

First random thought this morning

I have not heard anyone who seriously believed that the latest Indo-Pak standoff could actually escalate into a full-fledged war.

I am therefore totally unable to explain the losses in financial markets on last Thursday.

I suspect it could either be a case of foul play or something serious taking shape in the womb of time that will be revealed in due course.

Gather amunition before the war begins

As the date for RBI's periodic policy review date draws closer the anticipation regarding the likely move on policy rate is rising. Like most preceding policy reviews, the opinion is divided this time also.

The analysts and economists have been arguing against any decision to cut repo rate in today's MPC meet. However, the bond traders and investors appear convinced of a rate cut.

This dichotomy is not unprecedented. Rather it is very common during periods when the monetary policy is expected to play an aggressive role in the overall macroeconomic conditions. Usually it occurs closer to the peak and troughs of the rate and economic cycles.

More often the traders get it right. However, whenever they are wrong, the losses are huge. Whereas economists and analysts usually have not much to lose, should their expectations not materialize.

Though as usual I would avoid speculating what MPC statement to be released later in the day will read like; in the current instance, I would wish that a 25bps cut in repo rate is done in each of next three MPC meetings, beginning today.

This is nothing to do with the FM, industry or traders urging for a rate cut. I intuitively believe that under the current circumstance it would be the right thing to do. For example, consider the following:

(a) BoJ in its last policy statement has indicated that the current monetary policy direction may have lost its utility and a change would in the order. It is likely that US Fed may hike the key policy rates in next 3-6months, reversing its stance taken since December 2015. Some other key central banks may also be forced to change their current policy stance in 2017.

The immediate impact of such changes on global economy and market is unpredictable, thus higher volatility is likely, especially in the currency market.

Under the circumstances it might be desirable for RBI to create some policy cushion for defending INR and attracting higher flows by raising rates. This cushion is almost absent currently, in my view.

(b) The rate cut today will come at almost no cost as inflation outlook has improved materially; with IDS, disinvestment and spectrum sale the fiscal balance appears supportive of lower rates; economy is far from heated and with real estate market is at bottom no bubble is floating around. To the contrary, a rate cut today will help banks repair their bleeding balance sheets and get prepared for the next credit cycle as well as for any crisis like situation, should the global conditions deteriorate rather precipitately.

(d) The demand outlook is improving with government willing to spend more. Lower rates will have the desired multiplier impact

Monday, October 3, 2016

Nifty: tighten your belt

Thought for the day

"Lulled in the countless chambers of the brain, our thoughts are linked by many a hidden chain; awake but one, and in, what myriads rise!"

— Alexander Pope (English, 1688-1744)

Word for the day

Sublime (adj)

Complete; absolute; utter; supreme or outstanding.

Elevated or lofty in thought, language, etc. e.g., Paradise Lost is sublime poetry.

Malice towards none

Have the surgical strikes in PoK by Indian Army taken the government beyond any criticism?

First random thought this morning

The farmers in the border areas of Punjab have been evacuated by the Indian Army for security reasons. Many of them have the crops standing ready for harvest.

I am sure the State will compensate for them adequately for the financial loss. But the loss of precious food grain will not get compensated.

Nifty: tighten your belt

As pointed out last week, in September the divergence between the MoM change in headline Nifty value and the change in MoM average traded value has widened to the largest since March 2016.

There is enough evidence to suggest that this divergence shall get minimized in the month of October. In simple terms it implies that Nifty shall move in a much larger range this month, mostly trading in the upper half of the range and perhaps settling around or below the average.

Given the present chart patterns and placement of momentum indicators, it appears that after a week of consolidation, we may see a sharp jump higher in Nifty, before it settles down little lower to end the month with decent gains.

At the same time, it is critical to note that the intermediate uptrend from the intraday lows of September (8555.20) could be the last such up move in the larger up move that started from February intraday low (6825.80).

I expect Nifty to record an intraday high between 9370-9410 in this up move that may last anywhere between 3-13 weeks. A 8-10% shall likely follow post the tryst with the new peak.

In short technically expect a 8-10% Nifty up move from the current level followed by a 8-10% correction; all in the next 6months.

Last week, Nifty has defended the 8606-8630 range (on closing basis) despite rise in momentum. This morning there is nothing to suggest that this support base will be broken meaningfully this week also.

Bank Nifty though is looking shaky. As suggested last week, I would continue to avoid banks for any short term trading.

Friday, September 30, 2016

Strategy

Thought for the day

"Gratitude is usually the secret hope of further favors."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Lodestone (n)

Something that attracts strongly.

Malice towards none

Everyone gets to retreat back to barracks.

Indian Army can claim "We did it". Twiterrati can finally rest claiming "we are great". Politicians can submit ATR.

First random thought this morning

None of the members of the family of Mr. Bansal were co-accused in CBI's case.

Why even after 2days no process has been initiated against the CBI officers who allegedly drove them to death. Usually an FIR for abetment to suicide u/s 306 IPC is filed immediately on the basis of suicide note.

Is morality again overriding the legality?

Strategy

Based on the assumptions highlighted yesterday (see here), other strategy inputs that I have been sharing with the readers from time to time through this column, and market performance of the 1HFY17, my strategy for 2HFY17 and FY18 would be as follows.

It is pertinent to note, there are some key changes with respect to currency and rate outlook mentioned in my last strategy outline (see here) shared with readers in April 2016.

The strategy

(a) In the past one year, the government has shown strong resolve to afford a good deal of autonomy to the public sector enterprises (PSEs) which have been performing well. However, this resolve is yet to be tested in adverse circumstances, e.g., fuel pricing autonomy if crude price rise above US$80/bbl; or autonomy to banks if political considerations require loan waivers or sale of sick units if unions oppose the move etc.

For now, despite sharp outperformance of many PSEs, I would continue to avoid them. The exceptions could be couple of large banks and couple of other enterprises that may become irresistible due to short term business opportunities. (The change is from complete "no go" to surgical strike.)

(b) Consumption will remain the dominant theme in my equity investment portfolio. I would continue to focus more on consumable services - especially health, retailing, entertainment, and financing.

On product side, I would continue to focus on aspirational products like lifestyle drugs, beer, premium liquor, household upgrade (lighting, tiles, plywood), luxury housing, premium automobile, packaged food (non-basic), etc. (No change in this.)

(c) Technology & pharma will continue to be core theme in the portfolio. Focus will remain on innovators, designers, and engineering services. I would mostly avoid body shops and pure generic plays.

(d) Will begin to accumulate capital goods players (ex power equipment) and only niche EPC service providers.

(e) Would like to maintain a 5yr duration in my bond portfolio.

(f) Prefer USD exposure over EUR and YEN

(g) Mostly avoid commodity producers except cement.

(h) Lower return expectation from equity portfolio to 9-10% plus 1% dividend yield from earlier 11-12% plus 1% dividend yield.

(i) Will continue to avoid SME segment companies a and focus on upper end of the market, mostly BSE200.

Will divulge more in my regular Samvat strategy note later next month.

Thursday, September 29, 2016

Assumptions for Strategy

Thought for the day

"We have no patience with other people's vanity because it is offensive to our own."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Eristic (n)

A person who engages in disputation; controversialist.

Malice towards none

How relevant are SAARC, NAM and Commonwealth in the present context?

First random thought this morning

Watched the video of presidential debate between Ms. Clinton and Mr. Trump. Three observations:

(1) None of the two candidates appear worthy of becoming head of the most powerful state in the world.

(2) The degeneration in the quality of the leadership might be reflective of the general state of American society itself.

(3) Whosoever wins, it will not make any difference to my life.

Assumptions for Strategy

Continuing from yesterday (see here), I may share with my readers the latest assumptions that would, inter alia, drive my investment strategy for next couple of years; and the key highlights of my investment strategy.

Assumptions

1. The monetary policy of most developed nations and meaningful emerging markets will continue to be accommodative till at least 2018; though there is no evidence available to suggest that BoJ, ECB, BoE, SNB, US Fed, PoBC and RBI etc. will need to materially tighten their monetary policy even after 2018.

2. US Fed fund rates may rise quickly and peak in 1.5-1.75% range by end of 2018. The benchmark treasury yields may have already bottomed and may rise to 2 peak in .75-3% range.

3. US GDP growth might peak ~2.5% by end of 2017 and decelerate thereafter as economic cycle sets in. India & China will continue to grow in 6.5 - 7.5% range supporting the aggregate growth for Asian region. EU, UK and Japan may continue to flirt with recession but may muddle through avoiding any major contraction.

4. Brexit may actually not materialize by the end of 2018. The uncertainties and delays might impact the business to some extent.

5. The global consumption of fossil fuels may continue to underperform the supply. Prices of the conventional energy may continue to remain around the current levels, or moderate a little more.

6. Global demand (both consumption and investment) may not rise materially to cause any inflation scare. However, inflation could surprise on the upside if currency & rate adjustments are not managed well and investors move in a herd away from financial assets and into physical commodities. Precious metals in particular may remain in favor.

7. Indian bond yields may bottom around 5.5-5.75% and stabilize close to 6.5%.

8. INR may move between 65-69/per USD. No devaluation either by China or India.

9. The capex cycle in India may finally begin between 2H2017 and 1H2018. Demand for capital goods, industrial credit and EPC services may see material improvement.

10. The consumption demand - especially luxury consumption, credit and construction material (cement, paint, tiles, sanitary etc.) - to become stronger. Residential real estate to bottom out and start picking up....to continue

Wednesday, September 28, 2016

Lower....sooner

Thought for the day

"The surest way to be deceived is to consider oneself cleverer than others."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Bon mot (n)

A witty remark or comment; clever saying; witticism

Malice towards none

War with Pakistan - Seriously!

First random thought this morning

If we go by the media perceptions - US citizens are faced with a dilemma of choosing the best from two worst presidential candidates.

If I have any idea about the psychology of an average American, expect the voters' participation to be extremely low. Yes, avoiding tough decisions to the extent possible is a common American trait.

Lower....sooner

Some of my readers termed my yesterday post (see here) rather alarmist. I think, it needs some clarifications.

If the contention is that I am hinting at a major correction (10% or more) in the benchmark indices in near term, I must say, that is not the idea. My simple point is that there are early signs of global flows turning erratic in next few months. This capriciousness of flows may cause market volatility to rise materially, which I do not like.

Nonetheless, intermediate corrections in a larger market trend are normal and desirable. As of this morning, I do see the current trend peaking within 3-5% of the previous Nifty closing high of 8997 and correcting 7-10% from there. Such a correction would be healthy for the market and an opportunity to increase equity allocation for investors. I shall be sharing my strategy for preparing for the volatility, correction, raising equity allocation and leveraging the portfolio in subsequent posts.

Now coming back to where we left yesterday.

In my view, The US Fed would need to hike rates not for any conventional reason, e.g., to tame inflation or cooling down the overheating economy. This would be more to help pensioners and bring down the prices of financial assets (stocks and bonds) in sync with the economic reality.

In past five years, Fed has erred materially in estimating the growth of US economy. The realized growth since 2011 has been almost 50% lower than the forecast. Now, the long term median real GDP growth forecast is below 2% against over 3.5% in 2011.

The corporate earnings have been broadly following the macro growth trend. As per some estimates, S&P500 profit peaked in September 2014 and has fallen 19% since then. However, S&P value has continued to rise through multiple expansion. Currently S&P500 is trading at ~25x or close to bubble territory.

Similarly, the rally in US bonds is also beyond rational explanation. With the shrinking tax revenue, rising fiscal deficit and burgeoning public debt, the yields on US bonds may have some solid reason to move up.

The full employment theory of some Fed members might only be partially correct. An overwhelming majority of new jobs are reportedly part-time and contractual. Besides, the denominator is the 4.9% may not be reflective of the true position of workforce. A large number of people are above 60yrs of age but still offering themselves for work. Secondly, there are many who are out of workforce because their skill sets obsolete.

I therefore believe that while the rate hike may be necessary to prick the bubble in the financial assets, the Fed may not be able realize its dream of 3% federal funds rate and 4-4.5% benchmark 10yr yields.

The normalization may occur at much lower levels and much sooner than most expect....continue

Tuesday, September 27, 2016

I do not like roller coaster rides

Thought for the day

"A wise man thinks it more advantageous not to join the battle than to win."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Albatross (n)

A seemingly inescapable moral or emotional burden, as of guilt or responsibility.

Malice towards none

Is India rushing too hurriedly into the Paris deal, or NOW is the time to do it?

First random thought this morning

A large majority of Indians seem unable to decide whether Indo-Pak rivalry is about religion (Hindu-Muslim) or about geo-politics. The perception about and the response to the conflict are therefore mostly confused.

An occurrence of violence evokes extreme religious fervor. An initiative for peace evokes even stronger response from the people living on either side of the border!

Let's first decide what we want - (a) Friendship (peaceful co-existence) ; (b) Enmity (perpetual war); (c) Reunion (Unification through agreement or force)

I do not like roller coaster rides

Irrespective of the state of indecision at US Federal Reserve, the market participants appear preparing for a December hike in policy rates.

There is enough evidence to suggest that the market is now finding the rate hike inevitable. It is no longer a matter of "if", but just a question of "when".

The flattening US yield curve suggests that bond holders are now beginning to prefer longer maturities believing that a hike by Fed hike is inevitable and higher rates will keep inflation under check over mid to long term. (see here)

Chinese authorities have approved trading in credit default swaps (CDS) for local debt. This shows that they accept much higher delinquencies in the local bond market as US rates begin to rise, causing pressure on consumer demand (hence Chinese exports).

The central bankers that have been big buyers of US treasuries, believing these to be the safest haven, have been on a selling spree in past few months. Chinese and Japanese central bankers have sold US treasuries consistently for past three quarters, a record selling spree. (see here)

The reasons for such selling could be multiple. For example selling could have been necessary:

(a) to fund the local fiscal deficit as oil economies and Japan struggle with growth;

(b) to fund the demand for outflow of capital (e.g., in China) as local economy struggle;

(c) to defend local currencies as exports slow down and USD supplies contract due to lower US trade deficit; end of QE program of US Fed and easing US fiscal deficit;

(d) to prepare a war chest, should a currency war is unleashed.

Nonetheless, one major reason is that US bond rally is seen coming to end with the Fed hiking rates.

It is noteworthy that while many Central Banks have lowered their US treasury stock, none has been reported buying gold aggressively. It is clear that central bankers do not anticipate any material rise in inflation in near to midterm as they expect that higher rates will stem any chance of inflation getting out of control.

The question before a tiny investor like me, who does not have any dollar asset, but is invested in equities of Indian companies that may have material exposure to USD assets, liabilities, revenue and/or expenditure, is what should be the strategy under the current circumstances.

In normal course a stronger USD, consequent to Fed hike, should not be a problem for me. However, given that Indian rate cycle may be diverging from the US rate cycle for a year or two, capital flows may become a major challenge. The volatility that may result from a sudden drying up or even reversal of flows would put markets on a roller coaster. I am too scared of such rides....to continue

Also read:

Another false alarm

Monday, September 26, 2016

Nifty: Breakout in October?

Thought for the day

"Why can we remember the tiniest detail that has happened to us, and not remember how many times we have told it to the same person."

—Francois de La Rochefoucauld (French, 1613-1680)

Word for the day

Eutaxy (n)

Good order or management.

Malice towards none

Winter is certainly arriving early this year and promises to be harsh

First random thought this morning

Take one common person from the streets of Lahore and Delhi.

I will wholeheartedly support all war cries against Pakistani people, if any one of the studio experts, warmongers rallying at social media and feudal lords of Mumbai, could tell me any difference between these two persons.

Nifty: Breakout in October?

On past many occasions we have observed that the change in monthly average trading value is a useful leading indicator for Nifty movement in the coming month.

Any divergence in the monthly movement of Nifty and monthly average traded value is usually bridged in the next following 1-3months, depending on the movement in VIX.

If VIX also moves sharply with Nifty, then the divergence may take little longer to bridge. Otherwise, the convergence is seen in 4-6week period.

The following chart of Nifty movement since February this year shows that the convergence An analysis of past six months would show that the divergence is usually bridged in the following 4week period.

MTD in September 2016 Nifty has gained 1% from August closing, whereas the MTD average trading value is higher by 2% MoM. Presently the value of Nifty (8831.55) and monthly trading average for September MTD (8831.52) are the same. Any further correction in Nifty from here will lead to widening of divergence and improve the chances of a converging pattern next month.

I see the up move facing some resistance around 8866 level and a strong resistance around 8978-8999 range. 8774 is immediate support and 8630-8640 a strong support base.

A close above 8774 this month shall see Nifty breaking 9K barrier in next 4-6weeks and mark a new high, before a meaningful correction sets in.

As suggested last week (see here) Bank Nifty appears to be losing momentum. Watch closely for a weekly close outside 19560-20340 range to decide the next course of action. Near term banks are avoidable for trading.