Vijay Kumar Gaba

Thursday, March 28, 2019

Ignore the chimp at your own risk

Some food for thought

"Saddle your dreams before you ride 'em.

—Mary Webb (English Novelist, 1881-1927)

Word for the day

Skimble-scamble (adj)

Rambling; confused; nonsensical, e.g., a skimble-scamble explanation

First thought this morning

Many state governors, judicial officers, and bureaucrats have recently defied the protocol and openly supported ruling party and its leadership. It is constitutionally and ethically wrong and calls for action by the President of India.

However, if we put the constitutional and ethical problem aside, and try to analyze why would a governor or a bureaucrat go all the way out of his domain to defend and/or promote a political party or its leaders, we may get some interesting (for the lack of a better word) insights.

I have observed that every occurrence of this phenomenon does momentarily agitate a certain class of citizens, but no one finds it disturbing. Mostly, all such occurrences are forgotten by dinner time and not considered worth losing one's sleep over.

Perhaps, because such occurrences have been frequent in past 4-5 decades, and fully assimilated in our consciousness; or may be our moral compass is not designed to identify such behavior as moral turpitude. We either dismiss it as routine or accept it as inevitability. "What could we do?"; "All are alike"; "Chalta hai" are some common refrains.

I am not a student of psychology. But I do understand that this kind of behavior is usually impelled, inter alia, by (a) internal insecurities arising from incompetence; (b) feeling obligated to return some favor; (c) getting swayed by a wave of sentiments; (d) failing to assimilate the promotion in stature; (e) lack of dedication to the rule book (in this case); etc.

Nepotism, favoritism and convenience overriding the merit is the primary force that works behind all such occurrences. The Constitutional Oath of Office administered to all elected representatives and people holding constitutional posts — "....I shall perform my duties without fear or favor and without affection and ill will towards anyone..." has literally no sanctity.

Chart of the day

Ignore the chimp at your own risk

The Indian financial markets seems to have put behind the concerns over promoters' pledge, NBFCs' asset liability mismatch, rising delinquencies in small and personal loans, etc and decided to move on.

Blinded by some questionable understanding between the lenders and stressed promoters, the markets for the time being have decided to ignore the chimpanzee in the room.

Indubitably there are many positive trends have emerged in past one year. The IBC process has instilled a sense of urgency in the stressed promoters to repair their balance sheet, even by selling core assets, if needed. In past few days only, companies like DLF, GMR, HCC etc. have taken steps to materially lower their debt levels.

Promoters of beleaguered airline Jet Airways have given up their control to save the company from slipping into IBC process. Promoters of media company Zee Entertainment have also offered to sell controlling stake in the company to pare the debt in their unlisted entities. Similarly, many power companies have sought to resolve their delinquencies outside the IBC process.

As per a research report of Edelweiss, though the progress on the original 12 large stressed accounts put under IBC process is very slow, by end of 2018 "of the 34 stressed power projects identified with debt of INR1.8tn, eight projects (INR363bn) were resolved, two projects (INR164bn) have successfully changed hands, six projects (INR509bn) are in advanced stages of resolution (outside of NCLT), only seven cases (INR244bn) are referred to NCLT and 11 projects (INR494bn) have no significant developments in them".

This is very encouraging and augurs well for the health of Indian industries and financial system. Even more encouraging is the strong interest of global PE players in Indian stressed assets, which vouches for the good quality of assets. However, there are some areas of concern that need to be urgently addressed. The debt against promoter shares is one such area.

In a recent report, rating agency CRISIL has highlighted the extent of gravity of this issue. As per the mentioned report—

"An estimated Rs 38,000 crore of rated debt (accounting for 30-40% of total pledge debt of promoters), backed by pledge of shares, has been raised from the market to date. More than 60% of this is rated in the ‘AA’ category or above, and almost 90% is in the ‘A’ category or above
~90% of the rated pledge debt has transaction cover of less than 2 times. This is in sharp contrast to the Reserve Bank of India’s (RBI’s) prescription of a minimum collateral cover of 2 times for lending against shares by banks and non-banking financial companies (NBFCs)
~10% has transaction cover of 1.3 times or lower, and provides for additional illiquid collateral (unlisted shares, real estate mortgage) to compensate for the lower cover
For ~30% of the rated pledge debt, the pledged shares have to be liquidated within 10 days in order to recover debt and avoid a payment default following invocation
The rated pledge debt transactions are backed by shares of 32 listed companies, of which, 13 are rated in the ‘A’ category or below, or are unrated."

As the following chart shows, during 2005-18, 90% of NSE500 companies with promoters pledge witnessed market cap declines of more than 23% within a month. A 23% price drop implies that if a shares-backed transaction had an overall cover3 (includes both pledge and

unencumbered shares) of 1.3 times4 to start with, in 9 out 10 cases, the market value of the shares could have dropped below the debt contracted within a month, leading to losses for debt holders. During the same period, half of companies having such transactions witnessed market capitalization fall of more than 45%, i.e., even a cover of 1.8 times could have been fully depleted within a month in the case of 50% of companies.

As per CRISIL analysis, "in case the promoters do not have the ability to top up, the structures envisage certain timelines to avoid a payment default through sale of shares in the market. The typical timelines are less than 30 days. Around 90% of the rated pledge debt analysed provided less than 30 days to liquidate the shares, with ~30% envisaging less than 10 days. The timelines envisaged in the structure should be a function of the liquidity in the market to ensure orderly exit without any steep impact cost. However, the liquidity in the Indian market is insufficient to provide an orderly exit in less than 30 days.

As shown in Chart below, it would take more than 30 days to sell Rs 500 crore worth of shares of 50% of companies in the Nifty 500 index and more than 90 days for 30% of companies in the index, if shares worth the average daily turnover of the respective shares in 2018 were liquidated every day.

In my view, the market is ignoring the risk in promoters' pledge based on certain accommodations made in past couple of months. Obviously these accommodations are not a sustainable solution and would become redundant at some point in time. Anyone taking abet based on these accommodations need to take some extra care.

Wednesday, March 27, 2019

Strategy update

Some food for thought

"Give me good digestion, Lord, And also something to digest; but where and how that something comes I leave to Thee, who knoweth best."

—Mary Webb (English Novelist, 1881-1927)

Word for the day

Optics (n)

The way a situation, action, event, etc., is perceived by the public or by a particular group of people.

First thought this morning

Taking the Rythu Bandhu Scheme of Telangana government and PM-Kisan scheme of central government forward, the Congress Party has issued a sketch of the all encompassing minimum income guarantee (MIG) or universal basic income (UBI) scheme for the country.

Like MNREGA that was started on a pilot basis in few district and extended to cover the entire country in few years, this MIG is also proposed to be implemented in a phased manner over several years. Apparently, when fully implemented, the scheme proposes to guarantee minimum Rs6000/month income to the bottom 20% (appx 50mn) households, regardless of their region, religion, caste or occupation.

The Congress party may have proposed the scheme with a motive to take advantage in the forthcoming elections. But that does not take away the importance and necessity of MIG in Indian context, where number of workers are likely to far exceed the number of jobs available in foreseeable future and socio-economic income inequality have already reached alarming proportion.

Unfortunately, the government, ruling party, many economists & analysts sympathizing with them, have decided to out rightly dismiss the idea and even ridiculed the proposal. Many have chosen to criticize the proposal on the basis of fiscal implausibility. The others have dismissed it doubting the intentions of the proposer.

It may be pertinent to note that the proposer has only provided the headline for media. There are virtually no details available to make any comment on the proposal, leave alone an intelligent comment.

But the political bickering apart, I guess it is time that we debate pertinent issues, e.g., the following:

(a) Whether the time is ripe for India to introduce a MIG scheme that is all encompassing and not just limited to the land owing farmers?

(b) Since We the People of India are committed to building a "Socialist, Secular, Democratic Republic" through our Constitution, should we resist any transparent wealth redistribution plan that reduces the unjust socio-economic inequalities and ensures a dignified life for the underprivileged?

(c) If someone has made a proposal that in principle is found to be in wider public interest, would it not be proper for the government to invite the proposer for a presentation and explore the possibilities of implementing with whatever changes/improvements rather than ridiculing it or dismissing it with sheer contempt? After all in spite all its inefficiencies, MNREGA has worked for a decade and changed many lives!

Strategy update

Continuing from yesterday (see here)

I had reviewed my investment strategy last month (see here), and ascertained no need for any change. It is not usual to review the investment strategy at short interval of one month. However, the change in the global growth outlook and monetary policy stance of central bankers, I found it pertinent to review the strategy. Especially, in light of the likely monetary easing and fading of risk from a full-fledged Sino-US trade war. There are indications of change in direction of global flows towards emerging markets.

In domestic context, there is virtually no improvement in the earnings visibility and fiscal conditions. The consensus on election outcome appears to be favoring a NDA government with BJP likely falling well short of 272 mark.

I had expected most of these conditions in my December strategy note (see here). However, lower yields happening much earlier than expected, higher visibility of monetary easing and change in direction of FPI flows towards high yielding emerging markets are changes that warrant some changes in strategy.

Upon reviewing my strategy in this light, I have made few changes, which are highlighted below.

(a) Continue to maintain 15% allocation to gold.

(b) Cut debt allocation to 10% from 15% earlier and reduce the threshold for investing in duration products to 7.7% from 8% earlier.

(c) Increase equity allocation to 75% from 70% earlier. Out of this 75%, keep 60% invested in mix of quality large and midcap. Keep the balance 15% for active trading rather than invest in strategic portfolio as planned earlier.

(d) Continue to prefer PSU banks, pharma companies with domestic focus, construction companies with stretched balance sheets, which are most likely to survive, and real estate and ancillaries like cement, tiles, sanitary, plywood, electric fittings etc.

(e) I am mindful of the possibility of a significant global market correction and consequent major correction in Indian equities. I would like to hedge against this possibility through quality of stocks in portfolio rather than buying a put. In view of the higher risk, I am hiking my expected return from equities to 22-25% against 18-22% earlier.

(f) I shall be trading actively in at least 50% of my portfolio, against 25% planned earlier, to take advantage of higher volatility.

I would like to reiterate that I am not at all worried about the post election political situation in May 2019. Any major correction in market due the election outcome would be a great trading opportunity in my view. I would not be averse to using leverage to take advantage of this trading opportunity, if it does present itself.

Tuesday, March 26, 2019

Outlook and Strategy review

Some food for thought

"I want a real revolution, a real change in society: society, a great organic mass of well-regulated forces used for the bringing-about a happy life for all."

—William Morris (English Designer, 1834-1896)

Word for the day

Isolato (n)

A person who is physically or spiritually isolated from their times or society.

First thought this morning

The incumbent government has persistently sought to change the narrative of nationalism and patriotism in past five years. It wants citizens to blindly follow the path directed by it and believe whatever is narrated to them. Any resistance is met by serious allegations of sedition and anti nationalism.

As a responsible citizen, I do have full faith in my government and administration. I sincerely believe that the persons in power are people of integrity and good intentions. But that does not mean that I am willing to renounce my democratic right and obligation to ask questions and verify the bona fide of the conduct of the government and administration. Otherwise why would we need institutions like CAG, CVC and Lokpal.

I do believe that the Institution of Armed Forces is critical to sustainability of any democratic society. This Institution must be strong, capable and command complete faith of the citizen. This Institution should be beyond any suspicion at all times. It would be possible only when this Institution is fully accountable to people.

It is unfair to equate the soldiers who are just one part of the Institution of Armed Forces, with the institution itself. These brave individuals must be respected and honored for choosing an occupation that requires total commitment & dedication to the security of nation; and involves extreme risks. We the people owe a lot to the soldiers who make extreme sacrifice in line of their duty, and cannot do enough to repay the debt we owe to their families.

But valor of these soldiers cannot and should not absolve the Institution of Armed Forces from its accountability. The Institution must answer all questions that relate to the security & safety of its own personnel as well as security & safety of the nation and its people.

I refuse to accept this allegation that questioning the Institution of Armed forces is anti national or seditious. I have no sympathy with the opposition leaders who might be driven by their vested interests in questioning the government intent behind the airstrikes on Balakot. Nonetheless, I would like to know, for example:

(a) Whether the airstrikes were an act of revenge of Pulwama attack or was it aimed at preventing any recurrence of attacks on security forces in Pulwama, Pathankot, Uri, Gurdaspur etc.

(b) Has any enquiry been set up to investigate the security lapses leading to Pulwama attack? Shall we see action taken against people whose negligence caused loss of 44 precious lives?

(c) It is claimed the Prime Minister himself commanded the entire operation. Did Cabinet Committee on Security empower the Prime Minister to bypass the defense minister and command the Armed Forces himself? Was the supreme commander of Armed Forces, the President of India was duly informed before the strikes?

(d) What measures were taken to ensure the safety and security of people who would have been immediately affected if the Pakistan had decided to escalate the situation?

I also refuse to acknowledge that any political party, social or private organization has any right to term anyone anti national or seditious. It is for the law enforcement agencies and courts to decide that.

Outlook and Strategy review

The weather conditions in markets have suddenly changed. Some dark clouds have emerged from horizon to overcast what appeared like end of long winter and beginning of a glorious spring.

The first yield curve inversion in US (implying that 91days treasury bill yield is more than the 10yr treasury bond) since 2007 has raised the specter of recession again.

Last week, US Federal Reserve (Fed) in its latest monetary policy statement highlighted that "Economic activity has slowed from its solid growth rate in the fourth quarter" and "Recent indicators suggest slower growth of household spending and business fixed investment". Fed has accordingly paused the rate hikes and is not expected to make any changes in federal fund rates in the current year. Fed has also decided to end the monetary tightening program by September of 2019.

Early this month, The European Central Bank also revised downward its forecast for growth and inflation. It now expects headline inflation rate to slow down reaching 1.2% yoy for 2019 and the GDP growth rate to reach 1.1% yoy. Accordingly, ECB is also expected to hold its 0% rate through 2019 at least.

Bank of Japan has also expressed its intention to maintain "powerful easing monetary policy" for the time being, in view of the growth challenges.

Concerned by the growth slowdown, the People’s Bank of China said in January that it would supply lower-cost liquidity for as long as three years to banks willing to lend more to smaller companies, as policy makers roll out targeted measures aimed at shoring up the flagging economy.

The Reserve Bank of India (RBI) also cut its policy rates by 25bps in February, and changed its monetary policy stance to "neutral" from "calibrated tightening". RBI lowered its growth projections and inflation forecasts. A number of rating agencies have also lowered India's growth forecast for FY20.

In past couple of sessions markets have weakened, but certainly there is nothing to suggest that the markets are priced for a recession.

In Indian context particularly, two material events need to be priced in, i.e.,

(a) At least three agencies have forecasted that there are 60-75% chances of El Nino reviving this summer impacting the Indian monsoon. If this does happen, it shall further impact negatively the already subdued consumer demand.

(b) The model code of conduct remaining in effect for 2months, shall impact public spending and liquidity conditions. 4QFY19 and 1QFY20 results corporate may reflect this.

Given the growth challenges and trajectory of global monetary policy, I find it pertinent to visit my market outlook for next 9-12 months and examine whether any adjustment in investment strategy is warranted.

I feel the following two scenario plausible:

1. US & China slowing considerably, with FAANG and Financials bubble bursting and cryptos going from bad to worse, bringing curtains on the post GFC experiment with extraordinary monetary policies. We may then go back to the classical path or experiment with a new path.

In market parlance, the existing bubble will bust as a new one begins to inflate.

2. The post GFC extraordinary monetary policies getting accepted as a "normal"; global rates moving back to near zero and QE returning in full force.

In market parlance, more gas will be pumped in the existing bursting bubble.

Both these scenarios would mean a violent and devastating endgame before a new dawn. The timelines may though be uncertain and unexpectedly protracted.

These scenarios assume that China will no longer will the demand driver for natural resources, as it had been in past two decades or so; and also there is no visibility of a new demand driver like China. The new investment cycle is most likely to focus on development of "Human Resources" and "Technology" (Artificial Intelligence et al) rather than other "Natural Resources". So far China and US are the two major investors in this arena.

India so far is lagging far behind in both ideation and execution.

....to continue tomorrow