Vijay Kumar Gaba

 In the past one week, I discussed the current situation in the Indian financial markets with some seasoned investors and experienced market participants. It was after almost three months that I got an opportunity to discuss the markets with such an enlightened group of people. Mood of markets definitely appears to have changed remarkably since June 2022.

After my interaction with some senior market participants (bankers and investors) I had noted that the mood was rather despondent. The consensus in June appeared strongly in favor of a slow grind over the next 6-9months. The reference point of discussion was mostly the 2008 market crash. The market participants sounded cautious about rising cost of funds and drying liquidity; and feared major defaults that could trigger a global contagion. (see here).

Reactions of the market participants this time were diametrically opposite. Most of them were in fact trying more to convince themselves about “all is well” rather than discussing the market conditions objectively. They refused to acknowledge that the global macro conditions have deteriorated materially in the past three months, led primarily by Europe and China. They argued forcefully in favor of a “decoupled India” and “TINA”. Despite no visible improvement in Indian macro conditions; below par corporate performance in 1QFY23 and dark clouds over export growth that have sustained the 1.4% CAGR for India’s GDP in the past three years.

The platitudes like “Decade and century of India”; 5^th largest economy ahead of the UK” were advanced with impunity; as if they are trying to justify change in their stance from “extreme bearishness” to “cautious optimism” and “uber-bullishness”. Some of them even claimed that they did never advise underweight on Indian equities.

 Chasing multibaggers

Identifying and investing in “multibagger” stocks has always been a popular topic of discussion in the context of equity investments. The annals of stock markets are replete with folklore about how famous investors successfully identified and invested in “multibagger” stocks and made extraordinary returns.

The marketing pitches made by several financial service providers often include the claims of identifying multiple “multibagger” stocks at the “right time” and riding on these till the end.

Drawing inspiration from these folklores and claims, many investors strive to find “multibagger” stocks for investing. However, as the anecdotal evidence would suggest, very few of them are actually able to identify and invest in such stocks.

It is also common to find investors lamenting that they did actually identify a potential “multibagger” at the right time, but either did not invest in it; or invested an insignificant amount in it ; or the worst, exited their position too early with some gains (or losses).

Nonetheless, this fascination with “multibagger” continues to grow and has almost acquired the character of a cult. Thousands of investors are constantly losing money, chasing this mirage. Some of them even get addicted to buying stocks like they would buy a lottery ticket, hoping to overnight multiply their money several times. Piquantly driven by the fantasy of becoming rich overnight, they are not deterred by multiple failures and keep persisting.

If you are not a member of this cult, but still desire to own stocks that would go on to become multibaggers, it is important to understand a few basic things.

What is a “multibagger” stock?

“Multibagger” is not a standard term in relation to the investment jargon. Apparently, the investment Guru, Peter Lynch first used it in his book One Up on Wall Street (1988) to describe the stocks that have given more than 100% return to an investor. A stock giving 100% return is called two-bagger; a stock giving 1000% return is termed ten-bagger, so on and so forth.

The key points to note here are:

1.    There is no fixed timeframe for a stock to qualify as a “multibagger”. A stock that yields 500% return in five years (43% CAGR) and a stock that yields 500% return in 15years (12.7% CAGR), both would qualify to be called multibaggers.

2.    A stock could be a multibagger and a loser for different investors; depending upon the holding tenure of the respective investors. A stock that traded at Rs27 in 2020; rose to Rs135 in early 2022; and is now trading at Rs80. For the investors who bought this in 2020, it is still a multibagger; whereas the investors who bought this in early 2022 are facing loss of one third of their capital.

Thus, it is not the stock alone that is multibagger; it is the combination of stock, entry price and holding period – that give multibagger return.

3.    Two investors bought a stock at Rs50 each in 2007. Investor A bought 50 shares, representing a mere 0.002% of his total equity allocation of rupees one crore. Investors B however invested 5% of his total equity allocation of rupees one crore and bought 10000 shares. Both the investors are holding the stock in their portfolio till date and the current price is Rs12000. For both the investors the stock is a multibagger, but for the investor A it is cause of constant agony and regret; and for the investor B it is the primary source of his financial security.

Just to simplify our discussion, we may define a “multibagger” as a stock that has outperformed the benchmark index consistently for more than five years at least.

Could you plan a multibagger?

The odds of winning the first prize in the Kerala State Lottery are generally 1 in 9,000,000. The odds of winning any prize, which could even be less than the cost of the ticket (Rs40), are 1 in 119. Obviously, it is almost impossible to identify the ticket that will win a meaningful prize and buy that.

There are close to 2000 stocks traded on the National Stock Exchange. Of course, the odds of buying a stock that will sharply outperform the rest of the stocks are much better than a lottery ticket, if you choose a stock randomly. The odds would become much better if you pick a stock through a careful and in-depth analysis; rather than picking any stock randomly.

Definitely, investing in equities is not akin to buying a lottery ticket. Nonetheless, planning a “multibagger” (e.g., a stock that would consistently outperform the benchmark returns for more than five years) is an extremely difficult task.

An investor could identify a sector of the economy that is likely to the next up cycle. He/she could even identify the companies that are likely to perform very well in that economic upcycle. But availing that opportunity would need (a) surplus funds that could be invested for 5-10years; (b) control over the sentiments of greed and fear to prevent early exit in case of a sharp fall or rise; and (c) adequate financial backup to preempt a situation where the investment would need to be liquidated under duress.

Note: I am a tiny unknown investor and claim no expertise in identifying multibaggers. I strongly believe that investing in equities is equally about financial and mental strength. I have none and therefore I do not own any multibagger.

The National Statistical Office (NSO) released the estimates of National Income for the first quarter (April-June) of the current fiscal year (2022-2023) on Wednesday evening. A lot has already been written, said and debated about the reported GDP/GVA numbers. Apparently, the reported yoy GDP growth of 13.5% for 1QFY23 is slightly short of what the market consensus was expecting.

In my view, the economic growth of India has been grossly inadequate and unbalanced, especially in the past 5yrs. The worst part is that the manufacturing and construction sectors that are traditionally considered having material employment generation potential are growing the least. It is primarily the exports that have helped the Indian economy to grow at the rate of 1.4% CAGR in the past 3years. Given that the global economy has perhaps entered a phase of protracted slowdown or sub-optimal growth, the exports may not sustain the Indian economy for too long.

The markets must take cognizance of this. Especially the excitement in construction and capex space is not getting much support from the economic data sustain. Moreover, the piling inventories across supply chains globally and in India at a time when demand is getting crushed and inventory carrying costs are rising, also call for additional caution.

Technically markets are showing some strength and may move a little higher from the current levels. However, this would be a rally to sell into rather than getting infected with FOMO.

 ·         The European continent is facing its worst drought in 500yrs, leading to crop devastation, loss of livestock, wildfire, water shortages and accelerated glacier melting. The situation in about half of the continent is alarming – soil is losing moisture and vegetation is under stress. (read more)

·         Western states of the United States have witnessed persistent drought conditions in the past couple of decades. It is the longest and driest stretch in the past 1400yrs. A study published earlier this year suggested that “there’s a very strong chance the drought will continue through 2030.” The soil moisture in the affected states is at historic low. Studies have indicated that a couple of good years of rain are highly unlikely to change the drought situation materially. (read more)

·         Many provinces of China are witnessing the worst drought on record. River levels have diminished resulting in closure of hydroelectric projects and severe electricity shortages. Forest fires and grassland fires are common and severe. China's largest freshwater lake, Poyang Lake in Jiangxi province, has shrunk by about 75%. Thousands of farmers who relied on lake water or river waters have lost their crops. Drinking water is being rationed. (read more)

·         Brazil, Argentina and Paraguay, the three major agricultural producers in South America, experienced a prolonged period of drought and low water levels in their main rivers in the 2021-2022 crop season. The dry and hot weather  severely impacted harvests. The river transport of important summer crops, with maize and soybeans was amongst the main casualties. Various agencies estimated a 20 million tonne of shortfall in food production in these three countries alone. (read more)

·         Many parts of Australia are also witnessing significant deficiency in rainfall. For Tasmania and South Australia, area-average rainfall for July was among the lowest on record compared to all years since 1900. Serious rainfall deficiencies (totals in the lowest 10% of historical observations since 1900) continue to affect western Tasmania, the Roper-McArthur district of the Northern Territory and south-west of Western Australia for the period starting December 2021. Crop yields have been poor and wildfires rampant. (Read more)

·         Neighboring Pakistan is suffering from one of its worst floods in recent memory. The humanitarian situation in Pakistan has deteriorated further over the past two weeks as heavy rains continue to cause flooding, and landslides resulting in displacement and damage across the country. Extensive damage to crops and livestock has been reported. (read more)

·         Central and Eastern India is also witnessing a drought that has impacted the summer (Kharif) crop in the key states of UP, Bihar and West Bengal. (read more here , here and here)

·         To add to the climate pains, the war between Russia and Ukraine has further escalated the global food shortages.

It is obvious that “food scarcity” could be a major issue affecting the world population. Unfortunately, no central banker could help bring the food prices down under these conditions. The governments could help to a limited extent by rationing supplies, regulating wastages and rationalizing buffer stocks. However, they would also be helpless if the condition persists in 2023 also.

The question is how an investor could benefit from this situation. The traditional approach – investing in agro chemical, food commodities etc. may not work in this situation. The demand for agro chemicals could witness a sharp drop if the drought-like conditions persist. The food commodity trading and prices could be heavily regulated and controlled to discourage trading and profiteering. The farm equipment and irrigation infrastructure development businesses could also suffer from poor demand.

One of the obvious investment avenues in India could be cultivable land. However, a myriad of problems make this option less viable for most of the financial investors.

A recent tweet by Dr. A. Velumani, founder of Thyrocare Diagnostics, offers an interesting idea – investing in the goat farming business. However, in case of severe drought, fodder could be a serious problem for this business.

It is a basic human tendency to long for what they do not possess. It is common to find people who have struggled very hard to achieve certain goals; but almost instantly feel dissatisfied with (or indifferent to) the outcome. They either realize that it was not something they actually wanted in the first place; or they immediately shift the goal post and begin to struggle/strive for a different/higher goal. This basic human tendency, that often manifests in a constant need to move, evolve and grow, is at the core of all economic growth and development. And perhaps this is the key factor that undermines the issue of sustainability.

Metaverse is nothing but a realization that humans never wanted to globalize in the first place. They like to remain confined to their caves and tribes. It was perhaps the starvation and disease that would have forced the first tranche of immigration.

Of course since the end of the stone age, this realization has taken more than 5000 years; many rounds of polluting industrialization; chopping of billions of trees; extinction of many species; killing of millions of people in wars, to dawn upon the mankind. And it may actually not be the full circle and we may still want something more once we realize the goal of living in a predominantly virtual world.

If I may put this hypothesis in a more recent context-

·         The people of USSR were sick of the central command economy and wanted a democracy that facilitates their participation in the global growth and development; besides making the governance structure transparent, corruption free and progressive. Gorbachev gave them an opening to the world they were struggling to live in. In less than two decades, they chose to hand over the power to an authoritative leader who is not even committed to any socio-political ideology; aspires to restore Tsarist colonial ambitions and cares least for the global order, transparency and accountability.

·         China, which has consistently supported Pakistan’s demand of self determination by Kashmiri people at all global platforms, refuses the same rights to the people of Tibet and Taiwan. The Chinese authorities and businesses demand equal rights for their companies from the governments of foreign jurisdiction where such Chinese corporations have established operations. However it refuses to allow similar justice and freedom to its own corporations and entrepreneurs like Jack Ma.

·         We find that for almost a decade the central bankers of the developed world struggled to create inflation and full employment in their respective economies. When the inflation finally occurred, it is now their biggest problem.

·         The farmers, agriculture experts and politicians in India clamored for farm sector reforms for many decades. But when a significant part of these reforms were delivered, people launched a movement for reversal of these reforms.

·         The industrialists and financial market participants long for accelerated economic and fiscal (tax) reforms. However a mere mention of withdrawal of Income Tax exemptions and concessions (e.g., LTCG) makes them apprehensive.

The simple point is that the investors should not get passionately attached to a new trend or event. Most of these could be ephemeral; and could evaporate as soon as these go out of media headlines.

In the past one month the benchmark Nifty50 index has gained over 7%. With these gains Nifty returns are now positive YTD2022 as well on a one year basis. In fact, the August 2022 Nifty Future expiry was the highest since October 2021 Future expiry of 17857. Even for Bank Nifty, the August 2022 Future Expiry was highest ever; since October Future expiry of 39508. Indian equities are now outperforming most major global markets on a one year basis.

On one year bsis Nifty is now higher by ~6%.In this period, IT (-15%), Pharma (-8%) and Small Cap (-4%) are notable underperformers; while Energy (+39%), Media (+33%), Auto (+33%), PSU Banks (+30%), Realty (+21%) and Midcap (+14%) are notable outperformers.

The ~7% gain in the past one month has been led by Metals (+13.5%), Private Banks (+9.9%) and Energy (+9.8%). Pharma (+2.3%) and FMCG (3.3%) have been notable underperformers.

This strong market performance has occurred in spite of  – (i) below par 1QFY23 corporate performance; (ii) continued monetary tightening; (iii) elevated inflation; (iv) worsening current account and weakening currency; (v) weakening global growth impairing export growth outlook; (vi) erratic monsoon impacting kharif sowing and clouding rural demand outlook; and (vii) worsening geopolitical situation in China Sea as well as Ukraine. Obviously, there are doubts over the sustainability of the current market up move. The question thus arises “how does market look in the near term (next 6 months)?”

In my view-

(a)   The economic situation in Europe, US, and China may continue to worsen materially into summer as the energy crisis worsens; drought intensifies further; food inflation rises further; monetary tightening continues and global demand slithers further down.

(b)   Macro challenges in India may continue to remain intense in India as food inflation stays elevated in festival season; RBI tightens further in busy season; exports slowdown keeps CAD elevated; manufacturing growth continue to disappoint on poor export order flow; overall growth remains below the budget assumptions impacting the revenue collection estimates & public expenditure; election to some key states keeps reform agenda in check.

(c)    Relative stability and growth may keep the foreign flows positive. However, some of this could be neutralized by poor domestic institutional flows, as we have seen in the month of August.

(d)   The earnings downgrades may accelerate post 2QFY23, as even the current consensus on earnings growth (~15%/16.5% for FY23e/FY24e) looks slightly optimistic.

(d)   Technically, most Indian indices are in a neutral zone as of now – implying even risk reward in near term. The benchmark indices may rise or fall by 5-7% in the next 2-3months. However, in case Nifty does rise by 5% from the current level, the risk reward shall become very negative. For BankNifty though it may still remain neutral.

So in my view, Nifty may move in the 16250 – 18750 range, with occasional violation on either side, in the next 6 months. Most of the Nifty upside could be contributed by financials. BankNifty could therefore outperform materially. In technical terms the range for BankNifty could be 36800-44000, with occasional violation on either side.

 Some of the most popular video clips shared on social media in India in the recent past were of India’s External Affair Minister, Mr. S. Jaishankar, giving stern replies to the global media about India’s stand on Russia-Ukraine war. In these clips, the minister is seen ‘exposing’, the hypocrisy of European media and politicians in raising questions over India’s purchase of energy from Russia, despite sanctions imposed by US and EU, while the European countries continue to buy natural gas from Russia. Most social media constituents who shared these clips cited the confident and unabashed counteroffensive by the Indian minister as a harbinger of ‘rising India’ and ‘declining west’.

I personally have no disputes with the social media warriors on this issue. It does feel good to see a representative of the Indian government taking a firm stand against the developed nations on global platforms. However, the point I am presently more concerned about is ‘declining west’.

Worsening demography

With a total fertility rate of 1.6, the European Union’s population is on the decline. European Uinon, whose working population (aged 15 to 64) shrank for the first time in 2010 and is expected to decline every year to 2060. In contrast, the proportion of people aged 80 or over in the EU population is expected to more than double by 2050, reaching 11.4 %. In 2006 there were four people of working age (15-64) for each person aged 65 or over – by 2050 this ratio is projected to be just two people. Migration from other Eastern Europe is helping it to compensate for workers’ shortage to some extent, but it is far from adequate. Most European countries are therefore open to relax migration rules for the Asian immigrants. India’s demographic dividend may, to some extent, come from migration of young workers.

Climate change – Mother Nature showing no benevolence

Historians cite numerous reasons for the decline of the once Great Roman empire. Climate change and disease are also listed as prominent reasons from the Empire, once considered invincible (for example read here). European economy and strategic powers have been diminishing slowly in the post cold war era. The recent climatic disasters are threatening to acclerate this decline further.

As per a latest report by European Union Joint Research Center’s Global Drought Observatory (GDO) Analytical Report titled Drought in Europe – July 2022 – Europe Europe is experiencing its worst drought in at least 500 years. Hot and dry conditions are fueling wildfires and adversely impacting crop yields and electricity generation. About half part of the European continent is facing an alarming situation with a clear deficit of soil moisture. The summer temperature has risen to record levels disrupting transportation, displacing people and causing numerous deaths. Deficient rainfall has affected river flows across Europe – hitting the energy sector for hydropower generation and cooling systems of other power plants.

This climate catastrophe came soon after the Covid-19 pandemic severely crippled many European economies, besides causing numerous deaths and health complications.

Europe has already lost its technology leadership to the US and China. If the agriculture and energy dynamics change materially in the next one decade, the spectre of “the fall of Rome” might return to haunt Europe again. It is however too early to assess how this would  affect the rising Asian societies.

Some notes on the current state of the Indian economy.

Monsoon ‘abnormal’ so far

The monsoon season this year has been quite erratic so far. Statistically, during the period from 1^st June to 22^nd August the country has received 9% more than the normal rainfall. However, the temporal and spatial distribution of rainfall has been quite abnormal so far.

·         252 (36%) of the 703 districts in the country have witnessed ‘excess’ (20% to 59% above normal) to ‘large excess’ (60% or more above normal) of rains.

·         236 (34%) districts have received ‘normal’ (upto 19% above or below normal) rains.

·         215 (30%) districts have received ‘deficient’ (60% to 59% below normal) to ‘large deficient’ (more than 60% below normal) rains.

·         More importantly, the granaries of India – UP, Bihar, Jharkhand, West Bengal have been mostly deficient to large deficient. In UP, 66 out of 75 districts have been deficient to large deficient. In Bihar 35 out of 38 districts have received deficient to large deficient rainfall.

The agriculture activities have been affected in large part of the country due to erratic, large excess and deficient rainfall. However, the water storage levels in most reservoirs are now good and soil moisture is also better, which augurs well for the Rabi crop. Thus, despite a below par Kharif crop and poor summer vegetable crop; we may see decent overall agriculture growth in FY23. However, the rural demand in this festival season may be not buoyant. The rural credit may also face renewed stress in some pockets.

Infrastructure orders ‘strong’

NHAI reportedly awarded 6,306km of orders in FY22 – vs 4,788/3,211km in FY21/20, exceeding its target of 5000km. Other government departments and state governments are also accelerating the pace of infra order awarding, especially in roads, irrigation, metro, water and mining. It is expected that the order momentum may sustain in FY23 as well. Reportedly, more than Rs1trn of tenders have been issued in July 2022 alone. Roads, water, and railways continue to be the major contributors for the same.

Among sectors, roads, railways, water and irrigation, and power equipment (Solar EPC) saw strong inflows in April-July 2022. Growth in railways was driven by large wagon orders. Growth in power equipment was driven by solar EPC orders.

Considering the ‘above estimate’ performance of most infrastructure developers, it is evident that the execution may also be improving. It is reasonable to expect that the infrastructure activity may finally be taking off to an acceleration phase.

Inflation expectations ‘anchored’

Reported CPI for July 2022 was at 6.71%, at five month low level. Though, it remained above the RBI upper tolerance band of 6% for 7^th consecutive month. The core inflation-excluding food and fuel segments- came in at 6.04% in July compared to 6.22% in June. Thus a slowdown in inflation rate was primarily driven by food, transportation and communication.

The RBI Governor commented yesterday that “inflation is getting increasingly anchored; has moderated from the peak. Bond yields at the long end are reflecting the anchoring of inflation. Softening of crude and commodity prices is also supportive. Inflation has peaked and is expected to moderate.”

As per the brokerage firm JM Financials, “India’s inflation trajectory is trending downwards while core inflation should be range bound (5.9% - 6.4%) throughout the upcoming festive season before easing meaningfully. But the risk of percolation of high WPI inflation to retail inflation would keep CPI elevated, currently the wedge remains as high as 8.2% and even if July WPI print eases by 50bps, the wedge would still be 8%. Although global supply chains may show early signs of easing, geopolitical issues are far from over and any further escalation would negatively impact crude price and INR. We see Q2FY23 CPI inflation at 6.9% vs RBIs 7.1%, easing inflation would entail a policy action addressing more towards defending
INR than suppressing demand, hence Sep’22 MPC meet should see shallow rate hikes (30bps).”

Borrowing cost and deposit rates rising

As per rating firm CARE Ratings, “Credit offtake had shown an improving trend in the latter half of FY22, which has continued in the first four months of FY23. RBI has been working on reducing the liquidity surplus in the banking system which has been consistently reducing and is currently around the Rs 2 lakh crore mark from Rs 7 lakh crore at the beginning of 2022.”

Weighted average lending rate (WALR) for all banks has risen post RBI hiking the policy rates. Expectations of further policy rate hikes are also prompting certain banks to proactively raise rates. Deposits rates have also witnessed some hikes; though the rise in deposit rates, has been slower than the increase in lending rates.

From various recurring events that generate significant anticipation and anxiety amongst market participants, the speech of the US Federal Reserve chairman at Jackson Hole annual symposium is the most popular one. This year the speech is scheduled to be delivered on 26^th August. Since, the markets are again filled with anticipation and anxiety. I find it pertinent to highlight a few things about the event and its likely consequences.

Jackson Hole is Davos in Wyoming

Later this week the Fed Chairman Jerome Powell is scheduled to make a speech in a symposium held in Jackson Hole valley (Wyoming, USA). This annual symposium, sponsored by the Federal Reserve of Kansas City, has been held since 1978; and in Jackson Hole since 1981. The symposium is usually held in the month of August, just ahead of the pre scheduled US Federal Reserve Open Market Committee (FOMC) meeting in September.

Many prominent central bankers, finance ministers, reputable academicians and market participants take part in this symposium to discuss the currently important issues facing the global economy. In the distant past, some reputable economists, like James Tobin (Tobin Rule) and John Taylor (Taylor Rule), have presented their path breaking papers at the symposium.

It is customary for the US Fed representative (Usually the Chairman or a senior official) to present their thoughts on the topic selected for that year’s symposium. The topic for the 2022 symposium is “Reassessing Constraints on the Economy and Policy”.

There have been a couple of instances (Paul Walker 1982 and Greenspan 1989) where the US Fed representatives dropped some hints about the imminent policy changes in the ensuing FOMC meetings. But those hints were incidental and not by design. Otherwise, there has been no instance where the thoughts of the US Fed representatives have actually digressed from the given topic for the symposium. Nonetheless, various experts have been regularly conducting a post-mortem of their speeches to find mentions of the words and terms which they can use to market their own views in the garb of the Fed’s hints.

In fact in the past two decades, no path breaking paper has been presented at the symposium and Fed chairman speeches have been noted for all the wrong reasons; most notable being the Bernanke dismissal of sub-prime crisis (2007); and Greenspan’s advocacy for expansionary policies (2005), which was heavily criticised by Raghuram Rajan in 2005 and rest of the world in 2008.

It would therefore be not completely wrong to say that the Jackson Hole event is now mostly irrelevant for the financial markets. A harsher criticism would be to state that Jackson Hole is on the path to become the American version of annual outing of worlds’ elite held by an NGO (World Economic Forum) in Europe’s Davos.

For records, at the last year Jackson Hole symposium, the Fed Chairman did not say or hint anything that had not been said at previous FOMC meetings, Congressional testimonies and various public speeches. The focus was on the topic of the symposium (“Macroeconomic Policy in an Uneven Economy”) rather than the monetary policy of the US Federal Reserve. In fact, to highlight the role of monetary policy in the current macroeconomic environment, Chairman Powell had mentioned that “The period from 1950 through the early 1980s provides two important lessons for managing the risks and uncertainties we face today. The early days of stabilization policy in the 1950s taught monetary policymakers not to attempt to offset what are likely to be temporary fluctuations in inflation. Indeed, responding may do more harm than good, particularly in an era where policy rates are much closer to the effective lower bound even in good times.” (Speech of Fed Chairman Powell at 2021 Jackson Hole Symposium)

Do not rush to fill your buckets

In case an investor is feeling a rush to act in anticipation of what the Chairman Powell might (or might not) say at Jackson Hole this Friday, I would like to narrate the following to him/her:

If a geologist tells you, “the Himalayan Glaciers are melting fast and there will be no water in the Ganges in the year 2050”; what would be your instant reaction? Will you—

·         Rush to store water in buckets?

·         Begin to explore places which are not dependent on the Himalayan Rivers for their water needs, for relocation in next few years?

·         Commit yourself to the environment conservation by adopting 3R (Reduce, Reuse and Recycle) as part of your life so that the green house emission is reduced, global warming is reversed and the geologists are proven wrong?

·         Dismiss the information provided by the Geologist as fait accompli and get on with your routine life?

I may say with confidence that various people will react differently to this information, but none will rush to store water in buckets, and a very large majority will dismiss the information as fait accompli.

I believe that the finance and economics experts prophesying various policy changes are no different than the Geologist forecasting the end of the Himalayan glaciers; and the investors’ collective reaction to their prophecies is also no different. A large majority of investors dismiss the experts’ views and perhaps no one takes material investment decisions based on these prophecies. Nonetheless, these prophecies do create an environment of great anticipation with usual jitteriness and eagerness in the near term. One mistake most of the investor make in this environment of jitteriness and eagerness to do something, is to not ask themselves—

(a)   What is the situation that is being sought to change?

(b)   How the change would impact the businesses underlying their portfolio of investments?

(c)    How the action they are contemplating to take will protect them from the perceived adverse impact of the change in the status quo?

For example, if Quantitative Tightening (QT) is prompting you to take an action on your portfolio – look at the following US Money Supply chart (M2) chart and decide how long will it take for the US Money Supply to reach pre QE1 level.

Notwithstanding the official position about the state of economy in the US, the market is building an elevated probability of a recession (or a recession like, if I may say so) situation in 2023. The short term (1-2yr) bond yields are now higher than the benchmark 10yr yields in a number of developed economies, including US, UK, Canada, Sweden, and emerging economies like Brazil, Mexico, Hong Kong, Turkey, Pakistan etc.

Historically, the yield curve inversion has been a harbinger of recession in the majority of instances. For example, in the case of the US, the yield curve inversion has been followed by a recession in all of the past seven instances.

In this context, it is important to note that the US Federal Reserve (Fed) and European Central Bank (ECB) have unambiguously stated that they are willing to accept a measured slowdown in the economy to achieve the goal of price control. The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) also stated categorically that for now price control is the primary objective and not economic growth. This implies that RBI is also willing to accept a calibrated slowdown in the economy to meet the end of price stability.

As it appears from the commentary of global central bankers, renowned economists and widely acclaimed market experts, the process of monetary correction may be a protracted one; and hence the global economy may not return to the desired trajectory of growth anytime soon. The situation for the stronger emerging markets like India may however be different. These economies could find their own course and avoid recession. Nonetheless, the impact of the slower (or negative) global growth would be felt and remain a key obstacle to high growth.

In particular, if our growth plans have accorded high priority to (a) exports to developed countries and (b) reliance on manufacturing growth due to global businesses preferring Indian facilities over China or Germany (China+1 or Europe+1); then probably we our policy makers would need to rework the strategy for the interim period.

So far, we have not heard any credible plan from our policy makers to mitigate the impact of impending recession-like slowdown in our major trade partner economies. In such an environment, RBI’s 4.5% real GDP growth projection for 2HFY23 might prove to be marginally optimistic and growing 7% in FY24 would be a big challenge. The markets need to take cognizance of this, in my view.

After almost a decade the Indian financial sector seems to be out of troubled waters. Almost all significant banks are beyond solvency concerns and set to progress in the path of growth. The asset quality has shown steady improvement for most banks despite Covid disruptions. The loan growth has improved from historic lows seen in the past few years. Earning growth is strongly aided by healthy recovery from the bad accounts.

Moreover, the loan books of most tier 1 and Tier 2 banks are tested for stress and provisions are adequate to meet most foreseen adversities. These institutions have come a long way from the first announcement of Dirty Dozen (the largest 12 non performing accounts) in the summer of 2017. Eight of the notified 12 accounts have been resolved with more than 50% recovery. Resolution is under progress for two accounts and the other two are under liquidation. As of the end of FY22, no major potential stressed account has been reported that can materially alter the current status of any bank. The credit cost from hereon will mostly be under control with some defaults in the normal course of business.

The best part is that the rather stringent provisioning and disclosure norms have significantly enhanced the credibility of the books of banks. The capital adequacy is positive for aggressive lending. Obviously the outlook for Indian banks is bright and buoyant.

Most of the non-bank lenders (NBFCs) are also back on the path of steady growth. The asset liability mismatch (ALM) and asset quality concerns have been mostly addressed by almost all meaningful NBFCs. Many weaker players have been eliminated from the market. For the survivors, the business is brisk and profitable.

Obviously, for the investors in the financial sector better times lie ahead, even if the consensus overweight on the financial sector might slow down the trajectory of gains a little.

Notwithstanding the air of optimism all around, the sky may not be all blue and bright. There are scattered clouds that do not look menacing as of this morning; but certainly warrant a watch.

I shall be in particular watching some conglomerates that are growing too fast (both organically and inorganically) and are considerably leveraged. In some cases the leverage appears supported by the balance sheet that might have been engineered to look healthy but not necessarily backed by tangible assets. The cash generation is poor; thus the servicing capability could be severely impaired if the things do not go as per the plan, raising the spectre of dirty dozen all over again.

The number of systemically important (too big to fail) financial institutions is also growing steadily. The regulator (RBI) is keeping a closer vigil on these institutions. Additional regulatory provisions have also been prescribed for these. Nonetheless, in case of a global contagion like dotcom (2001-2001) or global financial crisis (2008-2009) the probability of a “big tree collapsing” in India is now certainly not zero.

From the business viewpoint, I hope that while aiming to achieve global size and economies of scale, the Indian managements would have learned key lessons from the decline of global conglomerates like General Electric and General Motors and demise of Lehman and Merrill Lynch etc.

 The latest episode of global inflation is impacting peoples’ lives in multiple ways, especially in developed countries where the present generation of citizens has not experienced this kind of rise in the cost of living; borrowing cost and challenges in accessing consumer credit. It is of course a significant challenge for the young investors and professional money managers who have been raised in an environment of profligate fiscal policies; abundance of liquidity; near zero cost of borrowing; persistent struggle to mitigate the deflationary pressures and unchallenged US supremacy over global markets and geopolitics. For them all the assumptions that underlined their investment strategies might be falling apart; just like the Dreamliner Titanic.

This episode of inflation and consequent monetary tightening would indubitably prove to be an important life lesson for the young investors and money managers; and go a long way in defining the future investment strategies and market directions.

Besides, there are some other noticeable side effects of the inflationary pressures on the global socio-economic milieu. For example consider the following:

There are several reports indicating that harassed by the rising cost of living and high rentals, many youngsters may be returning to live with their parents; several more may have delayed the decision to leave the parental homes; yet some other who were living alone are moving in with their partners and friends to save on rental and other costs (for example see here). It may be too early to conclude anything, but if this trend sustains we might find it catalyzing some interesting changes in the demographic profiles of many countries; housing market; immigration policies etc.

There is enough anecdotal evidence available to indicate that employees demand higher wages to manage the rising cost of living; but they seldom agree to wage cuts during the deflationary phase. The businesses therefore usually engage in workforce realignment to optimize their wage bill. The senior employees whose actual contribution is stagnating but wages are rising, are invariably replaced by younger employees which cost much less simply due to their lesser vintage. Inflation thus causes higher unemployment in middle and upper tier employees, who are either forced out of the labor market or accept new jobs at much lower wages. The governments however do not have this luxury of letting senior people go. They usually meet the goal by imposing a moratorium on fresh hiring and rationalizing non-wage costs, e.g., travel.

The products’ prices usually do not move in direct proportion to the raw material prices. During raw material inflation the margins of most companies shrink, unless they enjoy significant demand elasticity for their respective products and are able to pass on the entire raw material inflation on to their customers. However, during the raw material price deflation phase, a majority of companies do not pass on the benefit to their customers. This is the phase when most companies, that have survived the inflationary period, see their margins expanding.

As the rate of inflation declines, the prices of consumer goods do not necessarily fall. They just stop rising at a faster rate. Thus, if the wages of households have not risen in line with the rise in the cost of living, the hit to their consumption and/or savings could become structural.

Financial repression is one of the worst impacts of inflation. The savers lose real income while the borrowers get money at much lower real cost. Post inflation this situation is rarely reversed. Neutral real rate is usually the best case in a deflationary period. Positive real rates are not seen to last for any meaningful period.

To control inflation, a variety of fiscal and monetary policies are used by the governments and central banks. Higher interest rates, lower liquidity, higher tariffs to curb demand, subsidies to the poor to augment their income are some of the popular tools used to mitigate inflation and its impact. However, in case of deflation the use of fiscal policies is not very popular; even though in some cases incentives are offered to encourage demand. Withdrawing fiscal subsidies and incentives in the post inflation period however proves to be a serious political challenge. Thus, while the monetary expansion could be moderated in a relatively shorter span of time, the fiscal corrections could take much longer.

 The NITI Aayog recently published “India Innovation Index 2021” report, which presents “an in-depth analysis of the state of innovation in the Indian economy”. The India Innovation Index 2021 presents state-wise rankings based on the innovation landscape and performance of the country’s states and union territories. The latest framework of the index has been mapped from the Global Innovation Index, published annually by WIPO (World Intellectual Property Organization).

The report earnestly recognizes that human capital is the source of innovative ideas, knowledge, and practices. It notes that high innovation capabilities need heavy investment in human capital development at all levels to develop skills beyond technical knowledge, e.g., imaginative thinking, devising methods to tackle complex issues and keeping pace with the times.

The report emphasizes “the practice of promoting innovation at the grassroots is necessary to fully utilise the potential of the indigenous knowledge bases by engaging the local communities in the process.11 The exercise is of greater significance in a country like India where a considerable share of the population is engaged in the informal sectors. To monitor and promote grassroots innovation, the Government of India in 2000 established the National Innovation Foundation (NIF) as an autonomous body of the Department of Science and Technology. The foundation aims to drive innovation at the grassroots through documentation, protection of Intellectual Property Rights (IPR) and commercialising innovation and innovative techniques devised by unaided small-scale innovators. The institution was able to file 114 patents in the year 2019-20.”

R&D has played a significant role in the growth of developed countries. The countries that have high per capita R&D expenditure tend to have higher per capita GDP as well.

Innovation in India

In India, R&D investment has been relatively low. In the past few years, R&D investment in the country has declined from 0.8% of the GDP in 2008–09 to 0.7% in 2017-18. This is lower than the other BRICS nations—Brazil spends about 1.2%, Russia about 1.1%, China just above 2%, and South Africa around 0.8%, with the world average being about 1.8%. On the other hand, developed countries like the United States, Sweden, and Switzerland spend about 2.9%, 3.2% and 3.4%. Among all nations, Israel spends the most, 4.5%, of its GDP on R&D.

Dismal private participation in R&D

Besides very low R&D spends, another challenge in India is lack of private participation in the innovation process. About 60% of all R&D spend is incurred by the government against USA 10%, UK 6%, and Israel 1.5%. A major chunk of India’s R&D expenditure is thus on defense and space research; whereas healthcare and manufacturing account for ~13% of public sector R&D spending.

Huge regional disparities

The ability to innovate is dependent on the quality of human capital. It rests on the opportunities in terms of research and development. Lower spending on R&D, and less innovative opportunities may lead people to move from one region to another region - state/ country for better opportunity.

Overall Global Innovation Score for India is a dismal 14.56. Besides, there exist huge regional disparities within the country. Most of the R&D effort in India is concentrated in few states and cities. Some clusters in NCR, Karnataka, Tamil Nadu Maharashtra, Telengana and Gujarat account for a large proportion of overall innovation effort in the country.

Suggestion for improving the innovation rank of India

The report makes the following suggestions for improving the global innovation score of India to aid faster economic growth and development.

1.    GERD needs considerable improvement and should touch at least 2%, which would play an instrumental role in India achieving the goal of a 5 trillion economy and further influence its innovative footprint across the globe.

2.    The role of the private sector in research and development needs to pick up pace.

3.    The expenditure on human capital has been unable to create that knowledge base in the country, which could be due to the intricate reasons of bureaucracy, administration, outreach, etc. It is observed that innovation is skewed against the manufacturing sector. This requires inexorable efforts to overcome challenges and make the best use possible.

4.    India has been able to provide a conducive environment for businesses to thrive, in terms of a business environment, safety, and a legal environment, but we have not been able to support the same in terms of investment and knowledge workers. We need to harness the energy and potential of youth to augment knowledge workforce.

5.    We need to sincerely fill the gap between industry demand and what we produce through our education system.

6.    India needs to undertake efforts in creative goods and services, which have been ignored for a long time.

7.    In India, intangible assets like patents and trademarks filing process are complex and face procedural delays. We need to streamline this.

8.    Our states and Union Territories need to break silos and start working in tandem, as no state/UT can thrive alone endlessly without taking care of its peers.

About two months ago, I received a late night call from one of my close acquaintances. The man was in a tearing hurry. Almost gasping for breath, he informed me that the stock market in India is going to crash and the benchmark Nifty is certain to fall to at least 12500 levels. He had learned from some very credible sources that the markets world over are going to crash soon; and India may actually go the Sri Lanka way. “Crude prices will top US$140/bbl soon and USDINR will collapse to 85”, he sounded extremely confident. Half asleep, I did not know how to react to his claims instantaneously. To buy some time to react, I pleaded “could we discuss this in the morning, please!”.

When I called him in the afternoon, the next day, he had already liquidated half of his portfolio. He sounded quite relieved and exuded the confidence of a victor. I had no contact with him, till he called again yesterday evening. This time, he wanted to know “Could Nifty make a new high in the next 3-4months?” I again had no instant answer to his earnest inquisition. I am sure that the question was mostly rhetorical; since he sounded quite convinced about this proposition of market scaling new highs soon. I think he will deploy his cash in a day or two.

I am not sure, if this one isolated instance is indicative of a larger market trend, viz., the greed dominating the fears”. But from my experience of over three decades, I can certainly tell that this person definitely has a lot of people accompanying him “in” and “out” of markets at frequent intervals.

Many of these proudly claim themselves to be “seasoned investors”, who have the ability to read the pulse of the market and foresee the future trends well in time. They alternatively use “macroeconomic factors”; “technical charts”, “political developments”, “geopolitical events” and “valuation” arguments to camouflage their “greed and fear”.

One morning they would swear by valuations and economic fundamentals; and on other days they sound like experts and loyal followers of the Elliott Wave and Japanese Candle and Sticks. One day, they feel confident listening to the “mother of all bull market” narrative of Rakesh Jhunjhunwala and “fastest growing economy” claims of the finance minister, while the very next day they need tranquilizer to sleep because some Nancy Pelosi is boarding a flight to Taiwan. They confidently forecasted, in February 2022, the end of Ukraine within one week and beginning of WWIII.

What actually surprises me the most is that despite their frequent mood swings and mostly intuitive actions in the market, they are not only able to beat the benchmark indices consistently, but also outperform some of the most seasoned fund managers and long only investors; though they may not be earning to their full potential, meaning their actual return may be lower than what they could have made otherwise. This consistent outperformance lends them confidence and belief that their strategy and methods are the best way of “investing” in stocks.

I would never concur with them, even though I could never earn more than them from my investments. The question that arises from this is – if I cannot beat them, should I join them? My answer is an emphatic “No”. Because - I always sleep peacefully. I do not bother to call anyone at midnight to ask what is happening in the markets. I do not give a damn even if President Biden is also flying with Speaker Pelosi to Taiwan and PM Modi is flying to Tibet to meet the Dalai Lama. And I certainly do not care if Wave C of 3 is opening or it is an extended 2 Complex.