Vijay Kumar Gaba

Tuesday, November 21, 2017

Valuations - Starting from the end

"It is pure illusion to think that an opinion that passes down from century to century, from generation to generation, may not be entirely false."

—Pierre Bayle (French, 1647-1706)

Word for the day

Macaronic (adj)

Composed of a mixture of languages.

Malice towards none

Has the government erred in not marking the birth centenary of former Prime Minister Mrs. Indira Gandhi?

First random thought this morning

LKA build BJP from almost zero to a force to reckon with. NaMo has strengthened this force materially. But one thing that has confounded many is why LKA could not achieve what NaMo has.

I think I have solve at least first stage of the puzzle.

LKA mobilized millions in the name of Ram temple, but never tried to channelize the mob into a positive force working for betterment of life. Whereas NaMo mobilized millions of youth the name of corruption and has shown intent to channelize them into a positive force to work for clean India, self reliant India, self employed India, etc. This positive intent has made all the difference.

Karni Sena might have a lesson to learn here.

Valuations - Starting from the end

In past bull markets I have seen many analysts reengineering their valuation arguments. Instead of arriving at the fair value of a stock through the conventional earnings, cash flows and replacement value arguments, they would seek to apply innovative and fancy valuation criteria like foot falls (for retail stores), eye balls (for ecommerce portals), price to growth or PEG (for IT start ups), NAV per share (for real estate developers) etc. to justify the current market price (CMP). In this case CMP becomes the starting point of analysis.

I can see a similar trend emerging in the current market environment also.

In conventional sense, the return on the investment in publically traded equity is a function of 3 factors (a) earnings growth; (b) changes in price earnings (PE) ratio and (c) dividend.

The earnings growth is a function of multiple factors, e.g., (a) capacity (production capability); (b) demand environment (market leadership); (c) competitive landscape (pricing power, cost advantage); (d) innovation and technology advantage; (e) resource availability (raw material, labor, capital, managerial bandwidth etc.), etc.

The price earnings ratio (PER), one of the most popular equity valuation criteria, is the ratio between the earnings of a company and its market value. It broadly signifies that at the current rate of earnings how many years it will take for the company to add the value which an investor is paying today. Principally, an acceptable PER for a company's stock is defined by (a) the return on equity (RoE) a company is able to generate on sustainable basis and (b) the growth rate of earnings that could be achieved on sustainable basis. A company that could generate higher RoE consistently and is likely to grow faster, should be assigned a higher PER as compared to the ones which generate lower RoE or has low or highly cyclical earnings growth.

A rise in PER, if not commensurate with the rise in earnings profile needs deeper scrutiny. Sometime the rise in PER occurs due to correction in anomalies (undervaluation) of the past. This is a welcome move. Sometime, PER changes (re-rates) due to relative forces, e.g., rise of PER in comparable foreign markets or change in return profile of alternative assets like bonds, gold, real estate etc. This is usually unsustainable and therefore a short term phenomenon. Many times, demand-supply mismatch in publically traded equities also drives re-rating of PER (excess liquidity chasing few stocks and vice versa). This is again usually a short term phenomenon.

Sustainable rise in dividend yield is generally a sign of stable profitability growth (P&L improvement) and strong financial position (B/S improvement) and stronger cash flows. In some cases however it could reflect stagnation in growth.....to continue tomorrow

Friday, November 17, 2017

Mood of markets - divergent views

Thought for the day

"Do you know because I tell you so, or do you know, do you know."

—Gertrude Stein (American, 1874-1946)

Word for the day

Attenuate (v)

To weaken or reduce in force, intensity, effect, quantity, or value, e.g., to attenuate desire.

Malice towards none

Those clamoring for Rajput pride and opposing #Padmavati may please do something to stop female infanticide and incest that plagues their society and makes life hell for millions of living Rajasthani women.

First random thought this morning

There is section of people who is accusing judiciary and regulators for over enthusiasm and activism. Their grouse is that judiciary is overstepping its jurisdiction and may even be infringing the legislative and executive territory.

The point is how did our system reach this stage. It is clearly the failure and corruption of the legislative and executive that is driving this trend.

For example, if executive and legislature were proactive in checking the menace of pollution, why would NGT be needed at first place, and even if constituted, why would it need to pass some seemingly ridiculous orders!

Mood of markets - divergent views

In past few weeks, I have read a number of research reports and market analysis. I have also heard the views of a number of fund managers and investment strategists. Unfortunately, I have not been able to decipher much from all this. Admittedly, my prejudices could be major culprit here. Therefore, I would not like to burden my readers with my conclusions based on the views and opinions of experts.

I would however like to share some guideposts that may help readers form their own judgment about the current mood of markets.

I find that there are two distinct camps of analysts and fund managers:

(a) First camp comprises of those who have seen the exuberance that preceded the last global financial crisis (GFC) and also the melt down that followed it. Experts in this group have seen high growth, full employment, rising interest rates and double digit inflation, Lehman collapse, Merrill Lynch sale and General Motors at brink of bankruptcy. These experts were stress tested for 1930s type of global depression conditions. Many of these also completed the cycle of million dollar bonuses to no pay hike for 5-6yrs. Many of these navigated through GFC adroitly and manage to grow their stature. While others sank with the market but have staged a comeback, but with bruised egos and diminished stature. Most important, experts in this group have experienced asset price falling 50-80% in a matter of one year, from a all blue sky scenario.

(b) The second camp comprises of young people in their late 20s or early 30s, who started their investment career post GFC. These bright guys have mostly worked in 'whatever it takes" and environment, characterized by abundant liquidity, near zero interest rate, very low inflation, low growth that is acceptable as "new normal". The people in this group have only seen asset prices rising steadily while energy prices declined by more than 50%. The belief seems to be that events like Greece default, Brexit, China slowing down from 9%+ growth trajectory to 6%+ growth trajectory, major emerging economies like Russia and Brazil struggling for growth, and India growing at much slower pace are minor aberrations and asset prices have only one direction to move and that is north.

The stance and arguments extended by both the groups are obviously contrasting. Though fund managers from both the groups might be fully invested, the asset allocation and sector preferences do vary materially. Emerging Markets Debt, Gold, US Treasury, Euro, Japan, Chinese mid and small caps, Bitcoins, Frontier Markets etc. are some of the major divergences among the these two groups of experts.

Another stark difference is seen in the valuation argument, especially for equities. While the first group mostly sticks to the conventional valuation matrix, the second group is innovating methods that would justify the current price....more on this next week.

Thursday, November 16, 2017

Judging mood of market

Thought for the day

"The nineteenth century believed in science but the twentieth century does not."

—Gertrude Stein (American, 1874-1946)

Word for the day

Pneumatic (adj)

Of or relating to air, gases, or wind

Malice towards none

Rahul Gandhi - The Alchemist.

RaGa never fails to amaze us with revelation of his new side everyday!

First random thought this morning

Sometimes I find it very unfair. Price of a publicly traded equity share can rise infinitely. But it can fall only 100%.

The history of stock market therefore is dominated only by the winners. No one bothers to remember the stocks which lost 100% of their value. Even if these losers outnumber the winners by 100:1.

Judging mood of market

In the past 17 odd weeks, since Nifty first touched 10K level, the simple average traded value of Nifty has been 10064. The value will be lower if we take the volume weighted average. In this period market breadth has remained decisively negative. The net institutional flows (DII and FPI combined) have been mostly neutral in past 4months.

In period from July to October over Rs220bn have been invested in domestic equity mutual fund schemes through systematic investment plans (SIPs). The current monthly run rate for equity SIP flows is over Rs56bn/month.

This is the period when some significant economic events have taken place, the most notable being implementation of GST. The investors and businesses had been waiting eagerly for this event for past many years. Besides, implementation of new Bankruptcy code and announcement of a comprehensive plan to recapitalize beleaguered public sector lenders are being widely acclaimed as transformational events for Indian economy.

Two sets of quarterly results have been announced in this period. The general consensus amongst analysts and fund managers (at least going by their public utterances) appears to be that earnings for corporate India have bottomed out and a sharp recovery in imminent. Many reputable global fund managers and investment strategist who had turned their back on Indian equities have turned bullish on India in this period.

In the period between July and now, INR has weakened vs USD by almost 1.5%; benchmark yields have jumped up by almost 10%; RBI has cut policy rates once by 25bps and inflation has jumped higher by 200bps.

However, after scaling the mount 10K in last week of July 2017, Nifty has literally gone nowhere, despite much excitement and enthusiasm.

The moot point is weather the markets are still assimilating the changes and may make a move up after consolidating for few months; or market has already assimilated the changes and decided that rally since February 2016 is overdone and a correction would be in order....to continue

Wednesday, November 15, 2017

Strategy Review - 2

Thought for the day

"If you can do it then why do it?"

—Gertrude Stein (American, 1874-1946)

Word for the day

Wastrel (n)

A wasteful person; spendthrift.

An idler or good-for-nothing person

Malice towards none

When all the TV channels in the country unashamedly air private moments of an aspiring politician, why don't I hear a word from the crusaders of the Right to Privacy?

SC has upheld the right to privacy as a fundamental right.

Why should the police not take a suo moto action against people violating this right of Hardik Patel?

First random thought this morning

Any regular visitor to Mata Vaishno Devi Shrine would know that VIP culture has not spared this temple, like any other. It is common to see sundry government servants and their families being escorted by the soldiers in uniform. A number of people carry VIP slips for a privileged tryst with the Divine, while the common people, old and young, man and women, feeble and strong, all struggle in long queues.

The recent NGT order to limit the number of visitors to the holy Shrine will only exacerbate the VIP influence at the expense of the unprivileged devotees. But that is the story of all temples.

I find this appropriation of Deities by VIPs blasphemous, only when I fail to get a VIP ticket. What about you?

Strategy Review - 2

Considering the recent global and domestic developments (some of which I discussed in past couple of posts) I would like to factor in the following assumptions in my investment strategy for next few years.

It is important to note that these are strategic considerations in Indian context, and may or may not reflect on the short term investment strategy for 2018, that I will be sharing with the readers in 4-5weeks.

Factors be incorporated in strategy

(1) Higher inflation.

(2) Higher cost of capital.

(3) Technological disruptions in the areas of mobility and financial services. Going by the current views, the pace of obsolescence and redundancy could surprise the markets.

(4) Prospects of an intense cold war and a bi-polar world. India most likely ends up in the grouping led by US and including Japan. However, any ambivalence on part of India, might prove to be massive disaster in terms of foreign policy and trade.

(5) Greater emphasis on import substitution.

(6) Higher volatility

(7) Lower growth in real income

(8) Rise in risk premium

(9) Stronger INR

(10) Climate change

Strategy implications

· Higher weight for commodity producers and resource owners and lower weight for resource consumers.

· Higher premium to free cash flows and operating leverage.

· Lower weight to passenger mobility and conventional fuel.

· Higher weight to domestic consumption, especially upper middle class.

· Higher weight for sectors with large negative trade balance.

· Lower leverage.

· Higher allocation for expenditure necessary for more household members to go out for work.

· PE De-rating.

· Business automation; lower job-investment ratio; economies of scale.

· Lower dependence on conventional fuel.

· Also see

· In search of black swans

· Assimilating the change

Strategy Review

Tuesday, November 14, 2017

Strategy Review - 1

Thought for the day

"Everybody gets so much information all day long that they lose their common sense."

—Gertrude Stein (American, 1874-1946)

Word for the day

Eurhythmic (adj)

Characterized by a pleasing rhythm; harmoniously ordered or proportioned

Malice towards none

Besides Rakhi Sawant, Rahul Gandhi is the only person seems to be thoroughly enjoying his stint in politics, regardless of election results.

First random thought this morning

Imagine, schools shut in Cherrapunji due to rain, in Leh due to low air pressure, in Helsinki due to snowfall, or Congo due to heat wave. Obviously, children in these places will seldom get to go to school.

Why is that Children in Delhi are made to feel so weak and insecure that they are told not to come to school if it is too cold, too hot, or too dirty?

The better course would be to guide children about the risks and train them to weather these risks. Hiding them behind doors will only make them escapist and materially weaken their survival instincts.

Strategy Review - 1

In the wake of global financial crisis (GFC) in 2008-09, almost all big central bankers chose to follow what is now popularly known as non-conventional monetary policy. They expanded their balance sheets at exponential rates, by buying government as well as corporate securities; maintained rates at close to zero level (some even went below par and used negative rates). The objective was threefold: (a) To stabilize the financial markets and (b) to support sustainable faster growth; and (c) improve employment.

Most central banks were extremely successful in stabilizing the financial markets. Many large financial institutions which were at the brink of failure have revived and even strengthened their positions.

The objective of faster growth has so far been met with partial success only. There are pockets like US where growth has recovered but peaking at much below the pre-crisis level highs, whereas many other economies are still struggling to return to a sustainable growth path.

Employment conditions have improved materially in US and a few other places. But elsewhere there is not much evidence of any sustainable improvement in employment levels.

But if we see on global basis, the economic growth has not been encouraging as the large emerging economies (BRICS et. al.) that were racing fast during the crisis have slowed down considerably, since then.

Another thing that has not seen any material improvement is the status of indebtedness in various economies, especially those which were at the core of the problem. Their debt profiles have in fact worsened over past one decade.

A number of analysts has expected a hyperinflationary situation in the wake of extraordinary liquidity pumped into the global financial system as a result of quantitative easing (QE) program of various central bankers. It did surprise many that despite trillions of dollar being pumped into the system, inflation failed to pick up. Most developed world central bankers are still struggling to meet a modest 2% inflation target.

It is therefore reasonable to conclude the following from the above:

(a) The additional liquidity and fiscal profligacy since GFC has been used mostly to support markets and service the debt; and not create additional capacities or generate demand.

(b) It has perhaps been in the best interest of the debt laden governments to keep the cost of capital (interest rates) low, so that they can service the humongous debt without much difficulty.

(c) The employment levels may have improved in quantitative terms, but qualitatively there is not much improvement. Wage levels continue to remain poor and job certainty low. Consequently, higher employment levels are not reflecting to the desired levels in household demand for consumption and investment. On the contrary household leverage has risen past the pre crisis level in most economies.

(d) Since the entire effort since GFC has got mostly constricted to the financial markets and transactions, the demand for real goods, and therefore inflation, has lagged. The spurt seen in commodity prices in recent times can be attributed more to the supply restrictions (due to shut down capacities or scaled down production) rather than any pickup demand or liquidity issues.

But things may change going forward. New capacity additions and changing technology in automobile sector and popularization of renewable may be leading to rise in demand for few commodities like copper and aluminium etc.

This brings us to the our main topic of implications of the recent developments on Indian economy and the changes needed in investment strategy. In my view, the following global trends shall have meaningful impact on Indian economy in next few years:

1. The growing influence of right wing nationalism shall lead to more restrictions on trade, capital flows and labor movement. Active currency management may also gain currency even with many free market economies.

2. Higher (if not hyper) inflation shall occur and stay for long.

3. Electric mobility and renewable power shall gain popularity much faster than a majority of analysts are predicting today. Peak oil demand may also occur much before OPEC's forecast of late 2030s.

4. The geo-political tensions shall remain at higher level, even if it does not materializes in a conventional war. The cold war could be intense and protracted this time too. India so far has tried to maintain a balance, playing ball with both the potential groupings. This however may not be a sustainable strategy and Indian may eventually end up in a US led group. Worsening of relations with China, Russia and other major trade partners could have serious economic implications for India...to continue tomorrow.

Also see

In search of black swans

Assimilating the change

Friday, November 10, 2017

Assimilatng the change

Thought for the day

"What is the answer? In that case, what is the question?"

—Gertrude Stein (American, 1874-1946)

Word for the day

Razzle-Dazzle (n)

Showiness, brilliance, or virtuosity in technique or effect, often without concomitant substance or worth; flashy theatricality, e.g., The razzle-dazzle of the essay's metaphors cannot disguise its shallowness of thought.

Malice towards none

In childhood we had summer vacation and Christmas break.

My children now have (a) Heat wave vacation in May; (b) Cold wave vacation in January; and (c) Smog break in November.

First random thought this morning

In last one month two criminal cases have shaken everyone's confidence in Indian legal and judicial system. In infamous Aryushi murder case and Pradhyumn murder case, police, administration and lower judiciary seems to have acted purely under influence of perceptions created in media (electronic, print and social).

In knee jerk reaction steps are taken ruining innocent lives. Police arrests people based on media hype. Judges deny bail on ground of morality rather than legality of the case. State administration announces relief and mitigation measures based on TRP of the issue.

It's scary scenario. If you are not scared, pray you do not become the victim one day.

Assimilatng the change

As mentioned yesterday (see here), a number of changes are taking place in the global order that shall certainly have far reaching impact on our lives. Even though many of these changes may not look like so profound at this point in time.

It is important to note that we perhaps have seen the longest period of peace in Christian era with no major armed conflict since Vietnam war ended in 1975. The conflicts in Iraq, Kuwait, Afghanistan, Somalia, Bosnia, Syria etc. have been localized and never threatened the stability of world order. This non-violence and peaceful co-existence is not the basic human instinct in my view. It is critical to see that the beast that has been sleeping for 50years does not raise his head.

The three changes that are worth taking note are listed below. In my view, these changes are profound and will have far reaching implications for the global order.

1. Elevation of Xi Jinping

The amendment of the party constitution effectively confirms Xi Jinping’s as the Mao Zedong of the 21st century – a top leader with no constraints on tenure or retirement age.

As the Independent puts it "The inclusion of Xi’s name in the party’s document makes him only the third Chinese leader to be so honored, with his ideology joining Marxism-Leninism, Mao Zedong Thought and Deng Xiaoping Theory as a “guide to action”. It will now become compulsory learning for Chinese students, from primary schools through to universities."

After Mao, Communist Party ruled through a system of collective leadership. Now the party moves backward, again betting on a man who aims to restore the party’s central role in society, and nation’s central role in global affairs.

Xi Jinping thought embodies two important principles (a) the Party is in control of every aspect of life in China, from the economy to the internet, politics, culture and religion; and (b) China is on a path to become a true global superpower on its own terms. This puts to rest the expectations of China opening up and becoming more democratic as it became wealthier, converging its interests and political system with those of the West. The idea of political reform in a Western sense is now firmly ruled out.

Xi’s wants a nationalist, assertive China that will not threaten the world but will resolutely defend its interests.

Mao’s era was marked by revolution, Deng’s reformed and opened up China putting it on the path to become a global economic power. Xi’s era is likely to be characterized by full control and nationalism. To me it effectively seems like end of the unipolar world that emerged post collapse of USSR. I see Xi's OBOR endeavor as nothing but an attempt to erect the second pole in global geo-politics.

2. Right wing swing of global politics

If someone is thinking that Macron's victory in France has put breaks on the meteoric rise of right wing nationalism in global politics, he/she may be terribly wrong, in my view.

The swing that was widely recognized post Brexit vote last summer, has only gained strength since then. Political developments from US, UK, Spain, Czech Republic, New Zealand, India, et. al. all provide strong evidence to this trend.

Such rise in right wing nationalism historically has invariably worked against the notion of globalization and threatened the global peace.

3. Arab spring 2.0

The recent developments in Saudi Arab are most significant. It would be a mistake to see these developments as localized intra family struggle for power.

This must be analyzed in the context of (a) declining oil economy and rise of electric mobility; (b) strengthening of global alliance against Islamic fundamentalism, especially in view of the rise in terror attacks in Europe, that (c) forced isolation of terror sanctuaries like Qatar, Syria, Yemen, Lebanon, and Pakistan.

The elevation of crown prince of Saudi Arab Mohammad Bin Salman, who vows to transform SA economy beyond oil, implement radical politico-religious reforms, curb terror funding and end hostilities towards Israel to work together for a larger objective is an encouraging sign.

Nonetheless, these developments raise the specter of an armed conflict in the region, with China (and its ally Pakistan) and Russia taking sides with Iran, Syria, Lebanon and Qatar.

Besides long term geo-political implications, a sharp spike in energy prices could create imbalance in global markets. The positive would be a strong push to electric mobility (advancing peak oil demand forecasts from late 2030s to mid 2020s).

I believe that the world is certainly moving fast towards the new dawn.

The transition, like any previous episode, will obviously be tumultuous. But the opportunities will also be tremendous, as always.

I am definitely not eligible to analyze the full spectrum of the change and its wider implications. The idea of this writing is just to make readers aware and to motivate them to undertake intensive study of the patterns.

Nonetheless, I find it important to assess the implications for India and evaluate my investment strategy in that light.

...to continue tomorrow

Also see

In search of black swans