Vijay Kumar Gaba

 The recently concluded tour of Indian cricket team to Australia has been remarkable in many ways. I am sure, the cricket administrators, analysts, strategists and guides in the country would analyse the outcome of tour from the viewpoints of future playing strategies and improvement in fitness regime, and career path for the young promising players who may not get adequate opportunities due to limit of 11 playing members in the national team.

On my part, besides thoroughly enjoying two months of engrossing game of cricket, I have drawn some key inputs for investment strategy purpose from this tour.

Pujara vs Pant debate is meaningless

One of the prominent topics of discussions, before final day of the Brisbane test, was the “slow” batting of Cheteshawar Pujara; though the victory at Gabba ended this debate with tins of praise being heaped on Pujara for his grit and resilience. A loss or draw at Gabba might have seen strong criticism of Pujara.

On the other hand, Rishabh Pant, who has been consistently the target of critics for his irresponsible batting, was praised as true successor of Dhoni - A great finisher and match winner.

I find nothing new in this discussion and criticism. Players like K. Srikkanth, Virendra Sehwag, Yuvraj Singh, Kaluwitharana, Shahid Afridi, etc. have always faced this kind of criticism. The fact is that competitive cricket needs to strike a balance between entertainment and classical game. For every Gavaskar a Srikkanth; for every Tendulkar & Dravid, Sehwag & Yuvraj; and for every Jayasuriya a Kaluwitharana is needed. The balance between classical techniques and aggressive innovation is consistently leading to evolution of the game and keeping the interest of spectator alive.

Applying this analogy to investment strategy, we must understand that constructing an investment portfolio is like making a cricket team. The portfolio must strike a balance between safety, liquidity and returns. While anchoring the portfolio with consistent compounders, investors must keep trying the new businesses which could be potential winners due to their innovative methods and technology. Of course the failure rate in this endeavour will be high, but one winner will more than compensate for these failures and enhance overall portfolio return.

Just to illustrate, HUL played a Pujara for 10yr (2001-2010); ITC is playing the same game for past seven years; and RIL played it for six years (2011-2016). For these, the balance was provided by the likes of Bajaj Finance, Page Industries, Divis Lab, Eicher Motors, Havells, HCL Tech, PI Industries etc. Many rising stars though failed to live upto the expectations, e.g., IDFC First Bank, DHFL, Yes Bank, JP Associates, Suzlon, etc.

One pertinent question here would be what should be the proportion of Pujara’s and Pant’s in a balanced investment portfolio!

Well, for that one would need to sit with her/his investment adviser and work this out.

36 all out and 325/7 on fifth day Gabba pitch (January 2021) are both exceptions

On 19^th December 2020, the fabled Indian batting line up wilted under pressure and was all out for a mere 36 runs in Adelaide. One month later on 19^th January 2021, a much depleted team scored 325 on the fifth day Gabba pitch facing infamous hostile Australian bowling. The both performances are true but not normal. These kinds of performances do occur once in a while, but cannot be key parameters for evaluating the standard of Indian team.

The benchmark indices fell by 40% from peak in two months (February-march 2020) and have risen over 90% in past 10 months. The sharp fall and fast recovery, both are not normal conditions. These deep oscillations do occur almost every 10year, but cannot be a key parameter for investment strategy. Only a trading strategy can factor in these kinds of oscillations. As such these are more relevant from risk management viewpoint of brokers and lenders, rather than investors.

 The recent macroeconomic data indicates that Indian economic activity may soon reach to its pre Covid level. The latest reading on Nomura India Business resumption Index is 93.4, just 6.6% below pre Covid induced lockdown level. The media headlines and official commentary claims it to be a “V” shaped recovery, implying that one year may have been lost, but Indian economy is nearly back to “normal”. There is section of experts which is terming it to be a “K” shaped recovery rather than a “V” shaped one; implying that one part of the economy has raced much ahead while the other continues to slide.

Some noteworthy data includes:

IIP growth is now back to February 2020 level. In December, e-way bill collections rose by 15.9% to 6.42 crore in December 2020, the highest since April 2018. The mobility to work places ticked up in past 8 weeks, as shown by Google mobility index.

Elsewhere, China has reported positive growth of 2.3% (yoy) for 2020 as a whole. UK, USA and many other European countries have seen fresh surge in cases of infection and have re-imposed some mobility restrictions, hampering the process of economic recovery. In past couple of weeks the US job data has been disappointing.

These data certainly a matter of relief. However, in no way it makes me comfortable. I know from my travels and interaction with people that for a significantly large section of population, the normalization will take years, if not decades, of “high” economic growth. Besides, the amount of stimulus that has taken to bring the economy back to “pre Covid” level may not be available to take it back to pre global financial crisis (GFC) level; exatly we want to be.

For now, Indian economy is like a middle aged person suffering from chronic asthma and diabetes, who has just returned home after a successful open heart surgery.

One of the distinct childhood memories is about the Uncle, who used to visit foreign countries for work almost every year. After every foreign visit, he would host a family dinner. At the gathering he would explain the difference between heaven (Europe and USA) and hell (India). He would make every adult regret for taking birth in India and make every child aspire to settle abroad.

We (me and my brother) were usually not interested in what Uncle is saying. Our interest was limited to the last act – opening of goodies bag post dinner. He would very generously distribute the “gifts” he had brought from “foreign”. These gifts would invariably include – bathroom sleepers, shaving and dental kits, cosmetics and writing instruments picked from the hotel room he had stayed and flight he had travelled; bottles of perfume; some clothes; small toys; and souvenirs, mostly bought from dollar stores (this I know in hindsight after travelling myself). Three essential things were bottles of liquor bought from duty free shop, a wrist watch and some electronic gadget (camera, oven, juicer, VCR etc.). These items he would offer to sell. (In hindsight I know that he would recover the cost of his entire trip and gifts by selling these items.)

Presentation of Union budget, every year by the finance minister, always reminds me of the generous uncle. A great build up before the budget presentation; a long speech; a strong feeling of regret for being Indian middle class; distribution of some goodies for the poor; and higher taxes to meet the higher expenditure. Since the dream budgets of 1996; the same story has been repeated for past 25years. Almost every time, people end up disappointed and disillusioned after the fine print of the budget are explained to them the next morning.

Notwithstanding the outcome, the charade of pre-budget shows, writings, representations, expectations and analysis is repeated enthusiastically. Hopes are rekindled only to be shattered. This year is no different.

The grim reality of Union Budget 2021 is that the government is terribly short of resources and extraordinarily high on promise. To meet the promise, additional resources would need to be raised. The government knows it well. The businesses know it even better. Rest all (consultation with stakeholders etc.) is the Uncle’s dinner to sell the duty free liquor and gadgets.

For those who are expecting the finance minister to take out some bazooka from her tablet (this year budget is digital, hence no briefcase), I have stated this earlier also and would like to repeat:

The scope and importance of Union Budget has diminished materially over the past two decades.

·         Initially the changes in tax rates were made only through the Finance Bill which is part of the budget exercise. However, many springs ago the government assumed the power to change the rates of excise etc through notification outside the budget. Subsequently, the GST subsumed most of the indirect taxes and the power to alter GST rates has been exclusively vested in the GST Council. The Union Budget has no role to play in GST rates now.

·         The boundaries for rates of customs duty are now mostly set in accordance with the WTO agreements. The union government can change these rates to safeguard domestic industry from unfair pricing by overseas suppliers or to stabilize the domestic prices in times of abnormal supply shocks. These changes could be done whenever a need arises. The union budget has little role to play in this.

·         Post implementation of the 14th Finance Commission recommendations, the onus to implement a large number of welfare schemes has been transferred to the respective state government.

·         The petroleum products' pricing has been mostly deregulated and the budget provides no subsidies for the transportation fuel now.

·         Most of the public sector enterprises, like NHAI, Railway Subsidiaries, Oil & Marketing companies now raise resources directly rather than through the budgetary support.

·         The corporate tax rates were restructured materially in August 2019. It would not be reasonable to anticipate any further concessions in corporate tax.

·         Higher energy and food inflation may warrant some concessions in the personal taxation, especially for the smaller tax payers. Inflation scaled increase in basic exemption limit and standard deduction may be considered. But this will be subject to resource constraints.

·         The government has announced a National Infrastructure Pipeline (NIP) of Rs1.02trn in December 2019. This proposal was strengthened through various stimulus packages announced during the course of 2020. This obviously takes out almost all major projects from the union budget.

·         Disinvestment of public sector undertakings a continuous process. Though a provision for receipts from this head is made in the budget, there is no evidence of any correlation with the actual disinvestment proceeds and budget provisions, in past 30yeras of disinvestment process.

·         Telecom spectrum auction and bank recapitalization allocation are other two key items watched closely. Again, in past 20yrs, there is no evidence of any correlation between the actual allocation and budget provisions.

Analysis of various reports indicates that market participants may be expecting the following from Union Budget 2021:

(a)   Significantly higher government expenditure, especially on infrastructure building. Setting up of a specialized development finance institution (DFI) is also one of the key expectations.

(b)   Additional tax concessions to middle classes especially salaried people.

(c)    Concessions for housing sector, especially higher interest rate subvention; higher cut off limit for definition of affordable housing; additional concessions for developers of affordable housing projects including extension of tax holiday beyond March 2021.

(d)   Review of taxes on investment (STT, LTCG, Dividend Tax)

(e)    Continued suspension of FRBM till FY24.

(d)   Fresh (higher) allocation for bank recapitalization.

(e)    Cut in excise duty on automobile fuel.

(f)    Some progress on Bad Bank formation.

The fears of market include the usual wealth tax, estate duty, additional tax on tobacco products.

Clearly, the expectations this time are running quite low. Just for the sake of a good omen, I would also expect the following from the finance minister:

(1)   Make capital gains (Long term and Short Term) tax rate uniform across all asset classes. This will allow rationalization of asset allocation process by removing tax arbitrage between asset classes.

(2)   Formula to link the basic exemption with some objective criteria (e.g., inflation, per capita GDP, house price index, education and healthcare expense per household as per latest NSSO survey, etc.) This will make the taxation structure more equitable and end the need to speculate over exemption limit before every budget.

(3)   Refrain from imposing additional taxes and cess to cover the cost of Covid vaccination and stimulus.

I would however be not disappointed if FM refuses to oblige me by meeting any of my expectations. I know this is an exceptional year and she has many strings to balance.

Also read

What Finance Minister Needs To Do To Make History: The 10 Big ‘Asks’ From Budget 2021-22

You should be happy if there are no increases in income taxes: Kotak MF

Travel, Tourism sector expects pathbreaking Union Budget for post-Covid recovery

More income tax incentives for housing purchase necessary to revive realty sector

The latest earnings season has started on a very buoyant note, led by some IT companies. In line with the high speed macro indicators, most brokerages have upgraded their earnings estimates in past one month. The present estimates are building in a very strong earnings recovery over FY22-FY23. The estimates for the current year FY21 have also been upgraded sharply from a contraction of 5% to 12% to a growth of 5% to 12%. Currently, the market is estimating an earnings growth of 24% to 38% in FY22 and another 18% to 22% growth in FY23.

It is important to note that these estimates assume GDP growth of -7% to -7.5% in FY21; 9% to10% in FY22 and 4 to 5.5% in FY23; interest rate bottoming in FY21 and elevated inflation of 5 to 6% over FY22 and FY23.

This implies less than 3% CAGR of GDP over three year period of FY20-FY23. Whereas, the present estimates imply ~19% CAGR in Nifty EPS over FY20-FY23. Apparently, there is disconnect between the macro forecast and earnings forecast. In past two decades at least, there is no precedence of such strong earnings growth with a dismal economic growth.

Furthermore, the estimates assume a strong recovery in earnings of financials and materials, from a very low base. Just to give a sense, Kotak Institutional Research estimates 473% (yoy) growth in Banks PAT and 860% rise in Metal’s PAT in Q3FY21. Construction Material (86%) is the third fastest growth forecasted. These three sectors probably have the strongest correlation with the macroeconomic growth and stability. Next 9months may be a case of low base effect, but with 3% economic growth, higher interest and inflation, it is tough to fathom these sector continue clocking sustainable high growth.

So in all likelihood the earnings estimates for FY22 and FY23 will fall in due course, as has been the case historically. Credit Suisse highlighted in one of their December report that EPS estimates fall 10 to35% from the level that is first estimated.

In my view, therefore, it would not be advisable to consider aggregate earnings as a key factor for investment decision. Better would be focus on the companies where sustainable earning growth visibility is very high. Of course these stocks will also fall in case of a broader market correction, but the chances of their bounce back would be much higher.

I shall therefore remain agnostic to sectors and size of companies. I would rather focus on individual companies for investment. Sustainability of growth would be my key consideration in selecting the company.

Will jet fly high again?

One positive impact of Covid-19 pandemic for me is that it has increased my productivity significantly. I am saved from excruciating travel, which many times is completely unnecessary and avoidable. I am able to devote the time, money and energy saved from travel to useful and productive tasks. I am reasonably confident that this positive impact of the pandemic may sustain in foreseeable future also.

In last two days, I did video meetings with five corporate managements, located in Gujarat, Maharashtra, Andhra Pradesh and Bengaluru. In pre pandemic era, I would usually travel to meet companies for understanding their businesses. A one hour meeting in Bengaluru would mean, waking up at 3AM to catch a 6:50 flight, and reach home by 10PM. No longer is the case. I logged in at 3:58PM for a 4PM meeting from the comfort of my home; and was done at 5:10PM, well within time for the evening tea with my wife. Saved, Rs15000, 20hrs of time, 1500 calories, and stomach ailment from eating out.

There is no doubt that I would like this arrangement to continue in post pandemic era also; and limit my work related travel to only “unavoidable” category. Also, I have absolutely no reason to doubt that there are numerous other people who are happy with the present arrangement and would like this to continue.

Now, this thought brings me to some recent uber bullish analysis on airline and hospitality stocks, and sharp run up in the prices of a defunct airline, which hopes to start its operations in 15-18 months. I need to assess whether I would increase my leisure travel significantly to compensate for my lesser work related travel.

Is Tesla, Lehman of 2021?

Michael “Cassandra” Burry, the trader who made a fortune by taking a massive short bet on subprime credit during 2007-08 mania; and inspired a best seller book (The Big Short, Michael Lewis, 2010) and a block buster movie (The Big Short, Adam Mckay, 2015), has been a role model for many traders. I have seen many young traders aspiring to emulate Lewis’s conviction in his analysis and make big money. Michael is reportedly short in the stock of Tesla, Inc. after the stock bent ballistic, gaining 800% in past one year. He has reportedly stated that the stock price of tesla will “collapse”.

I am not sure how many young aspirants are emulating Burry on Tesla, but one thing I know for sure – if Burry is right then Tesla will not fall in isolation. It will bring the entire market down, like the Lehman bros did in 2008.

Too good to be true

Not long ago, social media and TV channels were hyper busy analyzing the potential beneficiaries of the Covid-19 vaccine and its logistics. Few large pharma companies, a logistic company, couple of glass manufacturers, air conditioning companies, an airlines etc were widely discussed as likely beneficiaries of this once in a century opportunity.

Well, two unlisted Indian entities have started to ship the vaccine this week. They do not require -80°C temperature to store and transport the vaccine. The vaccine is being procured exclusively by the government at controlled rate and apparently being provided free for now.

In the investing world, usually, the things that sound too good to be true are actually not true!

Alibaba getting nationalized?

As per media reports, Jack Ma, the founder of online retailer Alibaba, is missing for past two months, after he had highlighted some problems with the Chinese financial system. Many observers who keep a watch on Chinese developments have suspected that he might have been in custody of Chinese authorities. There are reports that the Chinese government may be planning to nationalize Jack Ma's Alibaba and the Ant Group.

The Chinese government has been reported to say, "Based on tip-offs received by the State Administration for Market Regulation in recent days, the administration will be investigating Alibaba for suspected monopolistic activities." (see here)

The truth may be known only few months (if at all). However, since there is no official word about the whereabouts of the legendary entrepreneur, the doubts are getting stronger. This is a strong reflection on the true colours of the Chinese model of free enterprise.

It may sound little sadistic, but I see this as an opportunity to aggressively push India as an alternative investment avenue; though some radical steps to promote ease of doing business would be a prerequisite.

Governments are pro reforms, regardless of party in power

The incumbent government led by BJP has implemented (or attempted to implement) many legislative, administrative and policy reforms, which the party had opposed vehemently when it was in opposition. GST, higher FDI limits in trade and industry, disinvestment of strategic and profit making public sector undertakings, and labour laws etc., are some of the examples.

This highlights that the “governments” in India are usually pro reforms, regardless of the party in power. This needs to be remembered in next elections.

 RBI released the 22^nd edition of its biannual Financial Stability Report (FSR) on Monday, January 11, 2021. The report highlights some key trends that could influence the financial markets in months to come. I note the following red flags raised in the report, which in my view could be relevant to my investment strategy:

Uneven and hesitant recovery, with disconnect in real activity and asset price

Economic activity has begun making a hesitant and uneven recovery from the unprecedented steep decline in the wake of the COVID-19 pandemic. Active intervention by central banks and fiscal authorities has been able to stabilize financial markets but there are risks of spillovers, with macrofinancial implications from disconnect between certain segments of financial markets and real sector activity. In a period of continued uncertainty, this has implications for the banking sector as its balance sheet is linked with corporate and household sector vulnerabilities.

COVID-19 pandemic-induced economic disruptions have exposed some fault lines in global economy. Increased public spending (stimulus) and sharply lower revenue receipts have enlarged the fiscal deficits across geographies, aggravating global debt vulnerabilities.

The credit risk of firms and households has accentuated. This could impact corporate earnings in short term. However, the equity prices continue to reflect strong earnings growth expectations. Developments that lead to re-evaluation of corporate earnings prospects will have significant implications for global flows, going forward.

Capital flows and exchange rate volatility

A hesitant recovery in capital flows to emerging markets (EMs) began in June 2020 and picked up strongly following positive news on COVID-19 vaccines. The response of foreign investors to primary issuances from EMs has been ebullient. Anticipating the COVID-19 vaccine induced economic boost, US yields of intermediate tenors (2– and 5-year) have started edging higher. This could have implications for future portfolio flows to EMs.

EM local currency bond portfolio returns in US$ terms have been lower than local currency as well as hedged returns since early 2020 as emerging market currencies have softened against the US$. This has led to sluggishness in EM local currency bond flows even as global bond markets have been pricing in a prolonged economic slowdown and benign inflationary conditions in Europe and US. In this scenario, any significant reassessment of either growth or inflation prospects, particularly for the US, can be potentially destabilising for EM local currency bond flows and exchange rates.

Improvement in bank asset quality might be misleading

By September 2020, the banking stability indicator (BSI) showed improvement in all its five dimensions (viz., asset quality; profitability; liquidity; efficiency; and soundness) that are considered for assessing the changes in underlying financial conditions and risks relative to their position in March 2020. This improvement reflects the regulatory reliefs and standstills in asset classification mentioned earlier and hence may not reflect the true underlying configuration of risks in various dimensions.

Banks risk losing better quality customers

A sharp decline in money market rates specifically since April 2020, has opened up a significant wedge between the marginal cost of fund based lending rate (MCLR) benchmark of banks and money market rates of corresponding tenor. Expensive bank finance may lead to more credit worthy borrowers with access to money markets shifting away from bank based working capital finance. Such disintermediation of better quality borrowers from banking channels could have implications for banking sector interest income and credit risk.

Banking sector prospects to see marginal changes in 2021

In the latest systemic risk survey (SRS) of October/November 2020 about one third of the respondents opined that the prospects of the Indian banking sector are going to ‘deteriorate marginally’ in the next one year as earnings of the banking industry may be negatively impacted due to slow recovery post lockdown, lower net interest margins, elevated asset quality concerns and a possible increase in provisioning requirements. On the other hand, about one fourth of the respondents felt that the prospects are going to improve marginally.

…stress to come with a lag

Domestically, corporate funding has been cushioned by policy measures and the loan moratorium announced in the face of the pandemic, but stresses would be visible with a lag. This has implications for the banking sector as corporate and banking sector vulnerabilities are interlinked.

Macro stress tests indicate a deterioration in SCBs’ asset quality and capital buffers as regulatory forbearances get wound down.

NPA ratio of banks may see sharp rise

The stress tests indicate that the GNPA ratio of all SCBs may increase from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 under the baseline scenario. If the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8 per cent. Among the bank groups, PSBs’ GNPA ratio of 9.7 per cent in September 2020 may increase to 16.2 per cent by September 2021 under the baseline scenario; the GNPA ratio of PVBs and FBs may increase from 4.6 per cent and 2.5 per cent to 7.9 per cent and 5.4 per cent, respectively, over the same period.

These GNPA projections are indicative of the possible economic impairment latent in banks’ portfolios, with implications for capital planning. A caveat is in order, though: considering the uncertainty regarding the unfolding economic outlook, and the extent to which regulatory dispensation under restructuring is utilised, the projected ratios are susceptible to change in a nonlinear fashion.

In light of the findings of FSR, the governor of RBI, Shaktikanta Das has cautioned the investors and financial institutions that “The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India” and “Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.

I take note of the above red flags and continue with my “underweight financials” strategy for 2021.

 Ricky Ponting, the former captain of the Australian cricket team, commented during a TV show on Sunday that Indian team may not be able to score 200 runs in the fourth inning of the third test match played in Sydney. Ponting was obviously trolled badly on unforgiving social media for his “prejudiced” and “audacious” forecast. India went on to score more than 300 runs and even managed to draw the test. Ponting later clarified that his “view” was based on the condition of the pitch on fourth day. The pitch did not deteriorate on fifth day as expected. Nothing much should be read into his statement. He need not have presented his defense. The social media would have forgotten his statement in couple of days, anyways.

The stock market experts (strategists, analysts, fund managers and seasoned investors etc.) who stick their neck out and make forecast about the market trends and likely levels of benchmark indices often face the situation like Ponting; especially for past 2 months those who are cautious on the market and warning a sharp correction are consistently at the receiving end. Regardless, the markets will keep rewarding investors and keep having corrections.

Moving on to business, I found the following five points worth noting from media reports in past couple of days. In my view, these five points aptly highlight the internal conflicts and challenges within the policymaking framework, and pose potential risk for the seemingly unstoppable stock rally.

1.    The road transport and highways minister Nitin Gadkari, highlighted that probably steel and cement manufacturers have made cartels to keep the prices artificially higher. The two being the key inputs for physical infrastructure development, may lead to material rise in the cost of development and even hamper the viability of projects. He even proposed a regulator for monitoring process of steel and cement (see here).

In UPA-1 tenure, the then finance minister tried to hit the cement cartel by introducing differential tariff structure based on price per bag, Rs190 being the differential point. Should the market expect something similar in weeks to come? In 2007-2008 the differential pricing and price regulation only helped the government in raking higher revenue. The industry and private consumers did not benefit much. (see here)

Besides, the suggestion for a pricing regulator also highlights the tendency of the government to impose deeper and wider regulation to control various segments of the economy. This is obviously contrary to the commitment of “less government more governance.” It also confirms the rising policy unpredictability.

2.    WPI inflation has now risen for seventh consecutive month led by food (see here). Energy prices have also been rising steadily over past few months. This may require a rethink on the RBI premise that food inflation may be mostly a seasonal phenomenon and wane in few months due to base effect. If the food & energy inflation persists, the second round effect may begin to become pronounced from the next quarter. The hopes of a meaningful monetary easing may be belied; and even fears of a rate hike might begin to bother markets.

3.    Many analysts are interpreting higher food inflation as good for rural income (and hence consumption demand); and higher energy prices as good for languishing energy sector stocks. “Cyclical” is projected to be the mood of this spring (see here). Higher energy prices shall reduce at least some of the cost advantage of cement and steel producers that has led to sharp earnings upgrades.

4.    The finance minister has earnestly committed a historic budget 2021. She went on to say that this shall be a budget unlike any presented in past 100yrs (see here).

There is no empirical evidence to support the finance ministers’ inclination to think radically or take risks. During the course of 2020, she made many attempts to enthuse the markets with a series of “historic” stimulus packages; but was hardly found inspiring by the markets.

The good thing is that markets may not be placing much high hopes from the budget; and the finance minister has a chance to surprise the markets this time. The bad thing is that no one is expecting higher taxes; even though the reports are indicating a serious discussion within the government about a Covid cess (see here). The ugly thing is that LTCG is again in the agenda of various budget discussions.

5.    TCS has reported an excellent set of numbers. Most other IT companies are expected to follow the suit. The Nifty IT has yielded a return of ~66% in past 12 months; ~89% in past 24 months; and 122% in past 36 months. In past 1 month, the IT sector has yielded a return of ~18% vs (~17% for Nifty in past 12 months). In past couple of months, most brokerages have published uber bullish reports on the sector, forecasting strong returns over next 2-3years. IT sector along with pharma, has been a massive outperformer for past 3yrs, over all other sectors.

The question is whether risk reward in the sector is still as attractive as it was a year ago?

In my view, the market is now running like a Formula One car. It can see the challenges and obstructions but cannot afford to stop or slow down. So far it has negotiated the sharp turns and obstructions brilliantly. But at least I cannot say with confidence that about the next mile. I am therefore happy watching the race sitting at the fringes, till it lasts. I have no intention of entering the track with my Alto K10 to compete with Ferrari SF90.

 Besides digital transformation of global economy, sustainability is the other theme that had dominated the investment strategies in past three years. The global energies have remained focused on enhancing the role of digital capabilities in our day to day life, and making the growth sustainable in terms of the pressure on natural resources and dispersal of harmful waste in the environment.

Scrolling through my social media timelines, I gathered some interesting instances of “sustainability” theme dominating the investment discourse.

·         Market capitalization of Tesla Inc., the US company making electric cars, among other things, has topped market of top 10 global auto makers; even though it’s annual revenue is about US$28bn (vs. Toyota revenue of US$572bn).

·         The stock price of Orsted A/S, a Danish largest energy company in Denmark and world's largest developer of offshore wind power, has risen by 275% (vs S&P500 growth of 36%)

·        Zhong Shanshan, the Chinese promoter of Nongfu Spring (water bottling and selling) and Wantai Biological (vaccine manufacturing) surpassed Oil Refining Moghul Mukesh Ambani and Oil retailer Jack Ma, to become the richest person in Asia.

·         Markets celebrated the victory of “climate change hawk” Joe Biden with London Stock Exchange’s FTSE making an all-time high, despite the country (UK) facing serious healthcare emergency and fresh lockdown.

In Indian context, stocks of companies like Borosil Renewable (PE 203x, Market Cap 3x Revenue); Suzlon Energy (Loss per share -2.95, Market Cap 2.6x Revenue) and Adani Greens (PE 9956x and Market Cap 67x Revenue) have been prominent amongst the most poplar shares in past one year.

It is evident that the stock markets, as usual, have embraced the trend enthusiastically, just like a toddler would embrace a new toy. It is very difficult to separate the toddler from his new acquisition. He/she would eat, sleep, play and do everything else with the new toy in his/her hand. Invariably, the alienation would occur only when a new toy is presented to the child or the old toy gets broken very badly.

Remember, the toddlers who fell in love with Suzlon & Inox Wind (wind energy)’ JP Power (Hydro Power); Himadri Chemical (Lithium Batteries) etc. are still nursing their wounds (emotional and financial).

Just to set the record straight, personally I am a huge supporter of the sustainability effort. I strongly believe that these efforts will create tremendous investment opportunities in next one decade. These opportunities need not come necessarily from the clean energy or producers of natural products. Many of these opportunities shall come from the existing businesses adopting sustainable methods, and thus improving their productivity and acceptability. As a tiny investor, I do not have resources to analyze the risk involved with businesses focused on new technologies and products. I would therefore focus on established businesses adopting new technologies and methods to become sustainable.

Some examples of such opportunities include – large FMCG companies becoming water and carbon neutral; large IT companies adopting solar energy and work from home as normal business practice; textile companies using natural colors.

 I find some of the recent analysis of US politics and its implications for financial and commodity markets, rather amusing. Most experts are presenting their prognosis of the future direction of asset prices (stocks, currencies, bonds, gold, oil, and other commodities) based on an upside down pyramid, with politicians and central banks as the primary basis of their assumptions.

The overly simplistic analysis indicates that the new US government will have to find a balance between the cost of servicing monstrous public debt (interest rates) and growth. The growth will look healthy in 2021 as the poor base effect kicks in; and so will the inflation. This shall prompt the Fed to normalize the policy rate to bring benchmark 10yr yields from present 0.95% to pre Covid level of 2.5%. This rise in yields will make the servicing of burgeoning debt extremely difficult, if not impossible. The Fed will therefore be forced to check the benchmark yields below the pre Covid levels, say at 2%. This will cause USD to tank another 10-20%, sending the prices of gold and other global commodities denominated in USD to stratosphere. Emerging markets, especially those exporting the commodities will gain significantly, at the expense of developed economies, particularly USA.

The analysis also assumes that a Democratic government in USA would work for normalizing trade relations with China, thus giving significant impetus to growth, leading to higher demand for industrial commodities.

From static empirical studies this analysis looks good. However, if we apply little accelerated rate of change to the historical economic trends, these assumptions may be lacking in many respects. For example, consider the following possibilities mostly ignored by these assumptions:

·         US Government and Fed decide to correct the fiscal and monetary indulgences of past couple of decades, by devaluation of USD and letting USD retire as global reserve currency.

·         Global commodities are no longer priced predominantly in USD. The share of neutral currencies (crypto etc.) and regional currencies (EUR, CNY, et al) increases substantially in global trade, making trade more bilateral than multilateral. (De-globalization)

·         Digital transformation leads to material rise in productivity, further adding to deflationary pressures created by aging demography of the developed world.

·         Consumption pattern change materially. The consumption of fossil fuels, steel, chemicals etc. declines structurally. (ESG)

·         The logistic constraints ease substantially and supply of commodities is restored to the pre Covid level soon.

·         Sino-US conflict is not about Trump or Republican standpoint. It is a conflict to retain (or gain) supremacy over global order. It continues to worsen with every new achievement of China. German Chancellor Merkel has led the European Union to conclude trade deal with China. This is despite Chinese aggression against neighboring countries; atrocities in Hong Kong; and suspicion over treatment of Alibaba promoter Jack Ma. Clearly, a strong anti US axis is emerging in the global order. The assumptions of high growth do not appear to be factoring the probability a sharply divided bi polar world, with few non-aligned countries.

Famous Spanish-American philosopher George Santayana famously said, “Those who do not remember the past are condemned to repeat it”. One of his less famous saying however was, “And those who do study the past are just as likely to make the same stupid mistake as those who do not”. The latter thought applies to the stock market participants more than the first;

Even though the standard guidance to the market participants is that historical performance is no guarantee to the future performance; most of the analysis and behavior is usually based on extrapolation of the past trends.

Analyzing the present consensus view of the analysts, strategists, investment managers and traders about the likely performance of Indian equities in short term (mostly next twelve months), I find that there is an unusually overwhelming consensus on the following trends:

(a)   The small and midcap stocks may do significantly better than their large cap peers largely due to sharper earnings upgrade.

(b)   Cyclicals businesses (commodities, auto, industrials and financials etc.) may do better than the secular businesses (FMCG, Pharma, Technology etc.) as the economic recovery gathers steam.

(c)    Growth stocks (businesses which have direct correlation with the economic growth like cement, steel, capital goods, oil & gas, financials, transport etc.) shall do better than the value stocks (stocks mainly bought for dividend yield, wealth preservation and secular growth, e.g., large FMCG, MNC Pharma, etc.) on relative cheap valuation.

However, a deeper peep into their analysis, gives an impression that most of them are relying heavily on the past underperformance of value, cyclical, mid and small cap etc.

In past 3 years (2018, 2019, 2020) The benchmark Nifty has gained ~34%. Only IT, financial services and services sectors have done better than the benchmark Nifty over this period. PSU Bank (-52%); Media (-52%); Auto (-23%) and Metals (-23%) have been major laggards. Small cap (-22%) and Midcap (-1%) have also lagged significantly.

This underperformance might to be the key driving force behind the present consensus view. I have absolutely no view on the correctness or otherwise of the consensus view, as it has no influence on my personal investment strategy. Nonetheless, I would like to share the following observations with the readers:

·         The small and midcap basket usually includes the following five categories of stocks:

(i)    Companies which are relatively new in the business. These companies may be growing fast and have the potential to become large; or they may not have potential to grow materially.

(ii)   Companies which were much larger in past but lost the advantage or made strategic mistakes on leverage, expansion, products etc.

(iii)  Companies which are older, stronger but their businesses are not scalable.

(iv)   Companies which have no meaningful business, but are listed on stock exchange for a variety of reasons.

(v)    Companies which have highly cyclical business. These companies do very well when their business cycle is good, but usually lose the entire gains in down cycles.

·         New companies with high growth potential and strong older companies with sustainable high dividend yields are the categories that create tremendous wealth for the shareholders.

·         Highly Cyclical businesses give massive returns to the investors who understand the business cycle and are able to buy the stocks at cusp of the upcycle and sell before the party ends.

·         Rest all categories usually inflict losses on investors; which in many cases result in erosion of entire capital invested.

·         Another noteworthy observation is that many small and midcap companies that appear to have given stupendous return in one market cycle, just disappear from market clandestinely. All hopes of recovering the losses made from investing in such companies, in future market cycles, are usually belied.

From the above observations, it could be deduced that to make meaningful money from small and midcap companies, one has to either have strong knowledge of the business cycles or have materially higher risk taking ability.

Smaller investors like me therefore should resist the allurement of quick gains. If they must, they should prefer to invest in a small and midcap fund managed by the professional fund managers, who have good knowledge of the business cycles and are usually emotionally unattached with any particular stock.

 "It is difficult to make predictions, particularly about the future." — Mark Twain

There must have been times, not long back in human history, when making economic forecast was a straight forward process based on rational thinking. The economists could predict the demand supply equilibrium and consequent price tendencies with reasonable accuracy. The investors and traders could use these forecasts to make a strategy best suited to the likely economic trends. The governments (and later central banks) could rely on these forecasts and design their monetary policy and fiscal response. If that were not to be the case, economics would not have got recognition as scientific discipline of study.

However, by observing historical trends in correlation between the economic forecasts and investors’/traders’ behavior and policy response to the forecast, I find that investors, traders and policy makers have seldom taken these forecasts seriously. In fact, the developed economies, with access to a large pool of qualified, trained, and experienced economists, appear to have faced far more serious economic (and market) debacles, than the poor third world economies in 19^th and 20^th century.

In past couple of decades, I find that the function of making economic forecast has become very complex, and to large extent speculative. Some of the reasons for this could be listed as follows:

·         The dematerialization of money, assets, labor, commodities and trade has completely changed the traditional demand-supply dynamics. Both the demand and supply of money, assets, commodities and labor is now significantly more sensitive to global conditions. The imbalances in demand-supply equilibrium could be bridged much faster. Similarly, the demand-supply gap can widen at much faster pace.

·         Globalization of trade & commerce has made the markets worldwide. Events like weather conditions, natural disasters, epidemics, etc. which traditionally impacted the demand supply equilibrium for many months, and sometimes years, no longer necessarily have a durable impact on local economy. The supply gaps could now be filled much faster through import of money, labor and commodities.

·         Internet has made the access to information easier, faster and cheaper. The market participants find it imperative to act on the streaming information with lightning speed, to take the first mover advantage. They have almost no time to verify the authenticity and repercussion of the information before acting on it. This adds material degree of speculation to the behavior of policy makers and market participants. This also makes it easy for the unscrupulous (smart in common market parlance) elements to manipulate the market and policy trends.

·         It has been seen that the policy response to economic data is mostly driven by considerations of political expediency and financial market buoyancy. Post dotcom bubble, as the digital economy has progressed at tremendous speed, the socio-economic inequalities have also increased at equivalent speed. The task of political establishment has therefore become easier.

Politicians have to keep the financial markets buoyant to placate the few rich; and keep subsidizing the majority poor to preserve their political constituency. High fiscal deficits and low to negative real rates are the two tools used almost universally by the governments across the world. Low rates (i) help the government to borrow cheap for profligate fiscal policies (more subsidies); and (ii) let the large corporates grow faster at the expense of poor saver. Obviously, this strategy does not agree with the traditional economic theory. There is nothing to indicate that the governments which are enjoying support of both rich and the poor with brilliant ease would not want the things to change.

·         Significant part of the global economy is now turning digital. The trend is prominently visible even in many developing countries. With this material changes are occurring in the consumption patterns and trading practices. The incremental income is now mostly spent on services (communication, travel, entertainment, etc.) even in lower middle class households. The correlation between higher income/liquidity and commodity inflation is weakening.

As a matter of routine practice, a myriad of experts have made predictions about the best trades for the year 2021. A weak USD, commodity inflation, industrial recovery, emerging markets are some of the overwhelming consensus trades.

In my view, the investors and traders must analyze the situation critically before agreeing with any of these trades. Personally, I am not too inclined towards “weaker USD” and “commodity inflation” trade.