Snowball Effect: Yet to Play?

SnowballRonald Coase once said, if you torture the data enough, it will confess to anything. But he seems to come awfully short when it comes to economic data for past five years for India. Whichever way one tortures, needle hardly moves from that one indication that the economy hasn’t done much in the last 5 years. GDP growth was at 7.4% in 2014 and now it is at 7.1%. Share of manufacturing has been languishing around 15% level for last 5 years from the peak of 17.5% in 2007.  Capital investment has fallen from 34.27% of GDP in 2014 to 30% level in 2018. Besides private consumption and govt. spending, much of the growth metrics has been drifting directionless since long. Yet, when this govt. came to power in 2014, one thing that was in abundance (and went unchecked) was hope. As we look back at the end of 5 years, the question we are asking is not what went wrong (some missteps are well debated and documented), but when will the payoff be for all the incremental reforms this administration has painstakingly penned over last 5 years?

Before that, here is the quick recap of those reform measures which have gone off the radar of investment community amid the slowdown and election noise.

IBC (Bankruptcy Code), one of the most under-rated reforms of this administration, will have far reaching impact on the structural shape of the growth in the coming cycles.

MPC (Monetary Policy Committee), the key reform that has the potential to transform the trajectory of inflation & interest rates and hence the trajectory of Rupee.

GST, RERA (Real Estate Law), DBT (Direct Benefit Transfer) the coherent strategy that runs seamlessly across these reforms to structurally swell the tax base and tax/GDP ratio to significantly higher levels.

These reforms, in isolation, may not seem big-bang, but when it rolls together along-with the expected, yet elusive, turn in investment demand, can create a big snow-ball effect for the growth, esp. when NPA and overcapacity issues are behind us. Of course, this is not a new expectation. Many, including this column, expected this effect to come into play in early or late 2018 itself.  But, uncertainty around general election coupled with EM outflows in 2018 had caused growth to sputter in the short-term resulting in delay in such a play.

But here is where the catch is. Longer the delay, the stronger the snow-ball effect that will come into play. From this perspective, growth pattern that will emerge post-election could be diametrically opposite to what happened in the last election. In the last election, markets ended up over-rating the political outcome as growth across the term came lackluster. This time, it might end up under-rating the extent of growth that will get galvanized by the foundation-work (above listed reforms) that has been laid in the last five years.

This prognosis is not of course without any caveat.  There is a risk of recession looming in US next year, if not this year. While that could take some shine off from the stellar story, it is unlikely to have lasting impact given the huge catch-up the economy has to do when it comes to investment cycle, as it has to offset the dry run it had, not for short-while, but for more than half-a-decade.

As someone wise said, markets are extremely efficient in the short-term while leaves a lot to be desired when it comes to long-term. It over-rates short-term developments while under-rates long-term implications. In the broader segment of small-mid-caps and in select pockets of large caps, markets have left lot on the table as it is in no hurry to discount the golden times that is ahead.

Happy Value Investing!!


The Coming Broader Play?


India has been a late starter in the ongoing EM (Emerging Markets) recovery. While the tide started turning in Jan itself for other emerging market peers, for India, signs of green shoots in flows started showing up only in early March. FIIs in their rush to make up the lost time, started pumping flows fervently as if there is no tomorrow, mainly through their favorite mode i.e. ETFs. With daily buying of over half a billion dollars, overall net flows quickly surged to surpass early highs to touch $4 Bn+ within weeks. Not a surprise that much of this fast money flowed into select few favorite large cap stocks, very handful of them, as anyone can easily guess. Sensex surged and broke out of its resistance to scale near all-time high. So was Nifty.

What about broader markets? They too participated, but to lesser extent, as domestic institutions were more on the sell mode. More importantly, if the FII flows, after the initial surge, continue to trickle in a more steady fashion, the action could shift to the broader small and mid-caps. As in the past cycles, when the action shifts, the movements in the broader space could surprise even the most optimistic ones. That is the nature of broader markets. They surprise on the downside (as happened in 2018) as well as on the upside (as could happen in 2019).  They are much less saner space than Sensex. At the same time, this lack of sanity is the precise reason why this space offers seductive long-term returns for seasoned investors.

As the action shifts, the coming broader play could set off many stocks on fire. This could happen either pre-election or post-election on a back-ended fashion. But whenever it happens, it will be reward time for anyone who has patiently built the portfolio brick-by-brick during the long and deadly winter of 2018. Hope the rewarding time is not too long.

Happy Value Investing!!

The Growing Disconnect?

With earnings season drawing close, one can’t help, but notice a distinct pattern that has emerged from this season. As the regular understanding goes, stellar results can seldom fail to give a fillip to the stock price. But this season proved otherwise. All that stellar results could do for any company, esp. in the broader space, was to stop the bleed, not reversing it. Such is the dislocation in the broader market. As a result, the disconnect between the price and value has worsened to worrying levels reflecting huge nervousness among investors. But looking from a contrarian perspective, valuations couldn’t be more attractive, esp. where the earnings have shown distinct upside momentum.

The positive news doesn’t just stop with the earnings. The positives are slowly and steadily out-weighing the negatives since the dawn of 2019. While the market, in its myopic mood, has ignored the growing positives that are listed below, when it will swing to the other extreme is anyone’s guess.

  • Rising hopes of trade settlement between China and US.
  • Receding fears of no-deal BrExit and hopes of its postponement.
  • Resumption of EM (Emerging Markets) carry trade with taps opening for EM flows.
  • Buoyancy in emerging market index (MSCI emerging market index is up by over 7% since the dawn of the new year)
  • Prospect of pause in the Fed’s interest rate hike cycle etc.

Of course, market sees more merit in the local liquidity fears and political uncertainties than heeding to the changing global cues. That could as well be right from the short-term perspective. But for long-term investors, they must take cues from the earlier political cycles to draw lessons that electoral outcomes hardly dictates market’s long-term trend. This understanding should help them to ignore the market’s political tantrums and use them to their advantage by investing into the volatility.

Happy Value Investing!

Emerging (markets) Divergence?

Bull Market

2019 started off with a hope for India. Emerging markets took cues from easing tensions on trade war between China and US, falling treasury yields on hopes that Fed would change its hawkish stance on fears of looming slow down, softening crude on surging supplies amid slowing growth and above all from prospects of weakening dollar, to chart out a promising recovery in their equities and currencies. One doesn’t need to go beyond looking at MSCI emerging market index to get a grasp on this. This index is up over 7% since the onset of the New Year. That is quite a lot for an index that fell nearly 20% in 2018. But that is only one part of the story. The twist to the story comes from what is happening right here in the Indian markets.

India is not as lucky as other emerging markets when it comes to recovery. 2018 was a year of synchronized fall across emerging markets. India wasn’t spared with any special treatment during the broad based correction last year. But, in the recovery, it is getting singled out with step-motherly treatment, so to say. Since the dawn of New Year, Nifty is down near 3% (as on 30th Jan), reflecting 10% under-performance over MSCI emerging market index. Part of this reason could be rooted in the out-performance of Nifty in the fall last year (Nifty fell much less compared to other emerging markets). But, still, it doesn’t fully explain the reason for this odd divergence between Nifty and broad emerging markets. One would hope that this under-performance will get adjusted when more confidence emerges on the stronger earnings growth for FY2020.

As one looks ahead, with support coming from emerging markets on improved FII flows, it is question of time before India participates in the broad based emerging market rally. Meanwhile, during this odd un-explainable divergence period, market in its myopic mindset, once again is throwing brilliant opportunities for long term investors, esp. in small and mid-cap universe with fears and rumors ruling the roost in the broader space.

Happy Value Investing!

Road ahead: Not so bumpy for growth!

Speed breakers like high inflation and high interest rates have always spelt trouble whenever India’s growth hits closer to double digit. Is that set to change?

As the famous quote goes, India disappoints both optimists and pessimists alike. It spares no one.  One can never be too optimistic nor too pessimistic as India has stunningly surprised both when it comes to its economy. Its ability to bounce back when least expected gets marred by its magical prowess to let its faithful lieutenants down when expectations run high. Of course, there are reasons for this less reassuring spectacle. They come from the stifling structural constraints in the economy that come from supply side issues like inflation and credit risks (capital starved) etc.

This is the pattern we have seen in every growth cycle in the past without single exception. Every time when growth accelerates to near double digit, it hits the inflation and credit bumps that drag the growth in subsequent years. The drag (downturn) lasts for much longer time than the dazzle (upcycle) because of daunting bad debts, the growth cycle leaves as legacy.

Will the coming decade be any different? There are reasons to believe that this predictable pattern is in for a makeover, paving the way for more sustainable growth from the next cycle onwards. This optimism may be at odds with the current negative sentiment that has notoriously swept thro’ the nation. Not getting swayed by the sullen mood across, staying objective, one can see the structural shift that will potentially get unlocked by some of the key reforms like Bankruptcy Code (IBC) and MPC (Monetary Policy Committee). IBC is one of the most under-rated reforms of this administration. In our view, IBC and MPC will go a long-way in addressing speed bump challenges to transform the current bumpy economic roadways into high-speed highways for sustainable high-growth era. More importantly, this is likely to happen, irrespective of shape and color of the next political formation at the center.

To look at them more in details, let us take the MPC first. For the first time, at CPI (Consumer Price Index) level there is inflation targeting, that too statutorily. MPC, by statute, is mandated to contain inflation at CPI level within +/-2% of 4% target. This key reform has the potential to transform the trajectory of inflation and interest rates in India. The positive rub-off on rupee can hardly be under-estimated as rupee’s annual attrition can abate meaningfully in the coming years with the material reduction in the relative inflationary gap with US. As some estimates suggest, the annual depreciation in rupee can potentially fall from current 6%+ level (appx) to sub-3% level (In reality, it happens in a dis-orderly fashion, not in smooth manner year after year) because of this structural change in the trajectory of inflation.

Moving on to the next, IBC undoubtedly will be one of the lasting legacy of this administration. It’s far reaching impact on the structural shape of the growth in the coming cycles has been least understood. One of the reasons why growth goes into huge grind (long drag) after every attempt to breach double-digit is because of humongous bad debt cycle that follows such high-growth cycle. With credit culture set for a massive clean-up on IBC’s extra-ordinary effectiveness in making promoters lot more wary to default (else they lose their business in the new IBC regime) and thus setting the stage for more secular and cleaner growth in the next cycle. In this context, it is important to highlight the latest stance of Ruia’s (Essar Steel) willingness to pay back the dues. This is a landmark event in the history of corporate defaults in India and one can expect more such positive surprises to come in future. This turnaround in borrowing and repayment culture is critical to break out into new growth orbit in the upcoming economic expansion.

Add to this, the long-term impact of improvised GST and increasing tax-to-GDP ratio on growing compliance, one can build a case for structural shift in India’s growth profile. It will not be a misplaced optimism to foresee a golden period ahead for India. Though, India had disappointed such optimists in the past, with these reforms, may be, time has come for India to disappoint the sceptics in a more convincing manner. Needless to say, India will offer exciting investment opportunities for stock-pickers in coming months and years. Watch out for interesting times!

Curious case of 2018!

If anything 2018 has taught us, it is on the futility of forecasting. Investors learnt once again, but in a more brutal fashion that forecasting is not the game any sensible investor should venture into. Investors who had structured their portfolios for a vigorous wobble in 2018, ended up facing an accident, esp. in the small and midcap space. Swings in many asset classes were so sharp that it wrecked much of the portfolios with no places to hide. Kudos to those investors who have survived 2018 and still have steam left to stitch together a promising portfolio for the coming months and years. Such is the mayhem in many asset prices.

Take for example, the rise and fall of crude prices. In late Oct, when crude was all set to cross 85$ mark, urge to forecast did not spare even the seasoned ones sitting in the swanky offices of Dalal street. One of the famous one, in his tweet, even ventured to throw a 100$ mark for crude just in few months. Of course, he was trolled later by twitterati when the crude crashed by 30%+ in few quick sessions, not long after his infamous tweet. The story is not much different when it comes to Rupee or the 10 year Gsec yield. Who would have guessed that 10 year would rise all the way from 7.15% in the beginning of year to 8.15%+ only to crash all the way back to 7.25%. That much for forecasting.

To top it all, fag end of 2018 is witnessing US markets behaving more like an emerging market in terms of sharp intra-day swings on growing noise on recession fears. This is another forecast that market participants are fearing which could put global markets on a rout. The still-fresh 2018 experience should guide the rational investors not to get swayed by such gloomy forecasts, but to stay focused on portfolio building with a keen eye on buying prices. This is not to suggest that recession fears have to be ignored. All it suggests is that no one knows for sure and it is impossible to predict macro given the large numbers of inter-dependent moving parts.

In hindsight, when one looks back one year down the line, one would realize that 2018 was an eventful year, not only for all the irrational swings, but also as one of those years that gave great entry points for long term believers in India story.

Wish you all a very Happy and Prosperous New Year!


Dollar story of small-cap index!

Is the savage correction in small-cap index scripted by domestic setbacks or by scarcity of dollars?

When the going is good, small cap space does wonder. It is the most seductive space with spicy returns, in such times. It turns sleazy when sentiments sour. Overall, it is not an easy space to be in, as one will see gut-wrenching volatility now and then. But they pay rich long-term rewards, if one has the right temperament to stay put, of course on the right stocks. Times like this, when they nosedive and undershoot, no dearth of experts to write obituary with some even calling not to touch this space till elections cycle gets over.  This in our view, is a misguided one and is based on misunderstanding about the ongoing correction.

Is there a way to put this correction in a context that can cut out the noise and give us a unique perspective that can help investors to make an informed decision? Here is an interesting chart that can help in this objective. This chart is a simple plotting of small cap index for last 15 years along-with the level of dollar index at critical points.


From this chart, one can decipher two distinct patterns…

  • Every time when the dollar index rallied, there was a big crash in small cap index, be it 2008, 2011, 2013 or now 2018. All big fall in small cap index has been accompanied by spike in dollar index.
  • More importantly, every time when small-cap index fell by a certain level, the subsequent bounce in the next immediate year has been stronger (by 1.5 times) irrespective of the narrative at that point in time. This is not a one year wonder, but a consistent repeating theme year after year for 15 years, without any exception. Going by this, given the fall of small cap index by over 25% this year, it is no brainer that the index will bounce by at-least 40%+ in the coming year.

Why then people are not jumping in to invest?

When this question is put across to investors, the response is weird. Investors give more weightage to the impending election cycle than to the data thrown by the chart. This clearly misses the point.

To put this correction in perspective, it is not anything India specific. It has nothing to do with domestic issues, though some domestic challenges like ILFS have aggravated the crack.  It is more to do the cycle of dollar strengthening and Fed tightening. As in the past, every time when dollar index made a strong rally, emerging markets like Asia (ex-Japan), Brazil, Russia etc. take a huge knock in their stocks, currencies and in their yields when money moves out of emerging markets. India is no exception to this. This is because of huge unwinding of EM carry trade on dollar strengthening. This explains why there is such a strong negative correlation in the chart between the small cap index and dollar index.

As happened in the past cycles, this is not a one-way traffic. EM carry trade does resume after a while. One can’t predict when this turns, but going by earlier cycles, it is reasonable to assume that it can’t take longer than 10 to 12 months, as even in the worst financial crisis of 2008, it didn’t take more than 14 months. When the trade resumes, money starts coming into EMs. That time again, it is not going to be India specific. When FIIs come back, they are going to allocate across EMs as a basket, based on some benchmarks like MSCI etc. India is unlikely to get left out just because of election risks. What will trigger the resumption of carry trade is a million dollar question. We don’t know.  It could be simply because of overselling or EM equities becoming more attractive in valuation because of beaten down currencies etc.

There are two critical observations here …

  • When carry trade resumes, markets may see a strong bounce irrespective of election risks as happened in the past cycles, and
  • Election risks unlikely to play a major role except for increased volatility closer to the election. The best way to deal with such risks, is to be stock specific and bottom up and keep buying whenever one gets the target price.

Already one can see the early signs. FII flows have turned net positive in the month of November after very long time. Ten year yield has come off from the high of 8.15% to 7.75 odd.  Rupee has come off from the low of 74 and the next in line could be dollar index. When it cracks, it will be EM times again. Watch out for interesting times.

Happy Value Investing!!