Vijay Kumar Gaba

Wednesday, February 26, 2020

COVID 19 - Strategy review

After initial round of denial and complacency, the global markets seems to be waking up to the grave threat that the spread of coronavirus poses to the global economy and therefore global markets.

As more foreigners emerge out of China mainland, the information opaqueness is diminishing insofar as the official Chinese claims and the popular perception of the spread of virus is concerned. It appears that the impact of virus far more serious initially estimated by global community or communicated by Chinese officials.

In past two weeks the reports have suggested that the coronavirus has invaded many more territories across Asia and Europe. Japan and South East Asia Countries appear to be worst impacted. Japan and South Korea have raised the threat alert level to the highest that allows the government to lock down cities and businesses. Italy has also reportedly shut down schools and crowded market places and stadiums till further notice.

WHO has feared that the virus could be a potential endemic that may impact millions of people. Even the Chinese premier Xi issued a stern warning to a gethering of over 170,000 government and ruling party officials -- the biggest of its kind saying, that the outbreak danger near the heart of the government.

As per a latest research report published by Bank of America, suggests that the US economy may be very close to the tipping point for slipping into a recession. As per the analysis at the popular ZeroHedge blog, "After more than a month of shocking complacency (because what, central banks will somehow print antibodies and "fix" the covid pandemic which will restore collapsing global supply chains?) traders are "suddenly" realizing that the coronavirus outbreak contains a significant likelihood of impact to the global economy and the potential to become a black bat, pardon, black swan type event. An event which could quickly spiral into a US - and global - recession."

IMF has also cautioned the global community that "coronavirus epidemic could put an already fragile global economy recovery at risk. In a statement made at G-20 meet, IMF chief Kristalina Georgieva said "Global growth was poised for a modest rebound to 3.3 percent this year, up from 2.9 percent last year. However, the COVID-19 virus -- a global health emergency -- has disrupted economic activity in China and could put the recovery at risk.

The global markets are obviously nervous. The investors are rushing to take shelter in the safe haven precious metals, USD and bonds. The risk assets - equities, emerging markets, and commodities are selling hard.

Indian markets have witnessed sharp correction accompanied with rise in implied volatility. With the result season over, budget digested and medium term credit policy in place, the market lacks much motivation to resist the selling pressure emanating from global nervousness. Moreover, we are entering the season when traditionally liquidity tightens due to year end settlement demand, harvesting and advance tax payments. Traditionally, in many parts of India, the fortnight before the festival of Holi is considered inauspicious for buying new things, marriages and other functions.

Under the circumstances, it would be reasonable to assume that the weakness in the markets may persist for little longer than most would have assumed.

The question many readers are asking, whether this fall is an opportunity to avail, an occasion to sit tight and wait for the tide to pass over, or a trigger to sell and run away.

Though it is too early, but still I would like to review my investment strategy in order to find answers to these queries.....to continue tomorrow

Tuesday, February 25, 2020

Development vs Growth

In my discussions with the various market participants in last one year, I have realized that "drivers" and "domestic workers" are perhaps the most influential reference points in their analysis and forecasts of the economy.

I have heard many of them proudly alluding to stories how the life in villages has improved in recent years. All the villages have connected to highways through all weather roads. Everyone is getting free money to build pucca houses. Houses in remote villages have got electricity and LPG connections. Children are going to English medium schools. Everyone has a smart phone and internet access. All have a basic bank account. Farmers are selling their crops through nationwide electronic trading platforms. Millions have people got their Ayushman (Health Insurance) cards and can avail free medical treatment in empanelled hospitals, etc.

Many popular analysts, investment advisors and fund managers, have famously narrated on social media, and also during public presentations, how some of their most successful investment ideas and investment strategies have been inspired by the discussions they had with their Uber driver on their way to or from airport.

I fully respect the idea of having a frank conversation with the "driver" or "domestic worker". However, the thought of any such conversation resulting in investment strategy sounds mostly frivolous to me.

I have also heard stories of development in the hinterlands from the immigrants. However, I am unable to correlate their stories to their living conditions in the cities, resistance to the idea of going back to the developed and connected homes, and the conditions I witness during my visits to the so claimed fast developing communities. The stories of drivers and domestic workers sound distinctly similar to the stories narrated by Indian immigrants living in foreign lands. Whenever they return to foreign lands after visiting India for few days, they proudly narrate to their friends how the things have changed back in India - the airports, the malls, drone photography in marriages, broad highways, luxury cars, etc. But while narrating this they are hardly imagining themselves returning back to India.

From the investment strategy viewpoint, I find a stark disconnect between the concepts of economic development and economic growth.

The immigrants are mostly talking about infrastructure development from a very low base. For them, no electricity in 50km radius to an electric connection 7kms away is a huge development. Also, from having to walk 10kms to catch a bus to the nearest town to a bus coming to village once in a day is massive development.

Whereas the analysts and investors are concerned about the growth rate from tomorrow onward because whatever has happened till today, is already there in the price.

My latest visit to some villages and tribal areas in central India highlighted the following to me:

(a) Education and medical amenities continue to remain very poor.

(b) Economic exploitation continues to remain elevated. The "agent" is charging Rs50-70 for every transfer of money from city to village. No one gets minimum wages paid.

(c) The roads are better but these are far from being good. Electricity condition has improved but remains far from acceptable level. Water availability remains critically poor.

(e) The house made even from bricks are mostly Kutchha. These add noting to cement and steel demand.

(f) Mobile phones are both boon and curse for the communities at large.

(g) The financial security of an average farmer is no better than it was 10years ago.

Thursday, February 20, 2020

Stick to your path

The growth vs. value debate is intensifying globally with each passing trading session. As a style, value investing has suffered a severe setback in past couple of years. The growth stocks have massively outperformed, transcending to a different stratosphere altogether. In the process the conventional valuation methods like price to earning ration (PER) and price to book ratio (P/BV) are suffering ignominious isolation. Many famous investors who stood firm to the principles of value investing appear to have changed their investment philosophy.

Mr. Ramdeo Agrawal of Motilal Oswal Financial Services, considered one of the legendary value investors in India famously said in a recent interview, "Value is out of fashion right now, deeply out of fashion. Even Warren Buffett is having a tough time.“Earlier you used to buy cheap. If you end up buying cheap, you were guaranteed to make money. That's not the scene now.” (see here)

Prashant Jain, CIO of HDFC AMC, another famous value investors in India, has so far stuck to his investment philosophy. His funds have miserably underperformed and HDFC AMC has lost the crown of largets AMC in the country to the public sector SBI AMC. To the contrary, Saurabh Mukherjea, founder of Marcellus Investment Managers, is a strong votary of growth investing. His fund has been one of the top performers in 2019, making Mukherjea the blue eyed boy of fund management industry.

Chris Pavese of the Broyhill Asset Management summarized the global scenario in his latest communication to the investors. He wrote, "Through the end of September, our return on invested capital was nearly double the strong gains enjoyed by passive indices. And for a brief moment, it seemed that value investing was finally returning to favor. In a single day, after WeWork’s botched IPO, investors who were long momentum and short value suffered their worst performance in almost a decade. We had hoped this was a sign of better things to come for value investors, but alas, it proved to be just another head fake. Our moment in the sun vanished just as quickly as it appeared, thanks in part to the Fed’s early Christmas present to investors. A $400 billion increase in the Fed’s balance sheet—in the fourth quarter alone—was more than enough to spark animal spirits and a speculative blow-off into year end, as we limped across the finish line."

While globally the famous FAANG continue to dominate the market performance, back home the retailer R. K. Damani (an avowed value investor himself) has become second richest Indian as the valuations of his retail venture have just breached the exosphere. The arguments extended by the fund managers and analysts in support of these valuations of the growth stocks reminds me of the astronomical valuations enjoyed by the ITeS stocks during dotcom boom era (1999-2000). Azim Premji of Wipro had then become one of the top five richest men in the world. The glory did not last too long. But few of the IT companies survived and validated their high valuations during bubble period.

I am sure some of the presently richly valued companies will also survive and justify their rich valuations today. But if history is any guide these survivors will be very few and most others will become value destroyer. Moreover, the price performance of growth stocks discounting future growth today shall also pause for a long time in due course. We seen bellwether stocks like HUL, RIL, Infosys, not giving return for many years in past couple of decades.

The question however remains what a common investors should doo under the circumstances. Should one shift from value stocks to growth and participate in the momentum? Should one lighten position in the growth portfolio and shift to value stocks?

I think the following advice given by the legendary poet Harivansh Rai Bachchan is the most appropriate under the circumstances—

अलग-अलग पथ बतलाते सब पर मैं यह बतलाता हूँ - 'राह पकड़ तू एक चला चल, पा जाएगा मधुशाला।

Wednesday, February 19, 2020

Not learning from expereinces is sheer extravagance

Yes Bank is a peculiar case study expanding across spheres of corporate governance; financial sector regulation; securities market regulation; investor behavior; crisis management; audit failure; risk management; decision making; and much more.

The consequences are (i) investors' wealth has eroded materially and (ii) the interest of the entire financial system, including depositors, has been imperiled.

By dithering on taking a prompt and appropriate action, the regulators are perhaps indicating that no lessons have been learned from the debacle of IL&FS and PMC. The worst, the bank continues to be a part of the benchmark Nifty50 and NiftyBank, forcing the passive investors to buy this poor quality stock. Besides, the equity shares of the bank continue to trade in the derivative segment encouraging speculative trades, especially by small investors in search of windfalls.

Apparently, the bank has been violating the prudential lending norms with impunity. Both the RBI (financial sector regulator) and the auditors have failed in detecting the divergences between the actual amount of non-performing loans and the reported amount.

SEBI has dithered in taking appropriate action against the company despite frequent under reporting of nonperforming assets. A popular perception is that the bank might have booked commission/fee on services, which is still not accrued to the bank, thus overstating the income of earlier years.

National Stocks Exchange (NSE) may have erred by not proactively excluding the stock from the benchmark indices (Nify50 and NiftyBank) and placing appropriate trading restrictions, e.g., placing the stock in Trade for Trade category after first rating downgrade. Similar mistakes have been made in past with Jet Airways, JP Associates, DHFL, ADAG companies. As an SRO, it is incumbent upon NSE to at least make all the brokers mandatorily inform the buyers of the stocks of such troubled companies about the risk involves every time a BUY order is placed. So that at least the gullible buyers are aware of the magnitude of the risk they are taking.

The traders and investors, especially the non institutional household investors, have been repeatedly lured by the prospects of hitting jackpot in a beaten down stock. Not learning even from their latest experiences in JP Group, DHFL, ADAG, Jet Airways etc., they have chased Yes Bank stock from the levels of Rs85-90 in past 6months, believing it to be a blue chip company despite frequent warning signs and rating downgrades.

The financial markets, especially some asset management companies and NBFCs, have still not fully recovered from the setback of IL&FS, Jet Airways and Zee Entertainment. Regardless, they failed in controlling their exposure to Yes Bank bonds and commercial papers, and face the prospects of a default. The raises stink over the risk management practices followed by these institutions.

The government has an excellent example of crisis management in takeover of Satyam Computers. A similar decision was taken to merge the beleaguered Global Trust Bank with oriental Bank of Commerce. However, similar alacrity has not been shown in managing the crisis of JP group, ADAG, Jet Airways and now Yes Bank. The takeover of Unitech has happened some 5-6years too late. A timely action could probably have saved many jobs, investors' wealth and lenders funds besides controlling the collateral damage to the financial markets.

Tuesday, February 18, 2020

Act before its too late

The global rating agency Moody's Investors Service has again slashed India’s 2020 GDP growth forecast. The latest projections by Moody's peg 2020 GDP growth to 5.4% (earlier 6.6%); and 2021 GDP growth to 5.8% (earlier 6.7%). The rating agency has highlighted the disruptions in global trade arising due to spread of coronavirus as one of the reasons for slower growth. In other concerns, lower than potential GST collections is one of the prominent concerns expressed by the agency.

If the history is any indicator of the trade trends, we can reasonably conclude that any major shift in the trade from one jurisdiction to the other, even if it is due to temporary disruptions, is not easily reversed after the disrupting condition cease to exist. Shift of automobile and electronics manufacturing from Japan to USA and then from USA to China is one example.

India lost some of its textile exports to Bangladesh due to child labor issues. We also lost currency and derivative trading business to Dubai and Singapore due to taxation and other issues. These shifts could not be reversed despite some serious efforts.

Within country, West Bengal lost Tata Motors plant to Gujarat. The state has failed to attract any other major industry after that despite many promotional efforts. Punjab lost its industry and financial strength due to militancy. It has failed to recover even after more than 25yrs have elapsed since end of militancy in the state.

China is presently facing two disruptions - one due to the trade related disputes with USA and the other due to spread of coronavirus. These disruptions must have prompted a rethink amongst many global businesses who source material and/or manufacturing services from China. A de-risking strategy would warrant diversification to alternative sources of supply for goods and services. Obviously most eligible sources like Vietnam, Taiwan, Malaysia, and Indonesia etc are apparently making concerted to welcome the businesses looking at diversification from China.

We do have seen some efforts being made in India. The efforts however appear limited to lowering of corporate tax rates in line with the other competing jurisdictions. No major effort seems to have been made to ensure smooth transition of business from China to India.

Missing this once in a decade kind of opportunity would be a costly mistake in my view. Evaluating this opportunity merely in terms of revenue or trade may not be appropriate. It must be viewed and understood from a much larger perspective.

With a huge number of unemployed, underemployed, unemployable and employed in disguised youth, rising socio-economic inequalities, burgeoning aspirations, increasingly shrinking blue collar jobs, stagnant wages which are awfully short in meeting youth aspirations, we are staring at (for lack of a better word) Latinization of our society - drugs, crime and sex becoming a way of life for the youth who finds it hard to find meaningful occupation and lacks resources for professional training and education.

The rising number of cases of petty crimes, drugs related crimes and arrests, sex related crimes, day light robberies, cyber crimes etc provide ample evidence that we are moving fast in that direction. For now, perhaps the religion and traditions are providing some checks and balances, but this resistance may not last much longer. Once we slip into the abyss, it may take decades to come out. Remember, the naxal movement that started in 1960s under similar circumstances, is still alive in some parts of the country.

The government needs to focus on employment generating ventures, not for potential revenue generation but from the social view point. A total and comprehensive review of the education and training ecosystem in the country is also needed urgently and desperately.

Friday, February 14, 2020

Latest data reignites stagflation fears

Two data points released on Wednesday has again brought the specter of stagflation in India to the fore.

The rise in food prices and telecom tariffs pushed the retail inflation in January 2020 to 7.59%, the highest level seen since May 2014. At the same time the industrial production recorded a decline of 0.3% in December 2019.

I agree with the viewpoint that at macro level we may not be facing any threat of stagflation in near term. I also believe that (a) the headline CPI number may be close to peaking and may ease considerably post summer, as estimated by the monetary policy committee (MPC) of RBI; and (b) the headline growth number may be close to bottom and we may see a gradual recovery from 2HFY21 onwards.

Notwithstanding the macro viewpoint, it is pertinent to keep in mind that a large segment of the population may already be experiencing stagflationary conditions.

There is no denying that the employment conditions have worsened in past one decade and there is no hint available that this trend will reverse anytime soon. The labor participation rate in 2019 was lowest
The real wage rate growth for agriculture labor that forms a major part of overall workforce have been consistently declining since summer of 2017 and have seen de-growth in 2019. This could be due to significant rise in MSP of main crops over past two years. But nonetheless, the rural inflation has been consistently higher than the urban inflation while the rural wages have not seen commensurate growth.
Latest rounds of consumer confidence survey conducted by RBI clearly indicate that more households across major cities in India have seen their income decrease than increase in past one year. Moreover, majority of households perceive that employment outlook in India has sharply deteriorated. (for more details see here)

In my view therefore it would not be fair to assume that a large segment of Indian population is experiencing stagflationary conditions and this situation is likely to last for many quarters to come.