Shaky shift

Monetary Policy : Was RBI too quick to abandon the accommodative stance in its Feb policy?

Back in Jan, when banks were awash with liquidity, thrown in generously by demonetization impact, debate was not about whether there will be a rate cut or not , but how aggressive it will be. Bond Markets were magnanimously marking up the gilts to new highs, as they started factoring in a sizable slice in the rates by RBI (rates and bond prices are inversely related). Some opportune analysts jumped in the fray to make outrageous forecasts on the 10 year yield (on the downside) to feed on to the media frenzy and thereby getting opportunity to hit headlines. Consensus trade was conspicuously long on bonds. Needless to say, traders were sitting on a sizable MTM (mark-to-market) gains in their bond portfolio. So far so good, so it appeared.

But all hell broke loose on 8th Feb when RBI, in an unusual move, decided to change its monetary stance from accommodative to neutral citing following fears.

  • Hardening profile of international crude prices.
  • Volatility in exchange rates on global cues which could impart upside pressures to domestic inflation.
  • Aggressive rate hikes by Fed on positive US outlook as reflected in the rising US yield
  • Impact of 7th pay commission on inflation

For the bond markets, that shift was surreal and bizarre, as they were counting on surging liquidity in the banking system for raving rate cuts. Shift in stance was significant as it ruled out rate cuts for the foreseeable period. That was a blow to the markets that were marking-in large cuts in the bond prices. What followed was mayhem in the bond markets, triggering a huge sell-off. Prices slumped and yield surged by over 50bps in few quick sessions.

Three months have passed since RBI took that significant shift in stance. We now have the real data to assess whether RBI/MPC (Monetary Policy Committee) went overboard on its fears. Here is the chart that captures the movement of those indices (since Feb) that RBI/MPC was tracking closely for its assessment. As can be inferred from the chart, none of them played out the way RBI had feared. In fact, all of them have moved in the opposite direction, much more favourably for a dovish stance than a hawkish one.


Though it is too early to draw any major conclusion, on the evidence of data over past three months, it certainly seems that RBI could have waited for more data before deciding on the shift in stance.  With softening crude and soaring Rupee, fears of spike in inflationary pressures have been proved totally unfounded. With additional support coming from slumping US ten year yield on rising risks for Trump’s reflationary trade ( with increasing fears on Trump’s ability to pump-up bipartisan support for fiscal stimulus or tax cuts), RBI/MPC might find it difficult to sustain its hawkish stance, unless these trends reverse.

For long-term debt investors, the current subdued price in the bond markets is a stellar opportunity given the potential upside in returns when the policy stance swings back to accommodative.  At the moment, data-points (ref chart above) are favourably inclined for such a shift, though timing of which is difficult to predict.


Happy Value Investing!!


When markets see no risks..

As someone wise said, markets are at the riskiest when there is widespread belief that there is no risk, since this makes investors feel it is safe to do risky things. With stock prices surging day-after-day (esp. in the broader markets), Indian markets may be racing recklessly in such a risky zone at the moment. The hardest thing for investors today is to spot where the risk could come from for our markets. When one has to struggle strenuously to spot the risks, investors increasingly feel safe to take higher and higher risks, which eventually makes the market riskiest. We may not be far from that stage.

This does not mean that the markets can’t rally further from here. In all likely-hood, the rally could relentlessly continue and test one’s patience on the upside. But with the rising risks, it is important to understand that valuation will regress to the mean sooner or later. This may be an apt time to remember the golden words of Buffett, “The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.

This is time for doing nothing, except few selective stock-specific actions with regard to pruning and profit booking. Raising cash levels in the portfolio using such selective actions is critical to capitalize on the correction that would eventually come.


Value from Contrarian Streak

Returns from investments are typically determined more by the price paid than the growth rate – Seth Klarman

Is investing all about identifying great companies or spotting the most mispriced ones? There are no easy answers to this. Growth investing gets glued on to the earnings so much that it exclusively focuses on its attempt to predict earnings growth to the decimal point. Invariably, it ends up spotting opportunities that are priced to perfection. With no safety cushion, any upset, which inevitably happens given the unpredictable business cycles, can dent the projections that have been made with so much precision by spreadsheet specialists. As a result, it becomes one of the most risky investing style in the long-term, though entices the investors with its short-term performance. It is a model designed to deliver short-term out-performance at the cost of long-term under-performance. Value Investing is diametrically opposite. It doesn’t excel in the enticing earnings model, but gets excited with the most mispriced moments. Value investing focuses on opportunities that are most mispriced to long-term intrinsic worth. Since growth is an embedded part of the intrinsic equation, it is a perfect blend of both.

Now, let us look at the more interesting part of investing. What is the inter-play of growth and value in terms of their contribution to the overall long-term returns? This is an interesting question to ponder. Intuitively, one might tend to believe that large part of long-term returns comes from growth. Surprisingly, the empirical evidence suggests otherwise. As the most renowned value investor Seth Klarman says, much of long-term returns come from the buying price ( Value) than the earnings (Growth). Our own experience in this market cycle (from FY13 to FY17) proves this beyond doubt. Below chart from our house research captures this data for stock ideas that we had invested in this cycle. Even to us, it was a big revelation that such a big part of returns (over 75%+ in most cases) had come from mispricing. Change in earnings had contributed far less in the overall returns.


Now comes the difficult part. To act decisively in the most mispriced moments require contrarian streak. For an investor, this is the most coveted asset. The big part of value, an investor or the fund manager brings, stems from this contrarian skill. It is as simple as that. As in life, simple things are the hardest to nurture and develop. More so with contrarian skill, as it encompasses enviable traits such as deep rooted conviction, rationality and agonizing patience. To paraphrase Warren Buffet, investing is less of an IQ game than an EQ (Emotional Quotient) one. Contrarian skill is one  big part of this EQuation. Another chart that captures this value brilliantly is the one pictured below on the behavioral gap. Nothing much to be said further I guess, to emphasize more on the role of temperamental skills (soft traits) on successful investing. “Less is more” is apt here too.



Happy Value Investing!!

The Budget Puzzle


Budget numbers reveal that there is some semblance of “Big Picture” behind the seemingly boring one.

For long-time budget watchers, few things are fairly straight. One, budget is progressively becoming a non-event, notwithstanding the boisterous media buzz ahead of the event and second, the responses from various constituencies are far more predictable. Pressure to be politically right (in their response) outweighs the urge to be out-spoken. Hence, much of the responses are guarded and sugar-coated. This budget was no exception. Media got tizzy around the budget, only to get disappointed with a drowsy one. Much expected cut in corporate tax and personal tax (across the spectrum) did not materialize. Usual hyperbolic statements-of-intent on various rural and infra schemes with throw-in here and throw-out there, dominated much of the budget speech.

Certainly, the budget was a disappointing one (for the immediate short-term at least), given the huge expectations. Beyond the regular ritual, is there a big picture that is popping?. Buried deep, some budget numbers, on closer look, offer hope of a structural shift, if not a grand design.

Central Theme : Broadening the Base by Operation Cleanup and GST

  • The spurt in income tax (personal) numbers over already a high base of last year, seen in conjunction with the upcoming GST, may have clues to the widening tax net in the coming years that will lead to higher fiscal space over time, pointing to structural downward shift in inflation / interest rates and hence changing the structural capacity of economy for higher growth.
  • To understand this, let us start with the basic budget assumptions. The underlying GDP growth assumption in the budget hardly inspires. Govt. expects growth to suffer in FY18 on two counts. First, the lingering effect of DeMo will keep a lid on growth for a while. Second, hiccups in GST implementation can hurt growth in the short-term. Hardly a surprise that the budget has assumed a muted growth of around 6.75% for FY18, much less than RBI’s forecast.
  • With such a sluggish sub-7% growth assumption, subdued tax numbers have been subsumed in the tax arithmetic in the budget, be it excise, service or corporate tax, but with one exception.
  • That exception is on the personal tax numbers. Govt. has assumed a robust 25%+ growth over a high base of last year, in which the personal income tax is likely to have grown over 21%+. Much of this is expected to flow directly from the effects of Operation Cleanup that will be rolled out using demon data mining. This would add up to over 50%+ surge in Income tax over two year period of FY17-FY18. Ref below chart that captures the changing tax mix brilliantly.



  • Add to this the rollout of GST, it is not difficult to decipher that the central thrust for this year is, widening the tax net on both direct and indirect taxes. Former from operation cleanup (DeMo data drive) and later from GST that is likely to galvanize tax compliance from the expected shift from unorganized to organized, gradually though. Proposed limits on cash transactions in the budget will further accelerate this shift from informal to formal economy.
  • Now, let us move forward by one year to FY19. This is when things will turn interesting. Economy would have come out of the clutches of DeMon and would be ready to leap-frog on stabilizing GST implementation. With much delayed capex recovery (private investment) in place by then, growth will gyrate to near 8% level and much more in the subsequent years. Precisely then, widening tax base will work wonder, boosting tax buoyancy and tax-GDP ratio. With huge headroom in fiscal space, macro will move into a much stronger position with inflation and interest rates trending structurally lower.

In summary, the dual reforms of this Govt. (DeMo and GST), when they play out over next few years, have the potential to have a dramatic multiplier effect to push the economy structurally into a higher growth-orbit, leave alone the potential political gains for the current administration on fiscal windfalls (thro’ seductive schemes for poor like the universal income scheme etc). Exciting times ahead for India macro!


Flows: Shifting Strands!

Interesting shift is underway in the composition of flows into equity market. Domestic flows have been on a second fiddle to FIIs for long. This is set to change in the coming months with domestic money expected to get its fair share of dominance. Multitude of factors have miraculously come together to aid this catharsis, so to say. Not least among them is the shifting trend in the household savings from physical to financial assets on weakening outlook for both gold and real estate prices. Gradual shift from informal to formal economy on GST, Digitization and DeMon (besides stronger benami act) would further accelerate this trend.

Early signs of such a shift are already here. Recent data on mutual fund inflows in the month of Nov and Dec (ref below chart) shows strong evidence to this emerging trend.


The rapid recovery in the Indian indices over last few weeks is largely on account of this phenomenon of shifting strands in the savings pattern. In earlier occasions, when FIIs selling surged, market’s weakness prolonged for a painful period. It made a comeback only when FII-buying resumed with greater gusto. But, not this time. Though intensity of selling has come down, actions continue to be muted on the FIIs front. That has not stopped the markets from recouping all the losses since 8th Nov. The credit for this feat, of course, goes to the dazzling domestic flows, as is evident in the above chart.

We will see more of this in the coming months. For value investors who had hoped for longer period of lull, this quick recovery has put a spanner on their nibbling plans. With valuations on the rise again, hard times are back for investors waiting on the sidelines for attractive levels.

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.