Vijay Kumar Gaba

Thursday, April 16, 2020

Sit back, relax and wait for the spring

The rise in stock markets world over must be baffling the investors as well analysts alike. At this time - when the world is staring at a high probability of deepest ever recession in global growth, disproportionate demand destruction; severe financial stress for households, prolonged disruption in global trade; colossal debt defaults; unsustainable monetary expansion; and total collapse in consumer sentiments - rise in prices of high risk asset like equity is definitely perplexing. It is however neither unprecedented nor surprising to me.

During July 2007 to December 2007, Nifty had recorded its highest ever levels, despite the sword of sub-prime collapse hanging on its head.

What we are witnessing is a similar phenomenon, commonly known as distribution pattern in technical analysis parlance.

As an investor, I need to persistently remind myself the following and many other similar things:

Many tenants are refusing (are unable) to pay rent worldwide
Many employers have either refused to pay salaries or cut the payout materially.
Farmers have been unable to harvest their crop.
Borrowers are refusing (are unable) to pay EMIs and interest.
Trade creditors are refusing (are unable) to settle their accounts.
Temples are closed and Deities are refusing to meet devotees.
2008-09 Global financial Crisis was mostly about liquidity. This time it is equally about both liquidity and solvency.

What else I need to remind myself is that the seed of next big bull market will be laid during this autumn of the market only. Like every time before, the next bull market will be much bigger than the previous one. We shall see a large bubble building in the market that will change many things in the real economy as well.

Tomorrow, I shall share some of my random thoughts on what could possibly drive the next bull market in equities.

Wednesday, April 15, 2020

Some random thoughts Post COVID-19 world - Part 3

Continuing from last week (see here and here), I would like to share some of my random thoughts on what this outbreak of COVID-19 could potentially mean for India, particularly in the short to medium term.

The present state of affairs

India is in the state of total lock down since past 3 weeks. In this period about 40-45% of the overall economic activities which are exempted from the lock down stipulations are only working. Presently it is estimated that it may take 3-6 months before the economy could return to the pre March level of activity.

It is important to note that the Indian economy had been consistently slowing down for past 3 years, especially due to the impact of demonetization (November 2016) and GST (July 2017). Unusual weather pattern have resulted in wide divergence in the regional economic performances. The rural stress in the regions that suffered from poor weather (flood, drought, etc) has been elevated; even though the overall farm sector growth recorded decent performance.

It is widely accepted that after discounting for the elevated government sector consumption and fiscal support to the rural sector (loan waivers, cash subsidy payments etc), the GDP growth of India had been significantly below par. The growth rate of almost all key components (savings, investment, private consumption etc.) of the economy has declined.

Besides, the second half of FY20 had witnessed widespread disruptions due to protests against implementation of Citizenship Amendment Act and some related matter. Thus, pre-March situation was not good enough; and here in the best case we are looking at reaching that "not good enough" situation in next 2-3 quarter, provided the virus is contained soon and lockdown does not need to be extended beyond 3rd May 2020.

The GDP growth estimates of various agencies for FY20 and FY21 now range between 3.5% to 4.7% and 0% to 4.2% respectively.

Challenge to make a fresh start

A large number of businesses, especially MSMEs, are facing serious challenges. For them it is not 40-50days of break. For many of them it would be like starting the business all over again with little capital and poor credit score. These businesses are staring at material discontinuity losses and cash flow problems, besides demand issues. Exporters in particular are in deep trouble as their overseas payments are stuck, future demand outlook is heavily clouded, inventory obsolescence risk is high, and expenses continue.

This would directly reflect on (i) employment conditions, (ii) economic growth, and (iii) asset quality of lenders. Indirectly, it may adversely impact (a) economic factors like discretionary consumption, savings, tax collection, and (b) social factors like number of people below poverty line, socio-economic inequalities, cases of petty crimes and non-compliance, mental health of people due to elevated stress & anxiety levels, physical health of people suffering from diabetes, hypertension, obesity etc.

It is natural to celebrate the fresh air in cities, clean water in rivers, lakes and sea, peacocks on terraces, deer on roads. Many of the children and youth in cities may have never experienced nature like this. But once the lock down is lifted we will have to deal with materially increased population of rodents and insects which are harmful for our health and inventories in shops, godowns, restaurants, etc.

Global challenges

India shall face multiple global challenges in the aftermath of COVID-19 outbreak. Poor export demand for traditional Indian products like textile & leather, automobile, gems & jewelry etc., lesser employment opportunities for young professionals, poor capital flows especially for startups etc are some of the obvious economic challenges.

The worst however could be the change in global outlook for the process of globalization itself. The developed nations which are bearing the worst impact of COVID-19 in terms of human losses, may be inclined towards closing (or narrowing) their borders to international trade and labor movement.

If the belief that COVID-19 spread is a consequence of Chinese irresponsibility or conspiracy, sustains, we may see substantial rise in geopolitical tension and trade & currency conflicts which have already impacted the global economy meaningfully in past three years.

In any case, if all goes well, it would be reasonable to expect travel restrictions and fear amongst travelers also.

The opportunity

Shift of global supply chain away from China

Post COVID-19, it is possible that China may be regarded as an irresponsible power, and may not be accepted as a major global leader or supplier. In particular, the mistrust between US and China may increase manifolds. We may likely see a Sino-China cold war that may last for many years, or may be decades.

The global supply chain presently relies heavily on China for components as well as manufacturing services. There is strong possibility that the businesses in developed economies may seek to establish manufacturing and/or sourcing facilities in other countries to reduce their reliance on China. Japan government for example has already announced incentives for shifting factories from China.

The window of this opportunity shall remain open for only a short while, as the competition is really tough with tens of Asian countries competing with each other to avail this opportunity. We would need to move really fast if we actually want to turn this crisis into a massive opportunity that could support India's economic growth for next couple of decades at least.

Investment in health infrastructure

The outbreak of COVID-19 has exposed gaps in the global healthcare infrastructure and protocols. I am confident that post COVID-19 containment the world will embark on an unprecedented investment mission to improve health infrastructure and protocols.

Many Indian businesses, especially the companies engaged in IT services, CRAM services, telemedicine and diagnostic services etc. shall have opportunity of gigantic proportion knocking on their doors.

Improvement in domestic health infrastructure

Incorporating the learnings from efforts to contain COVID-19, and existing programs & schemes for public health, sanitation, personal hygiene, etc., the government has the opportunity to materially improve the healthcare infrastructure in the country.

It may consider merging all such schemes & programs into a mega national mission. to ensure adequate healthcare facilities to all citizens through public and PPP ventures, total sanitation, comprehensive garbage management, preventing littering of all sorts, management of epidemics, seasonal diseases etc.

Thursday, April 9, 2020

Some random thoughts Post COVID-19 world + Part 2

The outbreak of COVID-19 pandemic has shaken the collective consciousness of the global community. Since WWII there have been many crises that have impacted more than region of the world. But this novel coronavirus is perhaps the most widespread and deep crisis that the humanity has faced in past 75years. The global financial crisis (GFC) of 2008-09 had impacted most global markets, but the impact on human life was not this serious.

This crisis has occurred at a time when the global order was resetting itself in the aftermath of the GFC. The central bankers were finding the ways to exit the unsustainable monetary policies adopted to mitigate the impact of GFC. The global trade imbalances that have persisted for almost 3 decades were correcting as China, US, EU, Japan, Russia, OPEC etc were actively engaged in aggressive trade (re)negotiations. Old trade and geopolitical blocks were weakening and new blocks were being formed. China had accelerated the drive to assume global leadership through mega initiatives like One Belt One Road (OBOR) and China Pakistan Economic Corridor. UK exiting the common European Market weakened the Europe to some extent. US tightened immigration rules, decided to withdraw from conflict zones like Afghanistan, Iraq, Libya and refused to engage in Syria signaling a paradigm shift in its policy towards globalization and, free trade.

The outbreak of novel coronavirus has however significantly changed the course of reset, in my view. I feel the following are some of the issues that may define the contours of the new order in post COVID-19 world.

1. The China may be regarded as an irresponsible power, and may not be accepted as a major global leader. In particular, the mistrust between US and China may increase manifolds. We may likely see a Sino-China cold war that may last for many years, or may be decades.

2. The vulnerabilities of US and Europe have been exposed by the coronavirus.

Post 9/11 incidence, we saw dramatic changes in the concept of internal security in US and many other countries. The suspects were shot dead without much provocation, disregarding all concerns for human rights and liberties. The culprits were chased and killed in foreign jurisdictions often disregarding sovereignty of these foreign lands. The diplomats, politicians and prominent personalities arriving in US and UK were strip searched and denied entry with impunity.

We shall see further rise in xenophobic tendencies of the developed western countries. Another major impact could be concerted effort to reverse the course of demography, especially in European countries that are turning old at an alarming rate. This could be achieved by substantial incentives for procreating aggressively or changes in the immigration policies to encourage let young professionals from developing countries settle there.

3. I do not believe that post COVID-19 world would be highly localized, nationalist and protectionist. Nonetheless, it is entirely possible that new trade and geopolitical blocks get formed. The new blocks thus formed will define the contours of new world order.

4. The global supply chain presently relies heavily on China for components as well as manufacturing services. Many developed countries get their fiscal gaps filled by China in lieu of using Chinese manufacturing services and allowing China access to their markets.

The new world order may see a massive shift in this trend. Countries may seek to limit their fiscal deficits and seek diversification of their supply chains. This will present many opportunities & threats to the emerging economies like India.

5. The dominance of USD as world's only reserve currency will face serious challenges from more neutral digital currencies.

6. The ideas like free trade, personal liberties, etc face serious challenges from the rising tendencies of government world over to exercise enhanced surveillance and control over personal conduct and data.

7. The business models, valuation models, risk assessment techniques, commercial contracts etc shall get redefined to build in probability of prolonged shut downs.

8. The foreign travel protocols may include vaccination as a pre requisite.

9. The business continuity planning may become a mainstream subject for all businesses, not just the mission critical processes and financial services.

10. A massive tsunami of debt defaults/waiver may hit the global financial system. Handling of this tsunami and subsequent recapitalization of the lenders will be a key challenge for the governments and central banks.

Inappropriate handling of this challenge may eventually lead to shortage of growth capital and thus rise in cost of capital. A sharp down leg of deflation could lay the foundation of an inflationary world for next decade or so.

Where India stands in this transition and what are the opportunities and threats?

I shall share my thoughts on this next week.

Wednesday, April 8, 2020

Some random thoughts Post COVID-19 world

Little more than a decade ago, a global financial crisis engulfed the global markets. The impact of the crisis on financial markets was mitigated in couple of years by collective efforts of the governments and central bankers. However, the social, geo political and economic impacts of the crisis largely remain unmitigated.

The "Reset" button pressed by the crisis has resulted in widening of socio-economic divide across the world. The geo political tensions have intensified materially. The rise in protectionism has adversely impacted the global trade. The rising unemployment in Europe and most commodity dependent economies in Asia, Africa and Latin America, declining growth in China, substantial cut in developmental aid to least developed nations due to fiscal pressures, has caused widespread human suffering for over a decade now.

The onslaught of novel coronavirus (COVID-19), in my view, will accelerate the "Reset" process leading to a new global order in next 5 years. But for COVID-19, the process might have taken 10-15 years.

I have written this before, but it would be in order to reiterate a brief account of the changes in world order that have taken place since advent of 20th century.

In 1917, Russian revolution successfully dismantled the Tsarist autocracy and laid the foundation of USSR. In the following decades, many smaller independent European states became subservient to a mighty Russian socialist army, and together formed one pole in the emerging bi-polar world, forever shrouded by the specter of cold war.

In the same year, USA decided to join the War as an associate of the Allies - a development that tilted the scale in favor of the Allies, bringing the War to an end in 1918. In the following decades, USA evolved into a formidable military and economic power that lead the democratic allies to become the second pole in the emerging bi-polar world.

The imperialist global order that existed in preceding centuries began to dismantle. Many colonies of European empires gained freedom. The British Empire that was built in three centuries and covered almost one fourth of the world population and area before the War, was completely dismantle in the following three decades.

It took three decades for the new order to consolidate. The new order was characterized by UN, NATO, WARSAW, Mao, Israel, NAM, Bretton Woods, World Bank, Cold War, energy cartel (OPEC), et. al. The globalization that was a norm prior to the first War was completely overpowered by the forces of nationalism and protectionism.

The post WWII order lasted till the German Wall fell and USSR disintegrated in early 1990s. This unleashed a new wave of globalization. Global Trade (WTO), Internet, dematerialization of assets, Europe integration into a single market, China's entry into mainstream global trade (through WTO), free flow of capital, G-20, BRICS, numerous FTAs, global war on Islamic fundamentalism, energy security, climate control and global financial crisis, dominated this phase.

After three decades, we are on the threshold for a fresh reset in the global order. I do not subscribe to the ideas that the process of globalization is reversible. I am therefore not anticipating that the emerging world order will be based on localization of trade and closed borders.

Tomorrow, I shall share my thoughts on the likely shape of the emerging global order and likely opportunities in post COVID-19 induced lockdown world.

Wednesday, April 1, 2020

Lessons from FY20 Rout

The new financial year is beginning on a rather somber note. The auspicious festivals of Navratri, Ram Navami, and Easter are also failing to lift the spirits of the people locked down in their homes. Offices, factories and shops are shut. No one has rushed to complete the usual year end compliances. Naturally, the financial markets are also despondent.

As an investors, my first instinct is to complete erase the memories of FY20. For an overwhelming majority of market participants, it has been a difficult and mostly forgettable year. Not only equity but the debt portfolios have also caused similar degree of pain for many investors. The fact that the previous year (FY19) had not been great either for most investors, exacerbates the concerns even further.

However, the student of markets in me is telling me not only to remember this year but rewind it every year to avoid mistakes that would have been made in past couple of years. The following lessons in particular must be learnt, memorized and practiced without fail.

1. Define your investment objectives and goals clearly. Success in investment endeavor depends largely on clarity in investment objectives.

Factors like growth, yield, income, risk, are dynamic and will keep on changing every year. Investors must periodically re-evaluate investment objectives and requirements.

2. Forming a solid investment team is cardinal to successful investment strategy. Carefully assess the honesty, competence, and objective of those giving you investment advice and services, e.g., investment advisor, Portfolio Manager, Mutual Fund Manager, stock broker,

3. Know: Why, How much, When, and Where to invest.

(i) Would you like to do the same business, as the company you are investing in is doing or planning to do, if you had sufficient financial resources?

(ii) Never invest in companies whose business you do not understand. Investment is much more than the roll of dice. Impulsive decisions are the ones you often regret.

(iii) Invest only that money which is free of obligations. Never borrow money for investing.

4. Remain informed about how your investments are performing. Be alert for news, legal changes, policy changes, and economic trends that could have a material impact on your investments.

5. Unreasonable expectations about return on investments may deprive you of even reasonable return.

6. Remember, you are not an institution, and never try to act like one. Do not calculate NAV of your portfolio daily, weekly or monthly. You are under no obligation to report your NAV to anyone.

7. Assess the success of investment strategy from the total returns you made on your entire portfolio. There will certainly few outliers. Do not celebrate or regret these outliers too much.

8. You cannot and need not invest in all good companies. Select those, which suit best to meet your investment objective, are fundamentally strong and suit your investment plan.

9. Remember the basic principle of economics, money does not grow on trees, and in the long run all good businesses will attain more or less the same level of profitability.

10. Try to use market movements to your advantage, only in businesses which you otherwise find good for investment. Never buy something just because it has fallen 70-80% from its last high price.

Tuesday, March 31, 2020

Nifty Scenario for March 2021

FY20 is the worst financial year since FY09 in terms of year on year Nifty returns. Nifty lost ~25% of its value during the year. Most of these losses have come in past one quarter (Q4FY20), during which Nifty lost close to 30% of its value.

In my view, considering the present circumstances and indications visible presently, the earnings and economic growth outlook remains heavily clouded for next 2-3 quarters. Thus, there are chances that the calendar year 2020 may turn out be a disappointing year in terms of equity returns.

Working on various scenarios for the Nifty levels one year from now, I concluded that Nifty may return 5-8% in next 12months considering flat earnings growth in FY21 and 10-15% growth in FY22; and valuations close to long term average of 17%. I appreciate that 10-15% yoy earnings growth in FY22 appears quite challenging in the present conditions. However, considering the lower base (no growth for 3years) and economic recovery due to easy monetary policy and lower effective tax rates, I am willing to work with these assumptions.

For March 2021, I assume the worst case Nifty level of ~6900, a most likely level of 9100 and a best case scenario of 11500. I am not ruling out an interim fall in Nifty to sub 6000 level.

This implies that I shall be looking at significantly increasing my equity exposure should Nifty fall below 7000 in next few months.

I fully realize that the economic disruption caused by the COVID-19 pandemic shall have deeper and wider impact that may last upto 2years. However, the $5trn new liquidity created worldwide shall support the financial assets, as the commodities prices continue to deflate. In India the government and RBI have started the process to kill the yields. The return on bonds and cash shall be meager, after a spurt in bond prices to adjust for the lower yields. The relative attractiveness of equities and real estate shall definitely increase in 6-9 months period. The FPI selling pressure shall cease in due course as redemption pressure on them eases and fresh liquidity is made available to unfreeze the markets.

AT the present levels of market, I am not panicked - either into buying or selling.

Friday, March 27, 2020

COVID-19 impact on economy

Most brokerages and rating agencies have highlighted the severe impact of the 21 days total lock down announced by the Government of India. For example consider the following:

1. JP Morgan estimates that the lock down will significantly impact 60% of GDP, though the post lock down rebound could be equally sharp. There will some permanent loss, depending on the length of the lock down. It expects global economy to enter into recession in H1'20, and since the India is fiscally constrained, the recovery will mostly depend upon the monetary easing and regulatory forbearance for stressed debt.

2. Deutsche Bank feels that the total lock down has pushed India into uncharted territory. We may see an unprecedented negative GDP growth print in 4QFY20 and/or 1QFY21. The government must announce a coordinated & front-loaded fiscal/monetary stimulus to mitigate the impact of lock down.

3. Jefferies highlights that the total lockdown shall significantly hit the near-term growth. However, there is a probability of a V-shaped recovery post lock down. Fiscal support for the affected workers/business can drive faster recovery. A double digit EPS decline in 4QFY20 may already be in the price.

4. The initial estimates of Nomura suggest that ~75% of the economy will be shutdown, resulting in a direct output loss of ~4.5%. Additionally, there will be indirect effects such as the persistence of public fear factor (even after the lockdown ends), a high risk that the livelihoods of the predominantly unorganised workforce will be hit and a sharp increase in corporate and banking sector stress, which are likely to further weigh on growth is beyond Q2 in H2 2020. It expects the central government to soon announce a stimulus package of ~0.7-1.1% of GDP. Along with the growth hit and poor tax collections, we expect the fiscal deficit for FY21 (year ending March 2021) to balloon by over 1% of GDP from the 3.5% target set in the budget (i.e. more than the escape clause leeway of 0.5% of GDP). Noumra feels that the monetary policy proactiveness has been missing so far; nonetheless it expects at least 50bp of policy easing on or before the 3 April policy meeting, accompanied by a host of liquidity injections and unconventional policy measures to reduce financial sector tightness, including large scale open market operations.

5. ING believes that the three-week nationwide lockdown will significantly dent India’s GDP growth, making this an even worse year for the economy than the 2008 Global financial crisis. This demands a stronger policy response. Until then, the looming economic misery is poised to push USD/INR above 80 in the coming days. As per ING The biggest whammy will be to private consumption, which accounts for 57% of India's GDP. With all non-essential consumption dropping virtually to zero for a week in the current quarter means year-on-year GDP growth plunges to just about 1%, and with two weeks of a hit in the next quarter could push it to about -5%. We would anticipate at least one more quarter of drag keeping growth in negative territory, beyond which the policy support and favourable base effects should drive recovery back to positive growth. While this shaves a full percentage point from the yearly growth in the current fiscal year (ends on 31 March 2020) to our estimated 4.0%, we have revised our forecast for the next financial year to 0.5% from 4.8%. This is a far cry from the government’s expectation of over 6% growth outlined in the FY2020-21 budget, which will surely be scaled back significantly as the Finance Ministry prepares fresh stimulus to stem the crisis. However, citing significant policy support, the official growth outlook may not be as bearish as ours, though we note that official growth tends to be overestimated by about 2%.

6. EMKAY Stock Broker feels many industries/SMEs will be running on zero revenues for close to a month and 'opening up’ after the lock down is likely to be measured. It expects permanent impact of 21 day shutdown even into the longer term numbers, anticipating that the shutdown could push unorganised sector to the brink.

Most other brokerages and rating agencies have expressed similar views and opinions. Both the macroeconomic growth forecast and earnings estimates have been materially moderated.

In my view, it is tough to estimate the actual outcome. The real picture could be very different from what we are anticipating today. For example consider the following:

(i) The lock down condition (total or partial) may continue for longer.

(ii) The bad weather has damaged some Rabi crop in North India. Shortage of labor for harvesting and transportation of crop to Mandi could cause some further damage. This will add to the poor data.

(iii) The nationwide protests against the Citizenship Amendment Law during December-February, had resulted in some serious disruptions, especially in North and east India. None of the forecasters seem to be accounting for that.

(iv) There were many industries, like automobile, who were struggling with high inventory and/or losses. This lock down could actually be a blessing in disguise for such businesses.

(v) Under the pretext of the lockdown, many financial institutions may be allowed to offer concession to the stressed borrowers. This could work either way - it may increase the NPA levels, or it may rationalize the provisioning and IBC proceedings, and actually help both the lenders and borrowers.

(vi) The government may get a reprieve from global rating agencies for indulging into some fiscal profligacy. This can actually help kick start the economy.

(vii) The global supply chain will definitely see a shift from China to other countries. If the government plays its cards right, the elusive capex cycle can start much earlier in India then currently anticipated.