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!

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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!

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