Biggest take-away from FM’s Boost!!


Financial markets are all about signaling, not so much about materiality. The biggest mis-step in the FM’s maiden budget was not so much about any particular measure, but about signaling. By taxing FPI through additional surcharge, they couldn’t have done anything worse on signaling, though materially the amount involved was less than 400 cr. No surprise that it took away 20000cr+ from the equity markets in terms of FII outflows since the time budget was presented (till 23rd Aug).

In a big relief, Govt. last week reversed some of those key mis-steps they had taken in the budget. There were many measures in the so called mini-budget that was announced last Friday. Though there were many steps of merit, the key take-away from the mini-budget is not anything about any steps, but again the signaling effect. It came in the form of Govt’s willingness to listen, humility to accept the mis-steps and ability to do the course correction. In our view this is the biggest take away from the booster shot from FM. This signaling effect can change the medium to long-term landscape of the market quite materially, though global cues will continue to dictate the trend in the immediate term.

Of course, for bears, there is no shortage of ammunition. Besides US-China trade war hiccups, there is a new found love with the inverted yield in US and its association with recession. It is another matter that not many inversions were followed by recessions (at least we had two such inversions in the last 4 years), though all recessions were preceded by inverted yield. Having said that global bears have their hands full to keep the markets edgy in the short-term. For India, having under-performed the global markets quite significantly this year so far on account domestic mis-steps, some catch-up (to cover this year’s under-performance) may be on cards, esp. if the festive season brings the much needed turn in the news-flow for the economy!!



Simple questions, no easy answers?


Downturns are no less exciting when it comes to anxious questions from investors. As a money manager, one gets pushed around by questions which may not have a clear short-term answer and yet have a broadly right long-term answer. Thought we should address couple of such questions through our monthly newsletter.

The most common ones that we face in a challenging environment like the one we are currently in,

  • Even if the Govt. takes measures to reverse some of the mis-steps, with no one willing to lend or take risk (liquidity/risk cycle broken), what will trigger the liquidity up-cycle for the real economy?
  • If nothing much is going to happen in the short-term, why not wait till things stabilize?

As any fund manager would concur, the first one is a more interesting one because it involves understanding of how the critical parts of engine works in the economy. With Govt. rolling back some of the mis-steps, it has also become a more relevant one.

Before proceeding to answer how liquidity cycle will turn, let us first understand what caused the severe choke in the liquidity cycle. What started as a usual risk-aversion on NPA crisis got aggravated by Govt’s overdrive on corp. cleanup, which further got accentuated by the cyclical slowdown in manufacturing esp. in autos. It is the confluence of these factors coming together than any one factor that pushed the economy into deeper slowdown. When all of them are playing out together, it appears as if it is apocalypse for India which is not surprising. But the impact on economy is huge because there is risk-aversion in each and every stage of the liquidity chain. Take autos for example. How fear of deeper slowdown results in serious risk-aversion in each link of the liquidity chain like bankers cutting down exposure to dealers/auto consumers, auto dealers cutting down on stocks that they carry (destocking), consumers in-turn postponing buying on unknown fear and so on. If one looks at the auto retail numbers and whole-sale numbers, one can see how dealer destocking has amplified this slowdown seriously. For e.g. in Aug, while the retail sales at the consumer level came down by 11%, the whole sale numbers at the OE level came down by over 25%+. The difference is on account of dealer destocking. Not to forget, when some bit of confidence comes back, the dealer re-stocking itself will optically boost the numbers at the OE level leading to dramatic change in the narrative in the media (flashing headlines like auto industry bounces back with a vengeance etc. will resurface mysteriously). Time for such change in news-flow is not far away.

Since people attribute, mistakenly though, to a single factor like Govt’s clean-up drive for the choke in the economy, naturally, they also think that this will never reverse as Govt. is unlikely to lose its grip on the clean-up. But in reality, over time, in the next few months, two of the three factors that caused the slowdown will reverse to give the required bump-up for the liquidity. This coupled with falling lending rates and rising liquidity in the system, will eventually de-clog the flow in the liquidity chain. Basically, the point is that the liquidity cycle will come back in full force once a bit of positive news-flow starts coming in. It looks like the “turn” in the auto demand in the festive season (even if the growth is just optical on low base effect, though better than expected monsoon is likely to revive rural consumption in the second half) could bring the initial trigger for the “turn” in the liquidity cycle.

Agreed, why not wait till we see some visibility of that turn? That brings us to our second question. Yes, one can wait for sure. But the challenge is, market doesn’t wait. It discounts far ahead. How do investors deal with this? Only way to deal with this, is to buy on pessimism without worrying about quotational losses in the short-term. How does one logically convince oneself to do that? Here is where our usual question we put to our investors who are in such a dilemma. If you have an opportunity now in which there is risk of 20% quotational loss in the short-term, but 2X gains in the medium to long-term (1 to 2 year), when would you buy? Of course, the answer is easy if one can time the bottom. Since it is not possible to time the bottom, one has to choose to buy now in spite of the risk of 20% notional loss. In theory, even this option sounds easy. But, when there is pessimism and uncertainty all around, it is difficult to execute this on the ground. The reason is, in such times, it is easy to get carried away by the fear that the risk of loss may be much higher, though it is still notional.

In conclusion, it all comes back to the same old understanding that, to execute value investing on the ground, one may not have any option but to buy when there is maximum pessimism without worrying about any trigger. Of course, it holds good in the top of the market as well (selling when there is all around exuberance). Both are difficult to execute (emotionally), but that is the only way to create long-term wealth. In that sense, in hindsight, this downturn will, most likely, go down in history as a one that threw a great life-time opportunity for long-term patient investors. Don’t miss it!!

Happy Value Investing!!


Choked by Clean-up Overdrive?


Recently, it has dawned on many seasoned investors that the Govt’s corporate cleanup drive may have an underestimated (and unanticipated to some extent) second and third order negative impact on the economy. It is now gradually being discovered that such a drive has choked the economy quite severely. For long time the economy was solely depending on private consumption and govt. investments for its growth. Even those cylinders have started sputtering now, leave alone the long-gone story of private capex.

With Govt. not letting its hands off the handle, does the clean-up overdrive risks killing the economy in the short-term? Tightening the noose on rating agencies, calling for bans on audit firms, penalizing bankers for past lending decisions and choking the corporates on compliance etc. are great long-term measures, but could be painful in the short-term for the economy as the entire financial eco-system recedes into risk-averse mode. Govt. needs to tread this path carefully because one does not want to see this corporate catharsis end up killing the patient i.e. economy.

Having said that, the long-term structural impact of this clean-up drive, equally shouldn’t be underestimated. The payoff will be huge, once we are through with the short-term pains. Imagine the multifold gains that will gush from improved corporate governance or more vigilant audit/ rating agencies or from prudent lending or enhanced tax compliance etc. The positive impact on long-term cost of money, macro metrics like fiscal and current account deficits etc. will be manifold to put the economy in a higher growth orbit. There is hardly any debate on that argument.

Coming to the short to medium term, there is a huge disconnect between what the market is pricing-in and what the actual growth is going to be. In the broader space, market is almost pricing-in a depression kind of scenario while the growth will still be near 7% for this year and the next. This disconnect in stock prices will get bridged at some point of time, though “when” will continue to be a question mark. Seasoned investors understand that India disappoints both optimists and pessimists equally (to quote the famous phrase of Ruchir Sharma). Time to disappoint the pessimists is not very far away!!

If you have bought Right, sit Tight…

It is an apt advice for any investor who is weighing options on what to do next in this stressed markets. But the challenge is not as much about knowing what to do, but how to do. The reason being, sitting tight is easier said than done. Many investors intuitively know that if they stay the course, they will get rewarded. After all, everything is cyclical. But they still fail to follow their own advice. Why?


History is full of people who are otherwise smart and intelligent, but do silly and stupid things from time to time. At work, we are constantly surprised by people who have brilliant mind, but doing simple mistakes. No different at home with people who we appreciate and look up to for their intelligence, slip on simple things. It begs a serious question, why competent people commit such simple mistakes?

This syndrome is more acute in the serious world of business and investing. Countless cases of otherwise successful businessmen or seasoned investors making bad decisions carried away by fear and greed. What explains all these? Simple reasoning that they get blinded by emotions (behavioral flaws) doesn’t fully explain the dynamics behind this ever recurring theme.

Where does one look for answers? This is where the understanding of cognitive process of the mind could help. As Zen teachings say, cognitive process is not independent and it is conditioned according to one’s bias, prejudices and fear. The process is a huge distorting machine leading to delusion rather than reflection of reality. Take for example, the views, the thoughts and the perceptions. They feed-in each other in a self-fulfilling fashion. The way one “perceives” conditions “thinking” and the way one “thinks” conditions “views”. In turn, the way one “views” things  conditions the “perception”. The whole thing works in a self-feeding loop to create self-deception. In this way, one can’t trust thoughts, views and perception because they are bent by the conditioning according to the bias, prejudices and fear.  It is like having a lens that bends everything that falls on it according to what one wants to see or doesn’t want to see (underlying bias). This is how all cognitive biases work to blind otherwise smart people to slip on simple things.

How is this related to “sitting tight” phenomenon that we started this piece with?  In sitting-tight, the cognitive biases come in various forms to make that process difficult. The most dominant ones are, the fear of further fall, self-doubt, recency bias (mind giving undue influence to what has happened recently), urge to see quick uptick in the portfolio, confirmation bias (getting proved right in the short-term) and loss of hope etc. They act as underlying bias to cloud the cognitive process which results in actions that otherwise look unwise. At the end of the day, one should not lose sight of the simple fact that these are cycles that eventually turn. As in the previous cycles, when they turn, the degree of bounce will be directly proportional to the extent of fall that preceded it. Who makes this simple stuff hard? The one that lies between the ears, right? If you de-clog it, what sounds simple can also become easy.

Happy Value Investing!!

Beyond the Budget…

Bull Market

Thought many times before writing this note. The fear was that we shouldn’t be adding to the woes of readers who are already inundated with expert views and opinions on the budget. When there is such an overdose of opinions, how do we write something that is relevant for our investors without getting lost in the sea of screaming headlines? It is another matter that budget’s significance is slowly receding into the realm of irrelevance. With indirect taxes (GST) out of its net, budget is turning out to be more of statement of intent with broad contours of expenditure plan than anything material. With Uniform-Tax-Code on the anvil for direct taxes, budget’s role will be get more marginalized in times to come.

So if this is not about budget, what is it about? This is more about the direction of the broader market, now that one event is out of its way.

First, there is no place for debate on the question of increasing stress for the economy. But the key point is, market (esp. the broader small and mid-cap space) is pricing-in a depression, if not anything worse. The objective here to discuss one key take-away from budget which is critical for the trajectory of the broader market. That is, what budget is likely to do for the bond yields and interest rates. They are heading much lower. This is consequent to some key measures in the budget as highlighted below.

  • Govt’s bold decision to go for sovereign bonds for 10 to 15% of its borrowings.
  • Greater liquidity measures for both banks and NBFCs
  • RBI’s immediate announcement after the budget for additional liquidity backstop for banks targeting NBFCs/HFCs
  • Govt’s decision to stick to fiscal glide path target in spite of pressures for increased stimulus.

Market in its knee-jerk reaction failed to appreciate the medium to long term implications on the bond yield (and thereby interest rates) of above critical measures.

Lower interest rates coupled with liquidity measures and with some resolutions in the liquidity-hit NBFC/HFCs, will reignite consumption in the coming months. When that gets supported by low base effect in auto and other consumer discretionary, the negative narrative on the economy will most likely to cede place to optimism in the second half of this year. Overall, when looked at  from this perspective, broader space is likely to reverse trend and might even surprise significantly on the upside when the manic mis-pricing starts playing out in the opposite direction (Small and mid-caps generally do well in a falling interest rate regime, as has been the case in previous cycles).

So, in summary, for getting back to 7 to 8% growth, this budget is good enough, though not for a breakout beyond that. We need a bolder budget to break into 9-10% growth cycle, which may be unrealistic to expect from a Govt. that thinks on incremental fashion. But where it gets interesting is, when the broader market  is pricing-in depressive scenario, 7-8% growth outlook is going to unlock substantial value just by adjustment in mis-pricing in small and mid-caps. Interesting times ahead!


Local cues to trump global pressures?


In 2014 when the current administration was voted to power with full majority, there was no stopping for the rally. Stocks surged as if there was no tomorrow. Come to 2019, the rally is less than spectacular for a more resounding victory than 2014. Some say that the market is yet to digest the outcome. Some say it is already priced-in. But, for a more convincing reason, one has to look beyond the local cues. The pressure is elsewhere.

Since early April, Asian markets have given up all the gains they made in the Ist quarter on account of rising rhetoric on trade tensions between US and China. India was no exception, though post exit polls, it recovered much of it. With ETFs pulling out money across emerging markets on fears of escalating trade war, negative global cues have come as a show-stopper for Indian markets. Now the question is who is going to trump whom in the tug-of-war between negative global and positive local cues?

No one knows the answer. But this friction has given a brilliant window for those sitting on fence still. With so much of cash sitting on sidelines (both from mutual funds and HNIs), it is question of time before local cues trump the trade war tantrums, though edgy credit markets in India  will  continue to be an overhang for a while. No prize for guessing which index benefits the most when local money starts gushing. Small and mid-cap indices will see a smart come back when local funds start finding better use for their idle cash as they fancy the broader space of small and midcaps more than the larger peers. Watch out for interesting times for broader space!


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!!