What is the central story emerging from earnings season?  

With the earning season just behind, it may be a good time to look at the macro picture that emerges from the micro earnings. Conference calls and management commentaries throw up a lot of insights into how outlook is shaping up for various sub-sectors. In this context, it is fascinating to reflect on the sense one is getting from such insights with respect to how demand is shaping up, esp.  in the consumption space. With a lion’s share of over 60% in the GDP, consumption is a critical space for a deep dive. Over there, the picture looks patchy and the underlying signals throw up distress in distinct spots.  The central story of the earning season, if there is one, it is the emerging divergence between luxury and mass segment. In a way it is a K story for the economy where the top end is shining while the inflationary burden on the bottom end is playing havoc with the mass market demand. It is not without reason that the social media is all buzz with funny memes on the divergent demand trends between underwear/chappals and luxury cars. In a way, it reflects the grim reality of K-shaped recovery India is facing now. As the theory goes, whenever people are tight on money, they don’t replace their underwear. Signals from underwear can only be ignored at one’s own peril.

The best place to start for the deep dive, is to look at the data points from the FMCG sector. How does the volume picture look like for this sector for the quarter gone by? As per NielsenIQ, the industry’s value growth of over 7% in the Oct-Dec quarter came more from price hikes than underlying volume growth. While the urban volumes managed to eke out marginal volume growth i.e.1.6%, rural segment saw a volume decline of 2.8%. Similarly, management commentaries from both Asian paints and Pidilite flagged stress in rural and semi-urban demand. Both these companies reported a flattish volume growth for the last quarter. The commentaries from hair-oil companies like Marico, Dabur or Bajaj Consumer are no different. They all sing the same tunes of rural and semi-urban stress. The picture is no different in other mass product segments like low priced footwear or entry-level motorbikes and so on. It may be pertinent here to note that the entry-level two wheelers are still down by over 35% from pre-pandemic volumes.

While mass segment is on a murky shape, on the other side, at the top end, picture couldn’t be more contrasting. Take the case of luxury cars. Sold out signs are there for everyone to see. It is hard not to miss the optimism from the management on premium cars. High double digit volume growth from Ethos, a luxury watch retailer is no coincidence. Same is the case with premium footwear or sportswear from companies like Campus Activewear or Metro Brands, contrasting the crashing demand for mass market retailers like Bata or Khadim. Though some of the volume pressures on the mass market are on account of high base effect in this quarter (lumped-up demand in the base quarter because of pent-up demand post covid opening in Oct-Dec’21), the K-shaped divergence is still distinct in the overall demand landscape.

Recovery in rural and semi-urban demand is critical if the shape of the recovery has to change from K to V. Though management commentaries are pointing to early signs of rural recovery, it may be too early to celebrate. Given the climatic heat effect on the Rabi crop yield and the possibility of a negative impact on monsoon from a probable El Nino phenomenon later this year, one needs to keep fingers crossed on sustainable rural recovery.

Will the delay in rural recovery derail the growth prospects for the economy? Will the 6.5% growth projections by RBI and IMF for the economy get scuttled by the continued stress in the sub-urban and rural segment? We will not have those answers any time soon. But that doesn’t stop us from looking at other shining spots of the economy. While consumption is going through the K-type divergence, prospects for infra and investment demand offer hope. One is witnessing stronger traction in those segments, thanks primarily to the initial signs of turns in the private capex and from the stronger push from the Govt on the public capex. The case in point is the increased allocation from Govt to the capex spending. It is at all-time high of 3.3% of the GDP for the FY23-24 as per budget projections. With divergent signals coming from different segments of the economy, money managers are not going to have it easy. When it comes to portfolio positioning, one can rationalize the portfolio to gain from the increased spending in capex allocation and restructure if required to adjust for the headwinds in the rural consumption side. Interesting times for portfolio and money managers!

This article of mine was published in the online edition of Economic Times (05/03/2023). Glad to share the link:https://economictimes.indiatimes.com/markets/stocks/news/what-is-the-central-story-emerging-from-earnings-season/articleshow/98429610.cms

What are the read-throughs from Nifty’s under-performance in January?

India stood out last year. The same decoupling story that made Indian markets to shine last year has come back to bite us in this year. Our markets are still decoupling, but in the opposite direction. Post Chinese reopening, last year’s underperforming markets are coming back with a vengeance while India is witnessing outflows. Though recent Adani saga has added new ammunition, the primary driver for India’s underperformance starting this year has been the FII reallocation to last year’s under-performing markets. So, the pertinent question to ask, is the current FII sell off that we are witnessing in the markets only about mild re-adjustment trade or a sign of larger things to come? Let us dive in.

As is well documented now, year 2022 was an exceptional year for Indian markets, in terms of relative performance. In the EM basket, every market fell except India. Circa 2023, reverse is on full display. Take for example Kospi. It fell by over 24% last year. This year, it is up 10%+. Or take the case of Hangseng. It was down by over 15% last year and now they are up by over 15% starting this year. Even if one looks at the overall MSCI EM index, it was down by over 22% last year. Now, this year, it is already up by over 10%+. But if one looks at India, decoupling is on full display. Nifty was up by 4% last year while, it is already down by near 3% (as on 28th Jan).

Looking at above pattern, in terms of FII flows, market may remain vulnerable for a while till the adjustment (reallocation) is complete. Of course, whenever such a reallocation trade happens, markets take anything negative that comes on the way to accelerate the adjustment process. On this, Adani expose couldn’t have come at a worse time. The short point is, with or without Adani expose, markets would still be correcting. While this (reallocation) will continue to be an overhang for the Indian markets in the short-term, for the overall EM tide, the January rush could be just the tip of the ice-berg if one believes that the EMs are set for long-term out-performance relative to US. It is not without reasons that we believe that the EMs are set for a stellar period in the coming years. Though there are many reasons, the primary one is the expected cyclical under-performance of US on account of limited headroom for neither multiple expansion nor margin expansion. As happened in most decades in the past, whenever US markets outperformed by a significant margin, it always came at the expense of emerging markets. Last decade was no exception. At the same breath, reverse has also been true for many decades. That is, whenever US markets struggled with sub-par returns, those decades belonged to emerging markets. Going by this, hopefully, we are in for such a turn now for emerging markets. If the crack in dollar index from the Oct peak of 115 to current 102 level is any indication, the overall tide for EMs have probably turned already esp. if one takes the following macro positives into account.

  • Moderating inflation i.e. sub 6% in India and sub 7% in US
  • Closer to end of rate-hike cycle i.e. 75/100 bps more to go in US and about 25bps more or a pause in India.
  • Russia-Ukraine conflict receding into background. Does not hog headlines too often as it used to.

That said, we can be sure about the EM turn only in hindsight.

Assuming it is a decisive turn for EMs, then, it will be a question of time before India couples back and starts moving in line with the overall EM tide. Of course, this is after the adjustment process is complete for last year’s resilience. Meanwhile, in the short-term, market will hope that the Adani sell-off and the impending Budget pass off peacefully without any major damage to the market’s current technical structure. Interesting times for Indian markets!

This article of mine was published in the online edition of Economic Times (05/02/2023). Glad to share the link:https://economictimes.indiatimes.com/markets/stocks/news/what-are-the-read-throughs-from-niftys-underperformance-in-january/articleshow/97620078.cms

Are Emerging Markets set for a turn from a decadal low tide?

It had been a dry run for emerging markets (EM) for a decade. It may come as a surprise to many that the emerging engines did not do much for the ten-year period ending December 2021. To be precise, MSCI EM index delivered a near-flattish annualized returns of 3% over that period. By contrast, in the same period, US markets (S&P) delivered a stunning outperformance by giving annualized returns of 14.2% in the same period. As happened in most decades in the past, whenever US markets outperformed by a significant margin, it always came at the expense of emerging markets. Last decade was no exception. At the same breath, reverse has also been true for many decades. That is, whenever US markets struggled with sub-par returns, those decades belonged to emerging markets. Are we in for such a turn now for emerging markets? Let us find out.

To make the case for emerging markets, let us first look at certain key historical data points in terms of how US and EMs have done in terms of returns in the last decade. For US, last decade was a stellar one in terms of returns. S&P delivered annualized returns of over 16.6% (14.2% excluding dividends) in this period. No complaints. On the other hand, emerging markets, as measured by MSCI EM index, delivered paltry returns of 3% (without dividends) annualized over the same period. It was such a striking and stark difference that made them two different worlds at either end of the spectrum in the investment universe. More interesting data emerges if one breaks down the S&P returns data in terms of contributions from sales growth, margin expansion and multiple gains. Here, let us use data from the recent study done by Christopher Bloomstran in his recent annual letter (as captured brilliantly by Akash Prakash (Amansa Capital) in his latest piece).  As per this, the overall return of 16.6% is made up of 3.8% sales growth, 4% margin expansion, 6.4% multiple expansion and finally 2.4% of dividend yield. This letter argues that, looking ahead into the next decade, even if one assumes that sales growth continues at 3% level, it is less likely that any gains will come from margin expansion or multiple gains, given that they are at more than peak on a cyclically adjusted basis. Adding another 2% growth from dividend yield, it projects a bleak prospects for the S&P annualized returns of near 5% in the coming decade. Taking it further, as a corollary, this would also mean that the emerging markets would shine brighter with a big outperformance in the next decade. This assumption is supported by the historical data points.

Now coming to India, in addition to this expected turn in favor of EMs, what will make the medium/long term outlook more compelling bull case is the huge tailwinds it is likely to get from the larger trends that are brewing globally. Borrowing from Morgan Stanley’s recent research note, larger global trends like Decarbonization, Deglobalization and Digitization are likely to disproportionately benefit India compared to any other country. It is difficult to spot any other country that will get a boost from all of these trends. While China+1 and Europe+1 are central to deglobalization, India’s push in green energy and hydrogen initiative is likely to invigorate the revival in private capex cycle. In digitization, though it covers a big scope and large spectrum, if one specifically limits the focus to offshoring potential on India becoming office to the world, the prospects seem extremely bright, esp. with work-from-anywhere trend gathering traction across global corporations. Of course, all these will not happen overnight, but will evolve over time.

In addition to above, India’s macro is also likely to gain momentum from the other cyclical trends listed below.

  • Cumulative low base effect of slow growth for many years.
  • Turn in property cycle having a multiplier effect on the economy.
  • Revival in Private Investment Demand.
  • Credit cycle turning in India on the back of clean-up of bank and corporate balance sheets.

Going by market actions in EMs and in India in particular over this down cycle, looks like, global investors are positioning themselves for leadership from these market segments in the next upcycle.  As is well known, in markets, if a sector falls much less in a down turn or if a sector demonstrates a lot of resilience in a falling market, then such sectors lead in the following bull market. If one extends the same logic to the EM basket or to specific markets within the EM, going by India’s convincing out-performance in the current down cycle, it will not be a surprise if India leads the next bull cycle within the emerging market basket which in all likelihood will out-shine markets like US where the returns are likely to sub-par in the next decade, as argued in the opening section of this article. It is time for EMs to carry the baton!

This article of mine was published in the online edition of Economic Times (04/12/2022). Glad to share the link:https://economictimes.indiatimes.com/markets/stocks/news/are-emerging-markets-set-for-turn-from-decadal-low-tide/articleshow/95978440.cms?from=mdr

Is gold ironically losing its shine when inflation is rearing its ugly head?

In these trying times, when inflation has begun to bite the consumers, gold should be reigning supreme. That is what conventional wisdom would say. Gold as a hedge against inflation is a textbook play, except that markets don’t play to the textbooks. Markets play to the momentum. For reasons we will discover later in the section, optically, it looks like that the momentum is not with the yellow metal. How else one would explain the loss of luster in gold in times like these when positive real returns (returns adjusted for inflation) are rarity.

In inflationary times, there is always a rush to risk-off trade to protect returns against inflation. One could count on gold in such struggling times because money moves to gold when investors turn risk-averse.   The current environment is one of the typical risk-off regimes where central banks globally are tightening liquidity to contain the inflation monster. But in this cycle too (as in 2013 cycle), it looks like that the typical pattern is not playing out. Or are we missing something?

First, on the gold performance, some surprising findings:

  • In dollar terms, gold has fallen by over 7% in the trailing twelve months.
  • In Rupee terms, optically it looks like it has delivered positive returns (one year) because of currency fall i.e. near 2%+ returns.
  • Most surprising data point is that gold in dollar terms has remained flat over the last decade. This may not be good news for gold bulls.

One of the main reasons why gold falls (in dollar terms) during Fed tightening cycle is that it is priced in dollars. When dollar becomes dearer, which typically it becomes during the tightening cycle, gold which is priced in dollar moves down. It was no different in 2013 taper cycle. In 2013-2015 taper cycle, when dollar index rallied by over 18%, gold in dollar terms fell by 16%. It was more or less in line with the dollar index rally. But in this cycle, dollar index has rallied by over 17% in the last one year. Gold fell too, but far less than what the dollar index did. What explains the gap this time?

In the last taper cycle, inflation was not such a big worry as it is now. Hence probably gold fell in line with the dynamics of the dollar index. But in this cycle, with inflation out of control, probably there is new money moving into gold which explains the out-performance of gold versus dollar index. Though superficially, at the outset, it looks like that gold prices have fallen in dollar terms, in relative to dollar index rally, it has out-performed. This outperformance couldn’t have happened without some momentum favoring gold. If one goes by this out-performance, conventional wisdom of gold as an inflation hedge does score some winning points. Unfortunately, the out-performance level is not adequate to compensate the rise in inflation (measured in local currencies) across different markets. For e.g., the gold has returned barely 2% returns in India (in local currency) over one year while the inflation is over 7%. From this perspective, one could argue that gold has lost its luster when it comes to inflation hedge. To understand this gap, one needs to understand how momentum works.

In momentum game, rally begets rally in virtuous feedback loop. What performs gets more fuel to perform better.  From this perspective, dollar has attracted more flows because of its stronger immediate past performance. In the competition between dollar and gold in the risk-off flows, the dollar has won hands-down because of the stronger momentum in its favor. Logic doesn’t work when momentum is in play. That explains the unexplainable fall in gold in these turbulent times. Interesting times to watch out for.

Happy Value Investing!!

Indian markets: Has the pendulum swung from decoupling to recoupling?

On the decoupling debate, few days of brutal market action was enough to make a twist in the tale. The debate has now moved from decoupling to recoupling in matter of days for India. The death knell for decoupling debate came when Fed in its latest policy meeting turned more hawkish with its forecast for a much prolonged hikes in the coming months in its fight against inflation. Post that meeting, global equities slumped, treasury yields rallied and dollar index surged. The global slump did not spare the Indian markets. The Fed scare had shaved off about 4% from Nifty in just few trading sessions with serious collateral damage to the currency and Gsec yield. Indian Rupee breached the long-held support level of 80 to move near 82 while the ten year Gsec yield surged by over 15bps. With this, the decoupling debate has been put to rest.

Until this meeting, India stood out like an oasis in the desert with its markets moving up amid a global equity slump. That led to Indian markets out-performing major indices globally. In the period between early Aug and mid-Sep (till 16th Sep), Nifty was up by over 2% while the MSCI EM index was down by over 4.0%. That was a stunning out-performance of over 6%. Even against MSCI World index, which was down by over 4.9%, the out-performance was significant. Looking at another data point, from June lows, Nifty was up by over 11% (until mid Sep) while Dow Jones was marginally negative. All around, India was charting out its own course amid global slump. 

What was happening? Many had rushed to prematurely call this an age of “decoupling’ for India, rationalizing it on the ample ammunition coming from favorable geo-politics, tail-winds from global supply chain diversification, turn of profit cycle driven by domestic demand etc.

Down cycle or upcycle, it is usually the developed markets, esp. the US market that sets the tone and the Emerging Markets (EMs) follow the course earnestly. It is very unusual for any EM market to stand out and step out of this rhythm. This has been the case for India as well in many cycles. It is difficult for anyone to recollect any single cycle where it was otherwise. It was always one of tight coupling with what was happening in the overall EM basket. But this cycle looked different. Though it was tightly coupled in the initial part of the current down cycle, since Aug, Indian market seemed to have stepped out to chart its own path, at least until mid Aug.

Was this decoupling for real or will the markets soon recouple? This was the question that was in many investors’ mind till last week. Now, turning the clock to end Sep, it is no longer a debate. Markets seemed to have given a decisive verdict to this question with Nifty catching up with the rest of the global markets in the slump.

What should investors do in these difficult times?

Investors need to keep a balanced perspective during these turbulent times for the markets. While India’s macro is a relative sweet-spot for global investors with an attractive growth cycle, stable forex reserves along with superior external debt profile (external dollar debt at 19.9% of the GDP with long-term papers constituting 80.4% of the overall external debt), in the short-term, it is difficult for any EM to stand out and shine given the global linkages and spill-over effects of Fed’s tightening. So, when the global macros is at a difficult spot, it is not easy for any major economy to decouple on a sustained basis. 

From this perspective, it is prudent for investors to expect short-term volatility, though India might continue to stay as a relative sweet-spot for global investors for the medium term from political, geo-strategic and market perspective. What it assures is that once the short-term volatility is digested and weathered, India might come back to out-perform very strongly the global and emerging markets. Given this robust medium term outlook, Investors should use the short-term volatility and corrections if any to their advantage.


This article of mine was published in the online edition of Economic Times (07/08/2022). Glad to share the link: https://economictimes.indiatimes.com/markets/stocks/news/indian-stock-market-has-the-pendulum-swung-from-decoupling-to-recoupling/articleshow/94595293.cms?from=mdr

The big Retail Rush: What is driving the consumption binge in India?

Data points for India and the world can’t be more divergent. While the world seems to be convulsing on the dread of triple R, India seems to be rejoicing on the rhythm of double R.  Triple R of Recession, Rate hikes and Reduction in central bank balance sheets dominate the narrative for the developed world whereas here in India, the double R of Retail Rush is reveling the retailers. Diwali seems to have set in early for consumer demand.

Retail business, PV sales, credit card spends and retail credit have seen a huge spurt in July after months of muted show. Both the RBI’s consumer confidence index and the CMIE’s consumer sentiments index (Center for Monitoring Indian Economy) have shown a significant spurt in July. More importantly, what is significant is that both these indices reflect the assessment on the future conditions of demand, besides the current one. This means the consumer confidence in India is likely to sustain in a durable manner, provided there are no further shocks from the global macro.

What is fascinating is the level of growth in July in the consumer retail vis-à-vis the pre-pandemic level in 2019 (not YOY from 2021). In most of categories, the growth numbers are gyrating at high double digits as listed below.  
23% in footwear
22% in apparel and clothing
32% in sports goods
23% in furniture & furnishing and 17% in QSR
17% in Consumer Durables & Electronics and 15% in jewelry

While opening up of contact-intensive services sectors and improved rural prospects on good monsoon etc. could be cited as some of the reasons for the rise in consumer sentiment, it doesn’t fully explain the extent of jump one is witnessing in various categories, esp. with respect to pre-pandemic levels. Looks like, there is more to it than what meets the eye. The reason being, the pandemic pent-up has been playing out for a while since March and hence can’t fully explain the surge in July, esp. when the global macro and inflation/interest rate scenario is much less favorable now compared to few months back.

So the key question to ask is, what is driving this consumption binge? If it is beyond the pandemic pent-up, what is it? In our view, it may be impossible to pinpoint to any one single factor that could be causing this upsurge. It could be because of a confluence of factors coming together in a coincidental manner to conspire this huge consumption surge. What could be these factors?

Here are some of the major ones…

  • With the clean-up of balance sheets and NPA cycle behind, banks and NBFCs are more than willing to lend, fueling credit growth (for e.g. latest data shows that a 77% jump in loans for consumer durables).
  • Cumulative pent-up (rather cumulative base effect) from accumulated demand because of slower growth over last six to seven years on account of teething troubles over reform measures such as GST, RERA etc. With these measures stabilizing, they are now acting as catalysts for renewed growth.
  • Opening up of contact-intensive service sectors and surge in disposable income among employees in technology and other services segments etc. have added, not in small measures to the consumer boost.
  • Improved confidence on India’s medium to long-term growth outlook on favorable geo-political settings (China+1 in particular), massive super-digitization cycle, progressive policy environment etc.

In summary, if one goes by above confluence, it looks like the surge we are witnessing in consumer demand is likely to sustain and could turn out to be a durable one. Further, there are early signs that the stress in the rural economy is easing as reflected in the fall in the demand for work under MNREGS in July (Mahatma Gandhi Rural Employment Guarantee Scheme). For the month of July, work demanded under this scheme fell to nearly half as compared to the prior month. This coupled with the improving prospects on the jobs front (due to an uptick in agricultural activity and a better monsoon which led to a 6-month drop in the unemployment rate in July), there is increasing confidence and comfort for a durable surge in consumer demand. Hope the Retail Rush becomes a double R block-buster for India in real terms like the theatre flick RRR in reel terms. Only time will tell. Interesting times!


Will the emerging market crisis eventually touch the Indian Shores or has India’s macro come a long way from fragile five days of 2013?

The crisis is deepening in emerging markets. The crack is widening far beyond the obvious names like Pakistan and Nepal. When a celebrated economy in the not-too-distant past is at the door-steps of IMF, one can understand the extent of crisis in the emerging markets. What was once extolled as a miracle economy, Bangladesh could now be bordering on an IMF bail-out?  Such is the scorching heat across emerging markets. In such a scary situation, one can’t help, but start digging deeper for any hidden macros risks in India. Could the consensus view of a relatively stable macro for India be clouded by few serious misgivings? Or, has India’s macro really come of age from those fragile days of 2013? Let us dive in and explore.

Emerging market crisis follows a very familiar pattern. In times of high liquidity cycle (while Fed is easing), money supply is abundant and it reaches far-away shores to seduce the usual EM suspects to go for an over-drive on consumption-driven growth with borrowed capital. In a playbook style, falling dollar index, rising local currency, cheaper imports, lower interest rates etc. all play together to fuel local consumption. In times of abundant liquidity, currency valuations get distorted to artificially high level so as to hide the underlying twin deficit problems (Current account and fiscal) that usually the case for most of the emerging markets which import much more than what they export. When the music stops, which usually does when Fed starts the tightening, the reverse dynamics of rising dollar index, falling local currency, surging interest rates etc. pushes up the hidden vulnerabilities to the surface. In these times, markets start looking closely at some of the metrics like dollar debt to GDP, current account deficit, level of forex reserves, upcoming dollar debt payments etc. with a microscope. If market smells a rat in any of those metrics, it beats down the currency in a vicious cycle to bring the country down to the brink of bankruptcy. This usually happens in a self-fulfilling feedback loop fashion with a falling currency triggering outflows which in turn fuels further fall in currency that in turn aggravates the already aggrieved twin deficits, inflation etc.

So, the key thing is the confidence of investors in the macro metrics. If it is broken, it triggers a vicious cycle as explained above. The confidence comes from various factors that include level of forex reserves, credibility of central bank in handling inflation, dollar debt to GDP, short-term debt payments, manageable current account etc.

Where does India stand on these?

Level of forex reserves are reasonably high at over eleven months of imports (even after its recent depletion in defending the Rupee). Similarly, India’s dollar debt is at a manageable level of around 19%+ of GDP, far lower than many Asian peers. India’s central bank enjoys high credibility in tackling inflation risks. These are positives for India. But there is one sticky spot for India. That is, India’s historical vulnerability from high current account deficit (CAD) that suddenly shoots up during such crisis times, esp. when crude goes beyond 100$ level amid weakening Rupee (as 80% of India’s energy requirements are imported). This has always been a potential landmine for India, esp. during Fed tightening cycle. Will this time be different?

To answer this, let us go back and look at the key difference between 2013 and now in terms of CAD vulnerability. Not to forget that India was clubbed as one of the countries in Fragile Five in 2013. The key macro difference between 2013 and now, comes from the differing trajectory of growth between crude and the software exports. Software exports in dollar terms have more than doubled in this period while crude imports in dollar terms have stagnated or marginally declined (even at this elevated level). Looking at the data points, software exports have surged from 70Bn dollars (appx) level in FY14 to 178Bn (as per Nasscom) dollars now (FY22) whereas energy imports (including LNG) have declined from 140Bn dollars level in FY14 to 130Bn dollars in FY22. This has brought in a huge comfort in easing our macro vulnerability from Oil risks. Today, software exports income covers more than the total oil bill by a factor of 1.3 times (even at this elevated oil price of 100$+) from a precarious situation in FY14 when oil bill was 2X of software exports income. This comfort is only going to increase multifold with the projection of over 300Bn dollar+ annual exports by 2025 as per Nasscom projections, given the huge super digitization cycle globally. Also, bear in mind how oil import as a share of total imports has come down from 30% level in FY14 to 21% level now (FY22). It doesn’t stop here. India’s focus under the current political leadership on renewables, ethanol blending, CNG infrastructure, potential leadership in green hydrogen, sourcing oil at discount from Russia etc. will further strengthen India’s macro architecture. Needless to say that India has come a long way in its macro stability esp. in its external financing and CAD management.   

In our view, this development will single-handedly change the contours of India’s macro risk profile. This change is the most under-debated and least understood across investment community. Add to this the Indian companies’ and banks’ rising credit profile on the back of huge cleanup of corporate and bank balance sheets. With NPA cycle behind, risk of potential accidents in the financial sector receding (such as ILFS in the 2018 tightening cycle), India’s macro seems to be among the few shining spots for global investors. This is probably the reason why India witnessed investments of near 34Bn dollars in the PE-VC (28% growth YOY) space in the Ist half of calendar year when FIIs were busy pulling out over 25Bn dollars from the equity markets. This emerging comfort on macro stability, progressive policy environment, Rupee’s relative strength and positive long-term growth prospects etc. probably could be the reasons for the rising confidence from domestic investment community and for the huge resilience Indian markets have demonstrated during the current crisis. Next few months will tell us whether this prognosis is right or wrong. Interesting times to watch out for!

This article of mine was published in the online edition of Economic Times (07/08/2022). Glad to share the link: https://economictimes.indiatimes.com/markets/stocks/news/will-the-emerging-market-crisis-eventually-touch-dalal-street/articleshow/93408910.cms

Will US Fed walk the talk on the stimulus exit?

If the news that the Fed has an ambitious plan for monetary tightening hasn’t reached you yet, you must be in a dwindling minority. Blueprint for a massive monetary exit has been out for a while now. It will be on a scale that world had not witnessed any time in the past. It has been set on a double R i.e. rate hikes and reduction in balance sheet size. If you are like me and wondering, is there a third R so that we can make it a nice sounding acronym of triple R (of course, no connection with the blockbuster flick RRR), yes, there is one which the Fed would like to desperately avoid in this game of tightening, that is, Recession.  What keeps the Fed awake late night is this, how to execute the first two “R”s rigorously without having to deal with the third R? Or will the worry of third R push the Fed to abandon its tightening plans half way? Let us dive in. 

Looking at the genesis of this inflation battle, there is a lot of merit in what some of the experts are echoing on Fed being far behind the curve on its fight against inflation. Unfortunately, Fed had seriously under-estimated the risk of how far the inflation will go. Initially, Fed assumed inflation will be transitory and it will come under control once the lock-down is behind. That assumption went completely awry because of Ukraine conflict and renewed Omicron related lock-down in China. Now, Fed has to make up its lost time by going for a lot more aggressive steps on its tightening to shore up its inflation-fighting credentials. One should expect an aggressive tightening now with an accelerated interest rate hikes and balance sheet shrinking. Beyond the already discounted aggressive rate-hikes, on balance sheet shrinking, in July-Aug, they are likely to start with $25Bn per month and accelerate to $90Bn+ monthly unwinding from second half. The plan is to complete the full run-down by end of 2023. That is a massive 1.7tn dollars of liquidity reduction.

Given the scale of this exit, there will be repercussions both to the asset prices and to the consumer demand. It is not going to be easy for Fed to run the full course. On slightest of the excuses, it might slow down or even reverse its course. Even if the Fed wants to go the full course, the political establishment may not have the will to face the consequences. Looking at the past cycles, one can see the familiar pattern of shorter down-cycles and longer up-cycles. There is a reason why down-cycles are shorter. One doesn’t need to look beyond Fed’s PUT (unconditional back-stop from Fed whenever markets go through trouble) for finding the reason. No sooner than the demand starts contracting because of Fed’s medicine, political pressure starts building up on Fed for easing up to start another round of stimulus. This has been the playbook in the past cycles. It is unlikely to be different this time too, though long-term solution lies in allowing the patient to go through the full medication to completely purge the excesses. Fed has been postponing this D-day for long. What will make the Fed to go for the final kill is a known unknown and should be left for a discussion for another day. For now, it is unlikely that the Fed will go the Paul Volcker way of hard landing. For the uninitiated, Paul Volcker was the Fed Chair in 1979 who took the inflation battle head-on and managed to vanquish it, though not without putting the US economy into a painful recession.  

Turning to inflation now, there seems to be some cooling off on the whole-sale prices. Freight prices are down on easing container shortages (except for crude containers). Supply chain issues no longer hit the headlines. Chip and fertilizer prices are down. So is palm oil price. There is a sort of crash in metal and commodity prices, but for crude. These lower prices will impact the WPI very quickly and then   transmit to consumer prices with a lag effect. To that extent, the worst is probably behind for the inflation, unless we have new surprises in store.

In all likelihood, with the worst is behind on inflation, Fed is most likely to use the incremental softening in inflation as an excuse to go slow on tightening by becoming less hawkish down the line. There is a good chance that Fed might opt to go with this politically palatable path, thereby postponing the eventual hard-blow to sometime in future. Where does it take us? If history is any guidance, we will see more of a zig-zag movement in rate-hikes/tightening rather than a full-hearted Paul Volcker like playbook. This would mean soft-landing without hard exit from stimulus. For equity markets, that would mean a shorter down-cycle and faster rebound. Though this could be the most likely outcome, no one can be sure about anything in the short-term as things are so volatile and uncertain on the inflation front. Given this, the best way to navigate this uncertainty is through a disciplined process of investing and asset allocation.        

Happy Value Investing!!!

Valuation of IT Stocks: Tactical Retreat or Irreversible Ramp-down?

Markets are magnifying machines. On the way up, it is all about what can go right as they magnify the greener pastures. On the way down, projection of pitfalls takes the primacy, as the magnification shifts to the murky side. Nature of the beast is such that it can never take a realistic or objective view. It swings between over-shooting and under-shooting. Since markets are born with the magnifying lens, it is investor’s job to wear the contra gear to keep off from the market’s fallacy.

One sector that is at the receiving end of this manic behavior is the IT sector. After two years of one-way run, stocks in this sector are getting brutally punished in the current downturn. Looking at the data points, in this calendar year, YTD, IT index is down by near 26%. In comparison, the Sensex is down only by 7.6%. In month of May (MTD) alone, the IT index is down by over 11%. If the fall at index level is 26%, one would fret to imagine the slump at the stock levels, esp. at the mid-cap end. In the pecking order of falling-from-grace, the one standing tall in this inglorious list is LTI (L&T Infotech) with a fall of over 47.8% followed by Mindtree at a touching distance. Even larger names like Wipro and TechM are not far away with a fall near 40% (all above data points as on 25th May).

One wonders, what has happened to all that sound-bites about super-digitization cycle, secular cloud transformation etc. that drove the valuations in this sector to stratospheric level in the last 2 years. Has anything materially changed or is it only a change of lens? Why is there a sudden rush among brokers to downgrade IT stocks? It started with JP Morgan and Nomura. Now, no brokerage wants to be left behind on this new down-grade rush. What explains this?

In our view, it is more of a valuation-reset than of any material change in growth projections or sector prospects. It is more of a narrative- following-price-action than the other way. As it happens always in the markets, price-action leads and then the narrative follows. Ironically, though the brokerages downgraded their target prices, none of them has downgraded their growth forecast for FY23. Even for FY24, they are less certain about the slowdown in tech spending. Downgrades are fast coming on fears of further price erosion.

So the next question to ask is, what triggered such a sharp price-action in the IT index relative to the Sensex and Nifty? For that, one needs to look at what is happening to NASDAQ stocks, because they are the lead indicators for the sentiment in the tech space. Taking that argument, probably, the rout in NASDAQ stocks explains the deadly derating that we are witnessing in Indian IT stocks. It was a common knowledge that the NASDAQ stocks were in a bubble zone and Fed action came as a much needed blow to prick it. As is to be expected, the meltdown in the NASDAQ had a massive rub-off effect on tech stocks globally. Indian IT stocks which were way off in valuations from their historical averages, had to bear much of the brunt from NASDAQ effect. Even after this sharp correction, the valuation in this sector is still far off from their historical levels and is yet to come to a fair valuation levels, esp. in the mid-cap IT space.

Having said that, none of the medium to long-term drivers for growth in IT space have gone away. Enterprises’ willingness to spend on digital and cloud transformation will continue to feed into above average earnings growth for the sector. But the growth in earnings is unlikely to translate into valuation growth as much of the stocks are still trading well above their historical averages. So in essence, nothing much would happen on the valuation front and the story going forward will be more of earnings catching up with the expensive valuation than anything else. That is the best-case scenario one can hope for IT stocks. To conclude, is it time for time correction for tech stocks? Only time will tell. Watch out for interesting times!

This article of mine was published in the online edition of Economic Times (05/06/2022). Glad to share the link: https://economictimes.indiatimes.com/markets/stocks/news/valuation-of-it-stocks-tactical-retreat-or-irreversible-ramp-down/articleshow/92018927.cms

When can FIIs return? Fed’s previous tightening cycle drops some clues

Taper is behind, but tightening is ahead. That is a subtle one-liner that captures what to expect from Fed going forward. On taper, US Fed stuck to its schedule. It began the program in early Jan and quickly finished it by winding down new bond purchases to zero by end of March’22. Now it is onto the next, rate-hikes and balance sheet shrinking. With monetary tightening in terms of balance-sheet reduction, expected to begin by Jul-Aug, it will not be out of place to peep into what happened in the previous stimulus cycle to get a sense of what lies ahead. Looking back, in the earlier Fed stimulus cycle (post Global Financial Crisis), though taper started in 2013, it wasn’t until late 2017 that the Fed really started taking serious steps to shrink its balance sheet. For the uninitiated, taper refers to winding down the size of the fresh bond purchases while balance sheet reduction refers to allowing those earlier purchased bonds to mature without repurchases. As is well known, the later has a much bigger impact on the market as the excess stimulus liquidity is pulled out of the markets by allowing the bonds to mature without repurchases. That’s how Fed scales down its balance sheet size after every stimulus cycle.

This time too, Fed has an ambitious plan to arm down its pandemic stimulus by planning to shrink its balance sheet by a sizable scale in the coming months. As per some estimates, it may, in all likelihood, start with 25Bn dollars a month from Jul-Aug, slowly accelerate to 95Bn and end the entire unwinding by 2023 December. If that happens, one is talking about taking out over 1.7tn+ dollars of liquidity out of the system in 18/19 months beginning July/Aug. To put that in perspective, it will be nearly thrice the amount that was pulled out in the previous cycle in 2018/19 i.e. about 660Bn dollars were pulled out as part of balance sheet reduction program from Feb’2018 and Aug’ 2019. 

By any scale, this is a massive unwinding. The world had not witnessed such a large-scale winding-down any time in the past. Of course, relative to what was pumped during pandemic (near 5 trillion dollars from April’20 to Mar’22), the scale of unwinding may not seem sensational. Given that the Fed’s balance sheet expanded from 4 trillion to near 9 trillion dollars in this period, a gradual reduction over the extended period is probably the best outcome one could hope for. Yet, markets are naturally worried whether FIIs will ever come back to emerging markets in this period when Fed is busy pruning its balance sheet. Given this huge overhang of liquidity challenge for the foreseeable time, it may seem realistic to assume that FIIs are unlikely to return any time soon, esp. after their massive exodus from India since Oct’21. For the record, they have pulled out over 23 billion dollars (net sales) since then.

It is precisely here, where a peep into the past liquidity cycle could throw some interesting insights into how FIIs behaved in a similar situation. Let us go back and look at the period between Jan’18 and Aug’19. In this period, Fed reduced its balance sheet by over 660bn dollars, by pulling out an average of 30bn dollars every month (exact amount varied from low of 16bn to as high as 61bn in different months). It helps further to split this period into two to understand how FIIs behavior changed over the time of the unwinding. In the initial part, as the Fed unwinding started, FIIs started pulling out in Feb’18 and accelerated their pace during the mid-year to reach the peak sometime in Oct-Nov’18. FIIs pulled out over 6.5bn dollars in this period. But, what happened post that was more interesting. Until this period, Fed’s unwinding was about 30Bn dollars per month, which it later increased it to 38Bn dollars per month from Jan’19 until Aug’19. Ironically, after the increased quantum of monthly unwinding from Fed, FII flows reversed into inflows and there was a massive net inflows of over 13bn dollars in the period between Jan’19 and Aug’19. Not to forget that in this period, over 300bn dollars was pulled out by Fed to reduce its balance sheet. So, what does one conclude from this?  Is there a co-relation between Fed’s unwinding and FII flows?  Of course, there is co-relation in the initial period, but not long after. More importantly, what is more interesting is that the inflows in the later part were twice the money that left in the initial part. Having said this, it is also important to keep in mind that no two cycles will be same. While the broad pattern may be similar, exact point at which the tide will change for FII flows could be difficult to predict. But what is more important to understand is that the FII money will come back much sooner than Fed’s timeline for unwinding. Not only it will be sooner, but it will be much larger than what went out. This is one reason why some seasoned investors are expecting a melt-up (bull- run) for Indian markets next year (2023). From this perspective, the current weakness, which is likely to continue for few months on account of Fed’s rate-hike and balance-sheet-shrinking overhang, is a great opportunity for long-term investors to lap up their positions, esp. on those sporadic panic days which will come often for a while.

Happy Value Investing!!!

This article of mine was published in the online edition of Economic Times (03/05/2022). Glad to share the link: https://economictimes.indiatimes.com/markets/stocks/news/when-can-fiis-return-feds-previous-tightening-cycle-drops-some-clues/articleshow/91284603.cms