Reforms: Time for the difficult ones?


Expectations are up on the reforms front as we approach the next budget. More so with Govt. showing some teeth now with respect to labor code. Govt. has introduced the new labor code bill in the lower house. If the labor bill passes the RS hurdle, it will be a big milestone in the reform agenda as this has been pending for decades. One of the key proposals in the labor code is with respect to Govt. taking executive power on fixing the threshold number for retrenchment (below the threshold, companies will not require Govt’s approval for retrenchment). If the threshold can be modified thro’ an executive action, not thro’ legislative approval (vide parliament), it will be a boost to investment. This in combination with the new tax code (15% tax for investments in new manufacturing) can be a game changer for attracting new investments in manufacturing, esp. in the back-drop of US-China trade frictions.

It doesn’t stop here. As some reports suggest, Govt. is closely looking at liberalizing the lease mechanism of agricultural land for industrial use. Though it is a state subject, if a central model code can successfully be adopted by interested state governments, then it can address one of the key structural supply side issues for unlocking manufacturing potential. While Govt. might do this quietly without brandishing this as a major land reform, the signs are there that the current administration is keen to get this out of the way.

If Govt. of the day can get these difficult reforms (land and labor) done, it will send a strong signal to investment community. This coupled with friendly taxation measures (either on DDT or LTCG) expected in the upcoming budget, one is looking at reform momentum gathering strong pace in the coming weeks and months. While market has started pricing-in this increased reform momentum, so far, this has been limited to select large-caps. Broader space is yet to see the benefits from improved traction in reforms. But, with early signs of visibility in closure of some of the stressed cases, both in NBFCs and in banks, thanks to quick responses from finance ministry (be in IBC amendments or special AIF fund for real estate stressed assets or recent SC ruling in Essar case etc.), it is question of time before the broader market picks up pace. In this context, current depressed valuation in the broader space is a great opportunity for investors with lot of patient capital.


Structural Spin to the Cyclical down-turn?


Millennials have a special place in this slowdown. Much of muck for the current ills in the economy is thrown at them.  Lot of things may go “over-the-top” for the Gen-Old, but for the millennials, OTT is central to everything they do. In fact, in our definition, OTT is not limited to only video or audio streaming services, but to even other  aggregator services like Uber, Swiggy or any such disruptions (as they lie “over-the-top” on the age-old platform). So far this is good. But where it takes a noisy turn is when analysts start giving an OTT spin to otherwise normal cyclical down-cycle to project a structural scare for such down-trends.

In times of slow-down, the scars of slump can be seen much beyond the realm of economy. During slow-down, it doesn’t surprise anyone to see the numbers sliding in various segments of the economy, be it consumption, manufacturing or services activities. The slump that surprises many is the slump in critical “thinking” during slow-down times, esp. when it comes to dissecting the long term sectoral trends. Slowdown colors the thinking so much that it starts seeing some of the otherwise normal cyclical down-trend as a structural one. This happens, because the analysts, in their over-enthusiasm, end-up over-estimating the short-term implications of a new trend, while under-estimating the long-term implications. This has occurred cycle-after-cycle. This down-cycle is no different except that this time analysts are hiding under OTT to give a structural spin.

One doesn’t need to go too far to understand how this played out in the past. Take for example, the IT slowdown in 2016. Normal cyclical slowdown in IT spending in US was amplified as a structural one using the new challenges the industry was facing that time from automation, machine learning and AI. Analysts took these disruptions and gave a structural scare which resulted in valuation de-rating in IT stocks in early 2016. What happened subsequently is there for everyone to see. Growth came back in 2017 and the noisy narrative on Automation/AI was slowly edged out by rosy prospects of increased IT spending. This led to re-rating of IT stocks. Seasoned investors who foresaw this ended-up gaining 2X-3X in some of the mid and small-cap IT stocks (as they were the worst hit by the structural scare).

Fast forward to now. OTT is a new monster now and as per arm-chair analysts, it is going to kill anything and everything that is going to come its way. The monster’s impact is more visible in the mayhem in the Radio, Broadcasting and in the Newsprint stocks. The structural scare is so much that some of the stocks in these sectors are going for a song, esp. from the mid and small cap ones. It doesn’t matter that the readership, listenership or viewership surveys don’t reflect those scary prognosis. EV is another one that is going to electrocute the entire auto industry as per some of the auto enthusiasts. It doesn’t matter we will take 30 years to build required charging infrastructure or it costs 3X the normal one if one goes by TCO (total cost of ownership). In both these cases, the market is amplifying the normal slowdown in ad-cycle (in the case of Radio, TV and Newsprint) and demand slowdown in the case of auto, feared by the noisy narrative of OTT and EV scare.

Going by the past cycles and by the past disruptions, such structural spins throw great life-time value opportunities for anyone who doesn’t suffer from slump in critical or contrarian thinking.  Of course, one can’t be blind to certain long-term changes. But when market de-rates to a level where mis-pricing goes to manic levels, there is lot to unlock in terms of future upside. Interesting times to watch out for!!

Happy Value Investing!!

Early signs?


Earnings reactions in the broader space have started to exhibit an encouraging trend. They are still irrational, but not as irrational as they used to be in the earlier quarters. Earlier, even great results met up with muted reaction from the market, leave alone iffy ones. No longer so. If the results are robust, they get rewarded to a reasonable extent. Of course, market’s negative reaction to even decent results, which is the hallmark of a downturn, is yet to change. This change in its reaction to stronger results, has led to rise in number of stocks, in the broader space, that are hitting 52 week highs for the first time in many months. Though, for now, these numbers are far and few. This trend, if it continues (that is a big if), can bring back some life into the small and mid-cap space in a gradual fashion.

It doesn’t stop here. There is another trend that could be a pointer to life coming back in the broader space, though it is too early to say. Market has made many attempts to gain momentum in the past few months. Every time it makes an attempt, some bad news comes in a miraculous fashion to mar the early signs of momentum. This month, it was SC’s blow to the telecom sector and the sensational turn of events at Infosys. Last month, it was PMC bank that did the damage. If at all there is anything to be inferred from these multiple attempts by the market to gain momentum, it is this – there is bottom in place now and it is question of time before luck runs out for the bad news and for the bears.

Add to this, the positive news-flow momentum that might come from the upcoming budget that is not far away.  The expectation from the budget will be high, given the rising reform-intent from this Govt. Some tweaking either in the long-term capital gains tax or in DDT may be on cards, besides the increasing chorus for cut in personal income tax. This coupled with Govt.’s growing inclination to side-step the fiscal puritan path to accommodate more growth oriented policies, market will start expecting more fiscal measures (stimulus) in the budget. This can help the market to successfully build and sustain momentum, which it has been trying for many months, but in vain. Interesting times to watch out for!!

Haven, not so safe?

Funds rushing to safety, thereby raising a potential risk of crowded trade in safe haven stocks.

The end-game for crowded trade is never cozy. It eventually crumbles and that too in a crucifying manner. We all know that. We don’t need to go too far into the history to get a sense of what happened to such trades. 2017 was one such year where momentum in small-caps slowly morphed into consensual crowded trade where fear-of-missing-out went berserk to create a bubble in that space. In crowded trade, momentum builds in a self-feeding fashion to set-off a bubble. This is probably is what we are witnessing in the select set of stocks in the name of flight to quality amid a brutal bear market in the broader space.

The role of business media in pumping up the buzz can never be under estimated. In 2017, one celebrated small cap fund manager (no prizes for guessing) got the disproportional airtime when small-caps were sizzling to scary levels. Of course, he fell into the seductive trap of new found media attention. Now, it is the turn of coffee-can clubs, who come in prime times and glorify investing into gifted names that are quoting at obscene valuations. Their glib talk, of course masks the fact that this is nothing but hiding in safe havens in the name of quality. They are now larger than life heroes for the business media in general and for the investment community in particular. Sun is shining on them now. What will bring down the binge in the so called crowded trade of quality (few handful of names that even the barber in the neighborhood would tell you how they will not lose money for you) is anyone’s guess.

Investors who chase the crowded trade have reasons to smile as they are proved right in the short-term. More so, when the contrarians get crushed month after month. But they fail to understand that the surest way to under-perform in the long-run is to fall into the trap of being seen smart in the short-term. Cycles after cycles show that contrarians have the last laugh, though they will have to survive the onslaught (having the stomach to digest notional losses and having the ability to pick the “quality” stocks from the beaten down space) by not only staying the course, but also by having willingness to look stupid in the short-term. That is not easy for institutional money managers, esp. when they are measured on daily NAVs. They have few options than joining crowded chorus.

Here is the table which explains the degree of insanity in the valuations of those gifted and glorified ones (TTM PE has expanded sharply for these).


Even momentum investors should be worried to touch these stocks at these scary valuations, however tempting it could be to hide. Having said that, it is not that they will stop rising or will correct in a hurry. Sometimes, the party can go on for long, esp. when there is premium for quality in a polarized market. The more they go up from here, riskier they will become and harder the correction that will ensue in this segment. While price correction may not be substantial, extended time correction can’t be ruled out in this space when optimism returns to the broader space.

It may not be out of place to end this note with this quote from Howard Marks.

“When everyone believes something is risky, their
unwillingness to buy usually reduces the price to the point
where it’s not risky. When everyone believes something
embodies no risk, they usually bid it up to the point where it’s
enormously risky.”

Happy Value Investing!!

Never waste a down-turn!

Invest when pessimism is all pervasive.

These are golden words, but only with respect to past corrections. But not so golden for the current one. When you read it in the investment biopics or in blog posts about past corrections, these words hit you with such an inspiration that you get locked and loaded for the next correction. But, ironically, when the next correction comes and presents opportunities, one sees more desperation than inspiration. The golden words are no longer cool when it comes to the present corrections. Why?

May be because, one sees happy ending in the past corrections or in investment biopics. But, present corrections are not about past, they are about future. When future is unclear, it is not as inspiring, though we all know the ending will be no different from past corrections. No down-cycles in the past had ended in any other way, however long they were. Yet, narrative is so negative that it numbs one into inaction and more often into despair. It is always both fascinating and amusing at once, to see this diverging psychological trend between past and present corrections.

Now, let us take a look at the below chart.


This is not a complex chart. It is a simple one with a clear underlying pattern that runs for fifteen long years. As per this, every time, when small-cap index has fallen by a significant percentage, the subsequent three-year return for the index has been equally substantial. There is no reason to believe that coming years will be any different. One should expect a sharp bounce in small-caps in the coming years.

If there is going to be such a big pay-off, why there is no mad rush? May be everyone is,

  • Waiting for the cloud to clear
  • Waiting for the bottom
  • Waiting because of inability (emotional) to digest notional losses
  • Waiting for others to make the first move
  • Waiting for stability

No one wants to do the waiting that is most crucial. That is, waiting in the market. That is key to value creation. As they say, money is made in waiting, not outside, but inside the market. As the past cycles indicate, by waiting outside, very big part of the rally will be missed when the music starts. It eventually ends up either as a perpetual wait or as a punishing late entry. Either way one misses out the large part of the upside.

Want to end this note with my favorite quote from Morgan Housel. It said, “All past corrections look like an opportunity, while all present and future corrections look like a risk”. At some point in future, the current correction in small-caps would be seen as a one-time life-time opportunity for sure. Do you want to see it as a missed one or amassed one? Of course, if anyone lets it slip, there will be no one else to blame but himself.

Happy Value Investing!!

Nirmala Put?


There is a new buzz word in the market. When you utter that, bulls get emboldened and bears get panicky. It is not Greenspan-Put or Fed-Put. It is a Put with a traditional and local flavor. Guessed it right. It is Nirmala Put!

With the successful surgical strike on bears with her secretly guarded tax reforms, one is not sure, bears will ever attempt any adventure in future, esp. after losing much of what they made over last few quarters (short-sellers got slaughtered in the so called surgical strike). With Nirmala Put acting as back-stop for domestic issues, bears can at best hope for some global melt-down to get back to their business. If global cues do not favor them, one may be slowly looking at good times, esp. when positive incremental news-flow is on cards from domestic economy i.e. be it auto numbers or discretionary consumption or FMCG volumes etc., sequential numbers are likely to turn positive in the festive season. Good news on the monsoon (so on rural growth) couldn’t have come at a better time. This doesn’t, in any way, mean that the liquidity or NBFC crisis is behind us. The overhang of Yes Bank, DHFL & India Bull Housing etc. will continue to weigh on the markets for a while. But, with strong signaling effect (bazooka) coming from the Govt. that they are ready to go to any extent to revive the economy, such overhangs are unlikely to have a lasting impact

The hope is that the reform measures may not stop with the tax cuts. With Govt. under pressure to raise non-tax revenues so as to end the year with a respectable fiscal deficit, one may see a huge pick-up in pace of strategic divestment (privatization) and asset monetization. One should expect more business friendly measures in the coming weeks and months.

So far, the rally has been limited to the big boys. It is yet to percolate down to the much neglected mortals like small-caps. It is a question of time before the tide turns for the tiny ones. But when that happens, rally will surprise on the upside as it did on the downside. Interesting times to watch out for!