Back to Basics!

Indian markets : With waning momentum, theme to shift from Growth to Value.

Markets love to stitch a story.  When the year began in 2016, it offered more than the required  recipe for stitching a consumption story. It all started with pay commission bounty. Budget took it from there and built on it with huge boost to rural spending. Monsoon moved next to spruce up the spice with its windfall gains on rainfall. But, for any story to steamroll into spellbinding saga, it needs the final bollywood-style splurge in the form of mega budget. This final push came in the form of EM carry trade i.e. gush of dollar flows into Emerging markets in search of better yield, that became a formidable up-tide.  What followed was a stupendous surge in consumption stocks in the next six months that eventually elevated the valuation of some sectors to unsustainable levels. Some of the shadow banks shining at 8+ times the book was one such scary outcome of this saga. But in the end, the fiction fizzled out on the lethal combo of Trumponomics and Demonetization. De-mon derailed the over-heated consumption theme while Trump Tantrum triggered the much expected reversal of EM carry trade. Both miraculously coincided (on the same date of Nov’8th to be precise) to bring the perfect storm to Indian stocks.

As the new year dawns, bruised markets are set for a makeover, if we may call so. When there is no story to stitch, as being the case now, markets find refuge in Value. With de-mon damage set to linger longer, it is easy to guess that the consumption will be the first casualty. Story is set to repeat on FII flows, except that it is in reverse this time. Outflows from EM will magnify the consumption crack as how the inflows glorified it during the up-tide. Going forward, the theme that is likely to dominate the early part of 2017 (at least) will be “Growth to de-rate and Value to re-rate” as someone succinctly put. In other words, when momentum moderates, Value comes to the rescue. This trend will gain more traction on the likely divergence between FIIs action and domestic flows. While FIIs rush to the exit doors, domestic flows will gather steam on the expected shift in savings from physical to financial assets on Govt’s crusade against black money. More so, with the weakening outlook for both property prices (on prospects of stronger benami act) and for gold. This divergence between FIIs and domestic funds will gravitate the markets to bottom-up stock picking (value theme) given the tendency of local funds to dabble in broader markets (small and mid-caps) in contrast to FIIs who fancy the larger cousins.

That said, it is not all gloom and doom for momentum theme. The later part of 2017 may have a surprise in store. The churn from growth to value is based on the premise that EMs will see continued outflows on stronger US prospects i.e. faster Fed rate hikes and surging dollar index. While this may be the case in the early part of 2017, one may not be so sure about this on the later part. As we move more into 2017, more realistic view may emerge on growth prospects for US which might temper the rally in dollar and consequently one would see more objective flows for EMs. On the domestic front, with base-effect kicking in the second half, supported by GST gaining traction, growth and consumption themes may revisit in the IInd half of 2017 with vengeance. It is going to be an interesting year to watch out for!

But for long-term investors, the question is not about Growth or Value. Can it be both i.e. Value embedded with Growth. As someone wise once said, long-term returns in stocks are function of two critical factors i.e. buying price and earnings growth. First one represents Value and the second one stands for Growth. Long-term portfolio returns are delivered by the synthesis of Value and Growth. Deep downturns in the markets provide stellar opportunities for such synthesis to steamroll. In this context, current market weakness is a wonderful opportunity to create value from delayed (not denied) growth!!

If historic data is anything to go by, FII sell-offs have always been a boon for long-term investors. Below chart brilliantly captures this phenomenon. The succeeding years of FII sell-offs, have always delivered huge returns to investors (pls note “always”). Going by this, when the year ends in 2017, investors who have capitalized on the current fall induced by FIIs will have more than ample reasons to cheer.


This is not to say everything is rosy. The damage the de-mon has inflicted will take a while to heal. But, markets mired in its manic mood set by FII sell-off, have chosen to ignore the medium and long-term prospects of changing financial landscape driven by demonetization. Markets seem to be under-estimating the dramatic multiplier effect of shift from informal to formal economy. When markets price-in only the short-term risks, not the medium to long-term prospects, which usually happens during aggressive sell-off by FIIs, subsequent years have always been hugely positive. Needless to say, current period is one more such opportunity for long-term investors.

Wish readers a very Happy and Prosperous New Year!

Trump Tantrum!

Traits of tantrums are very simple. They move money out of EMs (Emerging Markets), put EM currencies on run, take the treasury yield high ( US 10 year) and galvanize the dollar index. Way back in 2013, when Fed hinted at turning off  its QE (Quantitative Easing) programs ( or rather tapering it off), tantrum with above traits followed which later was euphonically called Taper Tantrums. Now emerging markets are under similar tantrum attack post Trump election on hopes of huge fiscal spending back in US i.e Trumpflation. The impact can be seen in the rise of dollar index ( crossed 101) and in the surge of US 10 year yield. EM currencies are under pressure resulting in FPI outflows from both debt and equity markets. Indian markets, being part of EM basket, has come under this attack. Over $5Bn has flowed out from FPI kitty from Indian markets ( equities and bonds) since US election outcome.

What has made it worse for Indian markets is the timing of demonetization. It came at a time when markets were about to get the tantrum attack. In that sense, it became a double whammy for the Indian markets. Normally, in such sharp corrections, dual factors come into play. One is the price damage and the other one is time correction. Price damage usually happens quickly while the time correction, as the name indicates, lasts a while. More so, when the short-term impact is negative for most of the sectors from demonetization. Time correction does turn at some point, though “when” is difficult to predict. Given this, savvy investors use time corrections to put money to work without trying to time the turn. From this perspective, the ongoing correction is a brilliant opportunity for investors who had missed out the rally to start investing for long-term.

While one may debate the short-term impacts of demonetization on GDP growth, long-term positives are rarely questioned, esp. if the Govt. takes this initiative to a logical conclusion with more curbs on benami property and gold hoardings. These measures have the potential to put the economy into a higher growth orbit structurally in the medium to long-term ( Ref our post titled “The Coming Shift”). Ongoing correction, in that sense, is a golden opportunity for long-term investors.


The Coming Shift!

India’s household savings : Dramatic multiplier effect from the coming shift from physical to financial assets.

Indian households love the luster of gold and patronage of property. These physical assets holds as much as two-thirds of their overall savings (below chart). Financial savings that include bank deposits, bonds and shares constitute the balance. When one translates this to percent of GDP, numbers looks abysmally low compared to global averages. With annual household savings around 16% level of GDP, annual saving in financial assets is stagnating at around 5% level while global averages are upwards of 20%. Below chart gives the cumulative distribution pattern ( not annual) of the Indian household assets. Such low level of financial savings have curtailed capital productivity, increased lending cost, choked economic growth in general. But, all that is set to change in the coming years.


Multiple factors have come together miraculously to conspire a deadly change in the household dynamics. First, it started with gold prices losing its luster, a trend that started a year back. The prolonged painful downturn in property prices came as a second blow to households. In normal times, these two would have been discounted as cyclical turns. But what is likely to change this otherwise cyclical turn into a powerful structural one that will prolong for a painful period is current administration’s ambitious drive to weed out black money. This drive is unlikely to stop with just demonetization. This will probably be taken to logical conclusion with more curbs on benami transactions and on gold stocking. Such steps are sure to change the landscape of household savings in a material fashion. Stars are aligned for such a dramatic shift, so to say.

This coming shift has the potential to trigger far reaching changes, some of which are:

  • Improved tax-to-GDP ratio leading to lower fiscal deficit structurally.
  • Inflation trajectory trending lower on improved fiscal deficit and on lower black money.
  • Deepening of corp. bond markets leading to better transmission of monetary policy rates.
  • Competitive cost of capital ( hence improved productivity) on structurally lower interest rates ( on higher liquidity, better transmission and on lower inflation)
  • Surge in FDI on stable and stronger currency (on structurally lower inflation) leading to significant ramp up in capital investments and hence higher GDP growth.
  • Large and faster business scale-up on improved primary equity offerings (IPOs).

All these, may seem incremental in isolation, but put together, can structurally put the economy in a higher growth orbit, which in turn can lead to dramatic increase in the per-capita income from the current paltry levels of  $1500+. This is not to say that the current policy initiatives will lead to immediate revival in growth momentum, given the stressed balance sheets of corporate and  banks. However, if the policy initiatives such as demonetization are taken to logical conclusion with further steps on both gold and property (benami), it will set long-term drivers in motion to put India on a higher growth orbit.

Happy Value Investing!