Spark Asia Impact Managers Private Limited (Formerly Spark Fund Managers Private Limited) is the Equity Asset Management (EAM) arm of Spark Capital (Spark). Since inception, Spark has cut its teeth on equities as an asset class. Be it assisting clients raise equity capital from investors in their role as investment bankers or recommending stocks directed at its wide roster of institutional investors as part of its erstwhile institutional equities business, the asset class is firmly imprinted in Spark's DNA. As proof, Spark's noteworthy track record has led it to being reckoned by market participants as an equities house possessing considerable heft. Leveraging off this body of expertise, the EAM initiative complements and completes the suite of equity solutions presented to clients.
SAIMPL has Asia Impact from Europe as a strategic investor. Asia Impact is an entity sponsored by a group of private bankers with considerable business success in Asia and deep roots in Southern Europe, through them we hope to tap European investors in order to give them the best that Indian markets can offer in the years to come.
With the PMS license coming through in November 2018, two approaches are currently being offered, subscriptions for both of which are open:
a) India@75 Flexicap Strategy: This approach will have the leeway to position the portfolio across the cap-curve continuum, depending on the team’s assessment of valuations, risks and volatility. Instead of being aligned with only a specific market-cap range, the strategy will look for safety (read large-cap) in phases characterised by frothy valuation and elevated risks; it will look to add to beta (read mid- and small-cap) when it believes valuation has turned saner and risks have receded. The belief is that this approach will seek to optimise client returns by tweaking portfolios to reflect attendant market realities. With a portfolio comprising 20-25 stocks, the objective will be to deliver superior returns adjusted for risk. Open-ended and long-only in structure, the minimum investment into the strategy is Rs 5 million.
b) Core and Satellite Strategy: This
strategy aims to capture on rotational sector momentum that
is a key feature of Indian equity markets. While the core
portfolio will reflect positions backed with high conviction
that can have a holding horizon of over 12 months, the
satellite component of the portfolio will focus on names
where there’s momentum on account of near-term business
drivers and event-related triggers (and a shorter holding
period). The portfolio will comprise between 12-18 names.
Given the strategy’s concentration, it is best suited for
investors who understand the volatility inherent in equities
and can be patient with their capital. Expected minimum
ticket size for this strategy is Rs 5 million.
Across both these approaches, investors have the option of
being onboarded either directly (Direct Plan) or through a
distributor/partner/intermediary (Regular Plan). For more
details, please refer to our Disclosure Document.
We are investors in India's growth at the right price. The price of growth needs to be sized up in a world of uncertainties. We seek to create alpha over market returns. Managing risks is key to achieving this. To do so, we need to understand the risks we run and the blind spots. Robust process and diversification of alpha sources is key to repeatable results. Recognising mistakes and taking corrective action is critical to this. Great investment results are as much about painstaking and patient execution as they are about stock-picking.
Summary of our investment philosophy:
We are investors in India's growth.
Growth needs to be properly priced. What we pay for what we buy is important. The price of what we hold is equally important.
Timing is not everything. But timing is important as cycles are getting vicious, shorter and are increasingly all-pervasive.
Go after alpha and don’t confuse beta for alpha.
Be aware of the risks we face. Quantify them where possible. Grade them. Identify and be wary of risks that are not well understood.
Go for good managements, robust business models, sustainable balance sheets and acceptable return ratios. Recognise that these are not good enough to generate alpha.
We are in an era of information overload. Information arbitrage is not a sustainable edge.
X-factor is in execution. Focus on building blocks. Do not become a prisoner to a given style. Flexibility of approach is an approach that is enduring.
Repeatability of performance emanates from good processes. That includes understanding alpha sources, alpha drags and not being dependent on a few outliers.
Recognise mistakes. Mistakes will happen. Take corrective action.
Our Investment Philosophy - An articulation of what we stand for:
We are firm believers in the dictum that financial products including equities have a fair price. The Indian equity story derives its optimistic outlook from the promise of growth that India holds forth. Piece these together and we get one important cornerstone of our investment philosophy - which is that we are investors in India's growth but only at the right price. No stock can be a Buy or even a Hold at all prices.
The second cornerstone of our philosophy underscores the fact that business cycles are getting shorter and therefore the same will apply for market cycles. All businesses carry some cyclicality. For some, it may be more pronounced and for others, it might be less so. In order to add value to our client strategies, a keen understanding of what drives growth and what can slow down growth is essential.
The third pillar of our investment philosophy is an acute recognition of the fact that fund managers create alpha and beta is in the domain of the market or the gods. A level of historic return, perceived as high, generated at the level of the market or a specific strategy/approach or product, does not tell us much. Our emphasis is in building alpha over time and let the market go about its business of discounting the growth in the economy at a pace and trajectory of its choice.
The fourth piece of our philosophy stresses the importance of risk management and that of good process. As India matures as a market, execution is going to be the key differentiator. Business mortality risk, management risk, cyclical risk, liquidity risk, balance sheet risk and valuation risk are all key to the success of execution. Our philosophy is accepting of the need to zero in on risks we may not understand well enough and focus on mitigating those.
The fifth aspect of our philosophy is what we will emphasize are hygiene factors. In an emerging market like India, managements can make or mar investor returns. Identifying management capability and alignment is critical. The other hygiene factor is in determining whether the business we invest is generating or is poised to generate returns on capital in excess of cost of capital on a sustained basis. The ability to generate shareholder value will depend on these. These are hygiene factors and do not offer investment nirvana.
Finally, the last and a crucial pillar of our philosophy is a lesson in humility. Recognising mistakes, benchmarking investment outcomes and not being a prisoner of any style are important to generate and repeat alpha. For alpha generation to be sustainable and repeatable, the sources should preferably be many. Diversifying the source of alpha, understanding the drivers, measuring them and building on the same, block by block – these are key to the good execution we seek to achieve. Part of this is understanding alpha destroyers as well. For this to be effective, we are clear that we should not be boxed into an investment style. Flexibility is the most potent weapon that we carry in our armoury.
Chief Investment Officer
Parameswara Iyer Krishnan is the Head of the EAM business at Spark Asia Impact Managers Pvt Ltd and its Chief Investment Officer. He is an industry veteran with over 32 years of experience in asset management across India/Regional Equities. Krishnan had a highly successful stint of 19 years with DNB Asset Management (DNB), a leading Scandinavian fund management house that is part of the largest bank & insurance house in Norway. During his tenure, he helped build Carlson Fund and DNB as the most credible India and Emerging Market voice in the Nordic region between 1998 and 2017.
As manager of Carlson Asian Small Cap Fund (CASC) and Carlson India Fund (CIF), he successfully negotiated a few crucial market cycles in India and Asia for close to two decades. CASC had NAV returns of 29% CAGR (in Euro terms) from 1999 to 2007. Assets under management (AUM) grew from under USD 10 mn to over USD 1 billion during the period. CASC was a highly regarded Asian growth fund in Northern Europe over a number of years. With an India allocation above 50% in 2014, CASC emerged as one of the top performing Asian funds across categories that year. CIF, starting in 2008, returned 15.9% CAGR (in Euro terms) between 2009 and 2017, despite the Indian rupee falling by 12.5% against the Euro during this period. Krishnan played a pivotal role in growing its AUM from USD 3 million at inception to about USD 150 mn.
In the 1990s, during the formative years of the Indian fund management industry, he was the first Portfolio Manager of India's maiden private-sector mutual fund scheme (now Franklin India Bluechip Fund). He started his career with SBI Mutual Fund in 1990 where he was responsible for India's first bank-sponsored mutual fund scheme, MRIS-1987.
Apart from India, Krishnan carries with him invaluable experience in Asian emerging markets such as China, Taiwan and Korea; he is amongst the few managers in the domestic fund management industry having regional experience. Krishnan has won several accolades as an India expert and country manager. He holds a B.E in Computer Science and PGDM from IIM, Bangalore.
Life is off balance nowadays. We plan to reflect on this on a lighter vein once in a way, from the lens of a market animal. There is never a dull moment in life. Why should there be? Enjoy the zigzag roller coaster with multiple twists. This part of our web experience will get populated only when we notice something interesting that puts us off balance.
Investing is the art of taking optimism to the limits of possibilities. Professional investing is all about bringing in discretion to that optimism. In the fabled story of the Indian markets, optimism has seen few boundaries. We know that Diwali is the festival of lights. But one never knew that it can also be construed as a festival of stock picks.
The market is in the business of pricing assets based on incoming data and not a place where festivities are supposed to bring about a firesale. Never mind. Professional investing has gone on from the world of fiduciary responsibilities to the bright new world of arc lights.
That said, the market pays scant regard to these milestones. It should not. The data that ought to have a bearing on stock prices has no correlation to any festival save for the fact that festivals bring about higher consumer spend which is usually in the price well in advance. Yet the practice of coming out with Diwali picks has endured.
The packaging of investment products or the positioning seem to have taken a lot of mindspace. One should not go so far to state that this has started to take precedence over substance. One hopes that it does not. Investing is too important for an individual or family for optics to prevail over substance.
It is ultimately for the investors to decide which side of the bread is buttered. The questions to ponder over are:
Should there be stock picks all the time?
Is investing about finding the right nest for hard earned
savings or about prime time entertainment?
In order to remain an optimist, should we assume that markets
will offer opportunities upon demand?
Investment Management service is like no other consumer product or service. It is certainly not an entertainment industry. Challenge that notion at your own peril. It is not akin to a high value consumer durable either. The investment management service itself is not very steeply priced nowadays. A consumer durable performs from day one whereas here, it takes time to experience and assess the outcomes in investment management. It is not like old wine because old wine is opened after it is bottled up for ages. In fund management, the consumer experiences the product day in and day out. It is a high touch product. The closest one can come to comparing is that this is like the good old family physician. It gets better with time. You feel the need every now and then. It is not out of place to mention that the family physician does not prescribe a course of action because it is festival time.
At the best of times, it has not been easy to make money in the markets on a consistent basis. Investors should think twice (or many times) before mixing festivity with the serious task of investing. The latter is too important to be treated as an entertainment sport. As for me, when there are picks or when you get a fruitful exit from a pick, that is when it should feel like Diwali.
On that note, wish you and your family a happy Deepavali!
I keep a couple of lovely crystal pieces at home. A raging bull and a lurking bear. They keep reminding me of the constant tussle in my professional life. A while back, these pets suffered some damage thanks to my maladroit hands. They started reminding me that there is an ageing bull around. I had to do something. I got this lovely Nandi to sit and stare at me from another piece of furniture. The calm demeanour, the poise and the grace of the Nandi are too conspicuous to be missed. This is a real life story but that does not matter. I have since started thinking about the ageing bull and the timeless Nandi.
Wiki tells me that Nandi comes from the root Tamil word that promises growth and which is meant to flourish. Are we seeing the true Nandi in our markets ? Is it for real ?
The ageing bull can damage itself. If you count the age of the bull from the time the Fed started fattening it, it is nearly a decade-and-a-half old. By the way, India is a baby bull that gallivants around the Mother in the States. Going by the duration of the previous avatars, the Mother is ageing rapidly. Mother's milk is good for the health of the baby bull. Nothing else is as nutritious. The incessant nourishment has kept the baby bubbling up with joy.
Then came the Inflation. The China shop announced a stock-out on commodities like steel. So far, the Mother Bull has handled the bad boy very well. That said, we all know what a bull in a China shop can do, that too when stocks are low. It is the job of the Fed to deal with the inflation virus before it assumes pandemic proportions. But then the Fed doubles up as the physician of last resort nowadays. It remains to be seen whether it is good with geriatric care.
Now comes the Delta. While the fan club of the Mother Bull may breathe easy on inflation, Delta hurts demand. Delta is taking its revenge on the much bandied-about revenge spending.
Is the world in a good place or not? Hard to decipher. One thing is clear. The fan club of the Mother Bull is much like the superstar fan clubs. Logic is permissible as long as the conclusion is along what the fans want.
So far so confusing. Now you know why I look up to the revered Nandi these days. But there is more to that. It is Made In India. It is part of Atmanirbhar Bharat. It represents prosperity, tradition, strength, resilience and is the Guardian Bull. Above all, it is calm and composed. Will it prove to be all of the above if and when the Mother bull takes a bow or a break ?
Past performance has been rather unedifying. But then, the past performance is not supposed to be indicative of the future. One reason why there is hope for the worshippers is that the lack of forest cover has driven the bear further away. Bear is searching for real estate. And the original Real estate is looking for returns. Returns in Real Estate are hard to come by in spite of repeated attempts at financial gymnastics.
Therein lies the hope for the Equity Bhakts. The TINA factor was coined in Delhi. It has now diversified its base to cover Mumbai as well. Believers galore and there is no other place to go. We now need fresh nourishment and good health for our Nandi. Vaccination is meant for the latter and to keep Delta kids from interfering. For nourishment, there is the business cycle. The Indian business cycle is young and raring to go.
To sum it up, it seems a good idea to look at the solid Nandi and forget about the crystal. Those living in concrete dwellings should not play with glass articles. Those who follow the timeless Nandi should not rush to get financial nirvana so quickly either. What is timeless deserves a break now and then. It is time for some introspection. Play for the long haul. Pray for the long haul.
Jai Ho Nandi.
Inflation has seldom caused so much confusion in the world. We thought it was a simple enough number. It measures the rate of change in prices of a basket of goods & services you and I are likely to consume. If it goes up, the price increase is in acceleration mode. Usually, this is no good news. First of all, this means that our income will give us lower bang for the buck. Secondly, the value of our savings is going down. After all, today's savings is the raw material for tomorrow's consumption.
The lessons of economic development also tell us that the countries who had low and stable inflation had the best shot at economic prosperity. People trust the value of their savings and know what to expect in a low and stable inflation environment. Such savings are available to people who need capital to invest and this sets in motion a so-called virtuous cycle.
When inflation goes up, central banks are expected to squirm in discomfort. Conventional wisdom tells us that interest rates will be pulled up so that savers get positive real rates of return. Higher interest rates would then correct the imbalance by slowing growth by just about enough to create a slack in labour markets which will moderate wage increases and then inflation itself. This is how the impresario is supposed to run the show. In a deft and sure-footed manner.
Now, we have inflation in the USA going up and touching levels not heard of for many years. The Fed however, is showing some ambivalence. On one side, conventional wisdom dictates that you act. On the other hand, the Fed has been so transparent in its thinking that even its future thoughts have been brought into public domain. It is pre-committed to low interest rates as it were. Their plot is known as the Dot Plot. It is a beautiful array of full stops which reassures everyone to go and make merry as long as the Fed is plotting the plot and dotting the dots. This diagram has told us that interest rates are not likely to increase meaningfully for a couple of years more.
The bond market in the USA, a gigantic arena where big boys play with money, is also telling us that interest rates are likely to stay low. The US ten-year treasury inflation protected bonds (TIPS as it is fondly referred to) are flashing yields deep in the negative territory. In other words, the markets are trying to tell investors that inflation may actually cool down. The Fed may well be right on its stance on inflation.
However, at the moment, prices are going up. This is reflected in CPI rates around the world. Commodities are on fire and prices appear to be sticky at their new bully pulpit.
That brings us to the issue of growth. The (bull) market pundits are telling us that growth, which seems to be picking up almost everywhere, will be at risk after some time. It is too tepid for inflation to stay up and so the Gods of inflation will make inflation pivot.
In all this, will some tightening of rates do any harm to us? After all, getting interest rates further down has hardly been a recipe for our good. Remember Japan? Why are we obsessed with near zero cost of money?
It appears the answer lies in who " we" are. If "we" are the denizens of the deal street, Dalal street or wall street, we want to have the cake and eat it too. Simple. We want just about enough inflation to keep the wolf of deflation away from the door. We want it to be below the radar which the Fed uses in occasional bursts of fealty to one of its key mandates; Price stability. We want governments to run as much fiscal deficit as required to keep growth staying above levels where markets will be worried. We want enough money sloshing around as global capital to seamlessly oil the deals that make every bull live happily hereafter. The last one is a tough ask because the fat animal is so bloated that it can't have enough. Never mind.
In this mad, mad world which will soon come to be known as la-la land, the Gods of inflation must be crazy to not do enough to let ordinary savers make a turn on their money by giving them real rates of returns on Treasury bonds. Or are they so wily that they are biding their time to strike? After all, an ageing and fat bull could be more fun to have a go at.
In India, we have not been fortunate to get the Goldilocks economy. But we got the Goldilocks Market. Or so it seems.
It seems the earnings are rising, the business cycle is on the ascendant, policy is music to the ears and stock prices are rising. That is the Desi version of the virtuous lock. If you are to believe the media blitzkrieg in poll bound states, our welfare State has solved all the problems of its citizens. But then, such image building is the political equivalent of improving the valuation of the brand in question. Par for the course in pre poll build up.
Goldilocks Market may itself be an oxymoron. Markets love extremes. At extremes, there is always a convincing explanation, often from bright people (well compensated for the effort). If P/E ratio is up, the refrain goes that P/E is a wrong measure. Or that the inverse correlation between bond yields and P/E is the correct measure. Or else, some cute analytical model that a few smart investors claim to possess will tell you how stocks can go higher. Anything is acceptable as long as the conclusion justifies buying stocks. Unfortunately, extremes don't last forever, and the protagonists usually come up with other theories or go on to explore greener pastures of punditry.
In 1992, the infamous Harshad Mehta propagated the concept of replacement value. Then, there was the era of how blue chips can break free from the pack and hit the stratosphere. It might be instructive to know that blue chips of the day also included stocks such as Century Textiles and Great Eastern Shipping. How many of the new gen fund managers would agree that these could even have been light blue in colour?
Then, there was the craze for MNC stocks and the tech boom that we are all aware of. Some emerging icons from that era included Visualsoft and Software Solutions. They submerged. There was the infra and real estate boom and that is even more recent.
It may be convenient to argue that the stocks that evaporated from those cauldrons were of dubious quality and that giants like Infosys emerged stronger from the turmoil. That is very true and no taking away from that. One is well advised to look carefully as to how long Infosys took to regain the previous high and how much capital may have been wiped out from the peak in the interim for people who for various reasons had to sell.
Thus, the issue is not always about whether the markets are right when they get excited. At the present moment, there is enough good reason to be optimistic on a number of counts - On the prospects of a great business cycle in India; On earnings growth; On stressed assets of banks; On revival of investment spending. The market has been right in picking up many of these pointers and more.
The question is more about how high is high enough. That was always the question on previous occasions as well. Replacement value can be one insightful metric, particularly when inflation is high. Blue chips created wealth and so did MNC stocks. Tech has been just short of Nirvana for many, including investors. But then, some investors still managed to lose a lot investing into these themes - when they chose to be indiscriminate about prices and about timing.
Market discourse is driven by market participants which comprise of Fund managers (including Yours Truly), Analysts, Investment Bankers and such like. The common binding factor for this tribe is that they benefit from bull markets. Bear markets affect their earnings. It would help if a simple version of disclaimers is added to the discourse from the market men which says that they adore rising markets and their prayers are always with the bulls.
If the Goldilocks Market is a reality that is here and for good, then its definition may read something along these lines.
Goldilocks Market is a market in which the Fund Managers from the comfort of their home office instruct broker dealers who punch the buttons to buy stocks at all prices on the basis of encouraging commentary from companies who give guidance which will always be short of what they will report, so carefully calibrated that they cannot miss the same. It is a market in which Analysts will do such brilliant work on that guidance that they in turn come out with numbers that the companies comfortably beat so that they can revise the numbers higher forever, in a carefully selected approved list of companies that can make their paying clients comfortable and richer. It is a market in which bankers will help raise capital which will not dilute earnings because their models will convince all concerned that growth will always justify the capital raise. It is a market in which investment bankers dare not go into the earnings part of the earnings model of unlisted companies as they are not supposed to be measured by profits. It is a market in which policy makers can raise deficits and debt without causing any disturbance in rates or to inflation. It is a market in which the primary function of Central Banks is to ensure that they give such guidance to markets in which they retain the right to act but relinquish the right to keep that choice with them.
If only life were that simple.
It occurs to me that this kind of market exists in a very well-known location that no one has been to. That place is known as Utopia.
We have another word the comes close - jugaad.
Corporate India seems to be in performance mode. It is dancing to the chest beating rhythm of the permabull community of India.
1. How are profits going up when GDP is going the other way?
2. How could the markets have gone up, up and now away - when large sections of Indian society have been in distress?
3. How come our Covid graph is showing an inverted picture of that in the Wealthy West?
All the above are worthy of intense research of the jugaad at work. No claims to clairvoyance and to be sure, we are not into research on the subject. Indians are supposed to be born with the Jugaad Gene and let me try a recipe for putting some food for thought on the table.
Third question first. There are those who have already gone on the front foot and announced that 50% of Indians have antibodies. Yes - I heard the head of a think tank say this on National media!!!. Even with our supposedly superior capabilities to make impossible things look easy, no data supports this, and we should leave medical science out of our rope tricks. We don’t know whether we will have another wave and where we are on the eventual curve of the pandemic. Let us leave it for Scientists, Vaccines and God.
1. GDP has taken a hard knock. Even the revised (and less damaging) fall of 7.5% on output is a display of Gross Domestic Pain of a severe order. Let us not trivialise that.
2. GDP measurement is not through double entry bookkeeping. It uses many assessments and approximations and, in a sense, GDP in a country like India lies in the eye of the beholder or the statistician. To be clear, I am not alleging any attempt at distorting data - the process has limitations even for the developed countries and in India with its large informal economy, FY21 is not a statistician's delight.
3. GDP measures an average and, in this instance, it looks like Indian economy has behaved a bit like the hapless gentleman who was doing well on average with his feet immersed in boiling water and his head stuck in a piece of ice.
Brings us a bit closer to stitching together an explanation to the profit growth being reported by the companies that have created immense wealth in one part of the country known to us as India.
India seems to be in fine fettle, if we look upon it as the
closed ecosystem that consists of some 200 odd top companies,
their customers, suppliers, shareholders, employees and
cheerleaders. It stands to the credit of the players involved
that they have weathered the storm rather well. It is not as if
they got a special stimulus which they actually did not.
To
begin with, these corporates and their brethren were not hurt by
the loan mela fiasco of the UPA era as they did not borrow much.
Then came demonetisation and this cohort never had a cash stash
to speak of. They did not require much of the digital push as
they were the ones pushing that juggernaut. When GST happened,
they were already compliant while some of the competition did
not know how to do business while paying taxes. The competition
could not do multitasking on this one.
Finally, the visitor from hell came along through China - Covid.
The folks in India took to work from home like fish to water. We have to say that Indian jugaad came up trumps on this one. Lateral thinking seems to be the factory setting on which we have been wired.
Now another uncomfortable truth is coming out. Bharat may not have been contributing as much to the economy before Covid 19 as was being estimated. For a healthy change, Bharat is not just in tier three cities and villages and India does not stop at municipal limits. Bharat is that part of our nation which was not driving consumption, productivity and the so-called upward mobility. India expanded its footprint but may have never trickled down to Bharat in three decades of liberalisation. Bharat has been impacted severely in this recession, but India has soldiered on. In the last ten months, India saw demand go up - be it in painting the town red (actually in towns and villages as per the leaders in this activity), personal mobility, buying the gadgets that solve all of life's problems, buying homes that became affordable thanks to the squeeze or services that enable domestic infighting to continue unabated. The rather uncomfortable truth is that many of the smaller enterprises (not all) were not competitive enough and may have been a drag on the economy. It also transpires that a certain part of the overall labour force was redundant viewed from the standpoint of economic productivity.
In short, demand drivers are from India. At this stage, Bharat
makes up a lot of numbers but is not commensurate in output or
demand.
On the supply side, efficiency gains that were eked out by
curtailing discretionary spending may have helped us learn some
lessons in cost cutting sans the subscription.
The first one is that you can lock down the people, but economic
exchange cannot be shut down for long. Secondly, most business
travel was beneficial only to the travel industry. Thirdly, high
decibel marketing campaigns were not required against
competition which may not have existed in the first place.
Fourthly, some of the folks hanging around in offices were
ornamental and maybe the offices to keep them appear busy were
not really required to drive revenues.
The profit story so far has been underpinned on demand from
India and the productivity gains that were borne out of
adversity. Recessions benefit a few that can stand up to the
carnage. In India, those are the listed leaders and the
ecosystem that thrives on them. Their profits have edged up
against all odds. If the tea leaves have a message, the outlook
is strengthening as we try to make sense out of all this. The
business cycle ahead may begin with positive surprises for many
incumbents and the smart contenders. This could well last well
into 2021.
What is next for Bharat ? We may see Bharat striking back when tomorrow comes. Bharat exposes the reality of a large under employment issue in India - what you may call disguised (un)employment. This will likely be a big challenge to the economy going forward as there are more voters in Bharat than there are in India. Besides, demand in India alone may not be enough to sustain the underlying aspirations - for the corporates and for individuals. Bharat cannot be left behind - both from an economic and certainly from a social angle.
The perennial optimists will have us believe that India will pull Bharat up when the recovery gains steam and everyone shall live happily thereafter. They may also aver that markets are saying so. That is the subject matter of the second question posed at the beginning of this piece.
The market left everyone speechless while sprinting up to the floor from which it came down by an elevator earlier on. It did not pause to stop and kept climbing. Market pundits who have egged on this rally are obviously nonchalant. They say we are not in a bubble. They say valuations measured on P/E miss the photo as interest rates have never been lower. Interest rates drilled down to negative territory in Japan three decades back. To put this in context, Japan was the most celebrated growth story in the world in the post War era. The mega low rates did not prevent the Japanese economy getting mired in a quagmire from which it is yet to come out fully. Japanese stock prices succumbed to the illogical acrophobia they were steered into. We saw something similar play out during the dot com bubble when technology stocks were certified as exempt from gravity.
Of course, the current refrain is that history is only for those who are old and/or out of sync. Jeremy Grantham made some remarks the other day about a stock market bubble. The bulls pulled out the analytics on that instantly. He has been bearish for a while and has got it wrong on the bull run of the last few years.
We note here that the average age of an Indian is less than 30. The average age of the market players (in India and elsewhere) could well be lower. Since markets are run by market men for the benefit of their types, a bullish trend is always a friend. Most investors have not been witness to trends that can also cause hurt.
1. Markets do not measure Gross National Happiness. They are
meant to price assets that the owners of capital (the rich) tend
to possess. Period.
2. In the current juncture, it is not clear whether markets are
keen on measuring profits or cash flows. They seem to be content
with beats of estimates which in the first place are primed to
generate beats. Never mind. Liquidity takes care of the sceptics
and spreadsheet is a revolutionary innovation for the market
3. Markets are not driven by good (or bad) analysis. Money
drives markets. Money may not grow on trees but the US Fed seems
to have effective printing machines however. The resultant
liquidity has been the lubricant that has energised all markets.
This has been the prime mover for the Indian market as well.
The humble observation here is that markets love extremes in their journey of price discovery. In India, they have been broadly right in sizing up the breadth and depth of the counter intuitive sweet spot that the listed corporates (those that are tracked - others don't matter) have stumbled into. Hence, anyone who calls this a bubble may go wrong for longer than he can afford the cost of indulging in such blasphemy. Market players love bull markets. Make no mistake about that.
At some point, the market may stop and look at where Bharat is. Bharat has a lot of people in it and such an introspection can only be postponed and not avoided.
For now, the dance of the bulls may continue into the night and it looks like we have a long night ahead. Just make sure that you carry your antidote for a hangover. For, the morning after has seldom been pleasant.
The fact that a period movie could have bust all sorts of box office records in the post-modern world was in itself an unexpected outcome. Was it the triumph of high tech in visual effects? Was it the melodrama of which there was less of it than in the usual Indian recipe? Was it the usual triumph of the hero over the villain which is almost axiomatic?
All these aside, there was something that was special. The winner-take-all manner in which events played out, mid-way and in the end. The winner has it all and the loser is left out in the stone age or was dead. The force with which the end game brings out the victor is truly seismic. The winner delivers the knockout punch in the most graphic (and gory) manner known to filmdom.
The market and the economy are displaying this characteristic to the fullest. Capitalism and market economies have no time for those who find themselves on the wrong foot. Is there a feedback loop at work here? (for better or not we do not know and may not care for now).
The latest market move has been perceived as one where no one seems to have made the bucks. Really? Mathematically, nothing can be farther from the truth. The wealth that has been generated has gone to someone's spreadsheet. The market may not be up by much if you refrain from the favourite pastime of some busybodies - annualising hourly moves and measuring what has gone up by how much from the worst moment of the market's life this year. But we are firmly at a new high and the market is as much about extremes as it is about the average.
There is one lesson from any recession that we have to focus on to understand the mind of the bull. Recessions are the ultimate clean up act in capitalism. For over a decade and more, India refused to do this but did the pandemic do it for us?
In other words, have we ended up eliminating all the marginal actors in a floundering economy who were a drag on growth? In the apocalyptic lockdown, there were companies that sold goods that consumers wanted to buy. For non-traded goods, the selling was even more intense and rewarding. It was as if there were two economies which were in play. In retrospect, India was always about many economies and not just even two. Unshackle the India that knows how to grow and leave the rest at least for now. That is what the system was reluctant to do and the pandemic managed to deliver.
IT sector for instance realised that the glass and steel monstrosities in which they assembled their raw material were a huge overkill. Capital goods companies found that e-tendering was not just a tool for confidentiality but for productivity as well. Consumer companies discovered that marketing spend as percentage of revenues is not cast in stone. Yoga trainers understood that their skill sets had nothing to do with their presence and the power of absence was a killer app. The biggest cost take out effort in history was engineered in the shortest possible timeframe. Free of cost.
This is what a recession is supposed to do. Which it seems to have done with finesse. Pardon me for not sparing a thought for the human cost. Unfortunately, market economies have always looked beyond wars, famines and all else in their path.
Economic cycles have often been powerful once the brutal clean up act is done. They will certainly last much longer than the shortest bear market in history and the quickest resurrection known to mankind after the original act.
It also stands to reason that the winners of this round will rule the morrow. The banks that raised capital will get the deposits and extend loans to the folks who may have the best intent and capacity to repay. The companies that have applied for the new PLI scheme are the ones that got their mojo to make such applications. The consumer czars who have delivered margins (if not top lines) are the ones who have a chance to grow when consumers go back shopping (online or by whatever means). We need not mourn the death of bus transport operators who were lugging reluctant passengers to destinations that they did not enjoy going to on journeys that were pointless.
All of this is good stuff. The stock market is not bothered about the few thousand companies that are struggling. It is bothered about the fistful of companies that are in the right place at the right time. That number may have shrunk a tad or two from earlier on in 2020. But Covid was only the highly destructive amplifier to a trend that started when crony loans were extended to pretenders in the name of free market years back. The seeds of destruction were sown long back.
Market economies deliver the financial equivalent of the cosmic cycle of good and bad enshrined in the Gita. India was a reluctant market economy but the pandemic may have pulled the fence from under it. The future looks much brighter when viewed from a five year horizon as against what passed off for non-growth in the last decade and change.
The extent to which the market has rewarded the winners is a point of discomfort. And then there is this problem of all boats rising with the tide. There will be air pockets and some nasty ones at that. There will be casualties and that is nothing new. These issues will be settled in the coming months.
The challenge for India is what it will do with those who could not keep up with all this. Many of them are in that position for no fault of theirs. Mao solved a similar problem in Chinese communism by redefining it. To be rich was to be glorious. The country moved on with no change in the colour of all growth henceforth. It continued to be red.
Are we so lucky in India? There are so many who are left behind. This is going to be the biggest risk to the bull charge. Of course other than the virus itself which seems to have been side-tracked in the USA (where it is the biggest comeback story other than the stock market). By vaccines yet to be administered and stimulus that draws from the empty.
To the banks who deliver negative real returns on diminishing savings? To the Central bank which has played on durations to get its controlling stakeholder cheaper money? To companies who have just realised that they can get more work for less by keeping away from offices and maybe even factories?
To an educational system that has pushed through a digital divide as a fait accompli? To a job market that may be in the middle of its biggest transformation ever on skill sets? To corporate honchos who have gained by talking about large capex but not putting their money where their mouth was?
These are questions that beg some answers when we go into 2021 in the hope that 2020 was the axiomatic annus horribilis. These questions may or may not impact the spreadsheets that are on overdrive to churn out FY22 upgrades. The market that was ahead of everything including the deadly virus in 2020 may not like to fall asleep on the wheel and find itself behind the curve.
On a cold morning a few millennia ago, in a battlefield in the Gangetic plains, one of the most famous and fair minded rulers from our lore faced the most decisive test of his Dharma. Yudhistira and his brothers were on the verge of losing the battle of their lives. Their guru Dronacharya was at his glorious best and was hitting the balls out of the park. Yudhistira was the Gold standard of his times on governance. He was the custodian of righteousness. Krishna, the Master of the Universe / Great leveller / Strategic Advisor, read the riot act to him. Winning is not important. Winning is everything. Soon, a hapless and unknowing battle weary elephant by name Ashwathama was collateral damage. Yudhistira made certain disclosures to Dronacharya with disclaimers lost in transit amidst the Dilli smog. The rest is, as they say, mythology.
The art of spin bowling was born in India.
Bishen Singh Bedi, B.S.Chandrashekhar, Anil Kumble and Muralitharan have gone on to be part of that legend. Stock market pundits are doing all of them proud. 23% drop in GDP was good as the worst is behind us. GST collections of over Rs 1 lakh crores in October is good because that is a perfect "V" shape. From where and to what point? Oh – don’t be a party popper. Talking of parties, those are good because the celebratory mood during the festival season signifies that all is always well. If such parties result in resurgence of the virus as the Europeans are learning, that will not be a negative surprise. After all, we can discount the vaccine that is yet to be born. We won’t lock down again. Once locked down, shy forever. Isn’t it? We are even opening colleges and schools you see. We are past the peak.
Going back to GDP, we will soon get the Q2 GDP. I bet that will be "better than expectations". When we got a 23% drop in GDP for Q1, the pundits were quick to mark down Q2. Data shows that Q2 has seen a good rebound in activity but the "market economists" have been unimpressed. How will we get "positively surprised" if they do so. Their clients want positive vibes all day long. Come Q4, and the positive surprise to GDP could go ballistic. Never mind that we lived through a month known as March 2020 when we were locked up in intense house arrest. The enterprising salesmen of our country could not do their usual hustling in the last fortnight of the last year and a very favorable base effect set in. But who cares? A beat in time is worth beating the hell out of those who got left out. We are in a world of "positive surprises". All that equities have to do is to dance to the beat. It is a market of the market men, by the market men and for the market men. Long live the beat.
If we thought we are alone in this fine art of spin bowling , think again. Americans are in a class of their own. Now that Joe Biden seems to have won the elections in the US, that is good. The Senate is still with the Republicans and they would reign in fiscal profligacy. Had Trump emerged the winner, that would have been good too. Who doesn’t want continuity? Did we teach spin bowling to Americans? Hard to make a case but who knows? We can be sure that there is Indo-American co-operation at work here.
Disclaimer: The contents of this blog/write up/article are the personal views of the author and do not constitute an advice or recommendation of the Company and its affiliates. The Company and its affiliates may have interests in one or more of the Indian stocks being mentioned herein. Readers are advised to consume the contents of this blog in the informal nature that they are presented. Neither the author nor the Company shall be liable for any investment decisions taken by the readers based on this blog/write up/article.
Articles / Visual content of interest and our take on the subject
1. While the estimates beat the street estimates, the consensus and even the outliers amongst the consensus were probably too conservative from the recency effect of the tepid Q3 GDP numbers. In other words, earlier on in FY21, there was this expectation that GDP for FY23 would grow by as much as 8.5%. After the inflation scare, the pendulum swung the other way and by too much. We had pointed this out in some of our commentaries. GDP growth estimation is far from perfect - however, there is too much of credibility attached to the forecasts. Hence when the numbers come out, there is a big beat of miss.
2. That said, the 7.2% growth that India clocked in FY23 makes it stand out amongst the comity of nations whose economies stand out. The internals are interesting in that capital formation is now a good part of the GDP and has clearly shown a pick-up. Broadly, the good performance from certain services such as trade, construction and travel is consistent with the high frequency indicators. Similarly, the lag in private consumption is something that is evident in the show put up by many consumer companies. Inflation hurts real disposable income and this has hurt consumption. As inflation eases, there is a chance that consumption does better in FY24 but we remain very selective.
3. Most important for the market, earnings downgrades may now taper off. With a real chance of private capex picking up some of the batons handed over by the government, core India led by infrastructure and manufacturing may be in for a more solid performance. Banking is all set to support this growth. With raw material prices easing, we see margins normalising for corporate India. All in all, expect upgrades for FY24. The pendulum had swung too much to one side and now it is on its way back to the equilibrium. Our eyes will now need to shift to FY25 or calendar 2024 when the world at large may continue to remain sluggish. Will India continue its growth momentum? That will be a key question going forward as markets will like to look forward as much as possible.
1. First of all, this is a backward looking data. If you see the rupee depreciation trend in August/September, it is clear that the market had already discounted the deterioration in the current account to a fair degree.
2. This is also a data point for one quarter. We need to assess the trend over a longer timeframe. For the half year ending September, the CAD is closer to 3.3% or so. For Q1, the CAD estimate was actually brought down.
3. More importantly, the trend of the CAD for the current quarter ending December and subsequent quarters will be key. Here, oil prices will certainly be a positive factor for the CAD. Non-oil imports have been rising at a rate exceeding merchandise export growth. This reflects the conundrum posed by continued economic recovery. If the cyclical recovery is sustained, import growth can continue to pose a problem for the CAD.
4. We cannot be bullish on growth in merchandise exports given the global growth outlook. However, there is already a steep slowdown. Given the continuing headwinds for global growth, CAD will depend on imports moderating. On that, the prospects are good for Q3 and Q4.
5. How the CAD is financed is also an important factor. The FDI/FPI flows have been weak in 2022. We should watch out for trends here.
In summary, there is no need to fret over the data for Q2. That said, the CAD is going to be a drag on the macro and growth in 2023. It is also useful to keep in mind that the downgrades to GDP that we have seen over the last few months may have factored all of this. Markets will now look to what may happen next.
1. We believe these comments are worth highlighting. Semantics on Hawkish vs Dovish apart, the fact is that Mr. Varma was ahead in his views on tightening. He asked for tightening rates at least one meeting prior to the RBI pivoting between policy meetings earlier this year.-He saw the same set of data points but was willing to translate the data into what they imply for policy-making
2. Mr. Varma has now called for a pause on rate hikes. We are not saying that his view will prevail. However, his logic is sound. There have been steep hikes and the effect of this on inflation usually shows up with a lag. He has not called for a reversal but a pause.
3. Irrespective of whether there will be a pause in this quarter or not, we may be near the end of the tightening cycle in India. This is strongly buttressed by the lower oil & commodity prices.
4. The risk to this view emanates from the runaway USD. It is a global problem and India is collateral damage. While that is a serious concern, there is every reason to believe that some pent up capital flows will hit India with a bang post the dollar tantrums.
1. The rate hike was expected. No surprises there.
2. RBI upped the inflation forecast for FY23 from 5.7% to 6.75%. This is a recognition of the writing on the wall as it were.
3. Thus, RBI has responded to the problem and data in front of everyone with full alacrity over the last one month. This was after being in denial/misreading the data in the previous 2-3 months. Be that as it may.
4. The fact that RBI has shown flexibility and agility to do justice to its mandate will enhance its credibility a lot. This will be seen as a contrast from 2012-13 when the fact that RBI was behind the curve became a problem for the economy and the markets.
5. On the need for further policy action, further hikes in Repo rates are inevitable. However, bond yields at around 7.5% adequately price in the outlook for inflation and rates as it stands today.
1. What is noticeable is the fact that mobility seems to have come back to normal (pre-Covid levels) for recreation/leisure as well as for visits to workplaces. With comfort picking up on the fact that Covid may have entered an endemic zone in India, we can expect a strong growth in travel, leisure & recreation, particularly going into the summer.
2. Leisure travel had already shown signs of a good pick-up before December when the Omicron wave hit activity. This wave was less disruptive and now, early signs show that demand driven by mobility-driven activities is going very strong. This augurs well for the economy.
3. Business travel is another matter altogether. While some amount of business travel will be back, it is not clear what the new normal will be for how the post-pandemic offices will look like. The most likely scenario is for a hybrid work model for much of the services sector. Work related travel should settle at a lower base and may not be a growth segment.
4. This is not a zero sum game. Overall, the efficiency gains from lesser business travel and flexible workplaces may result in opportunities elsewhere. More spending on home and in leisure have been trends which have been flagged off.
5. While consumption looks to normalize, we believe that growth in the coming year will still be dependent on investment spending - be it in infrastructure (government), housing (individuals) or private capex. Private capex pick-up is yet to be clearly visible but is likely to materialise driven by higher commodity prices, revival in manufacturing and improving balance sheets. This will hold the key to growth in FY23.
1. The supply disruption in chips has been a factor weighing on vehicle sales for the last few quarters. The issue does not appear to have been sorted out and could drag on till the first quarter of FY23 though the situation can ease substantially going forward.
2. While car sales may have been impacted by the chip shortage, we believe the problems for two-wheelers started even earlier. The drop in sales for the market leader is quite discernible. Whereas FY23 can have a base effect which will come into play, we are not sanguine that this segment will have a sustainable growth. Transition to EV, changing customer preferences and other factors can pose challenges to demand.
3. Commercial vehicles are setting up for a good cyclical recovery. This is a segment where demand had fallen off steeply even before the pandemic owing to the transition to new emission norms. With the economy looking to recover, the rebound here can be substantial.
4. The recovery could be delayed due to fuel prices and the possible negative effect on the economy from higher oil prices. The strong comeback on mobility indicators is a reassuring sign
1. RBI kept the rates unchanged, as against an expectation of a possible tightening move.
2. More importantly, RBI expects the FY23 inflation to come in at 4.5% which seems (as the optics would have it) to be against the grain.
3. The RBI stance seems to be contrary to the concern from central banks in developed countries who expect inflation to be sticky.
Further, RBI expects growth to be somewhat of a challenge. While Q1 GDP (FY22-23) is expected at 17.2% (low base effect from the second wave), the same is expected to slow down to 4.2% by Q3 and improve only to 4.5% by Q4. The RBI forecast on inflation and its seemingly dovish stance may be coming from its assessment that India does not have a growth overheating issue just yet.
Our views on the above starting from our expectation on growth are:
1. The GDP growth should come in higher for Q3 and Q4 for FY23 - substantially higher than the 4-4.5% which RBI is forecasting. There is no adverse base effect from FY22 (FY22 is just about back to FY20 levels - nothing more) and the tailwinds from a more robust banking system, generally benign rates, capex thrust, revival in manufacturing/commodities and global demand recovery are not consistent with a steep slowdown in growth in Q3 & Q4 (Is the RBI expecting a major slowdown in global growth or a major financial market disruption? - We do not know but that should not be a base case).
We expect growth to stay close to 6% or better for Q3 & Q4. That is not overheating by any yardstick.
2. If growth stays strong, RBI may have to re-visit the accommodative stance in the coming quarters. It is possible that RBI does not want to go in for a pre-emptive tightening. At a time when the nominal GDP is just about back at FY20 levels, there is no need for such a tightening. Expectation of a so-called hawkish stance is premature and is missing the point.
The western countries suffer from massive negative real rates and their problems cannot be compared and equated with ours.
3. The above could however put the RBI projection of inflation at some risk. But then again, it depends on how commodity prices behave. If commodity inflation stays under control, India's inflation trajectory need not mimic that of the West. Indian economy is in a different phase of its macro-journey and if supply side issues are addressed, inflation can stay under control
However, the expectation of 4.5% looks ambitious. We also acknowledge that the Indian policy makers have in the past countenanced inflation more leniently than they should have. That will remain a point of concern.
1. The gross direct tax collections till December 16 are well ahead of the budget estimates for FY22. On direct taxes alone, the beat over the budget estimates may be to the tune of Rs 1.5 lakhs if not more by the time we get to March 2022.
2. More importantly, the gross direct tax collections till December are over 30% higher than the PRE-PANDEMIC YEAR FY19-20. While the overall economy is just above pre-pandemic levels, the increase in tax collection is so palpable and should pull up the economic growth as we go forward.
3. The GST collection for the Centre (other than SGST) can well exceed the target for the current year by Rs 2 lakhs- 2.5 lakh crore. The target as per budget is Rs 6.3 lakhs and the run rate till November shows that we are about to cross the full year target three months ahead. Fourth quarter is usually a strong period.
4. There could be a serious slippage in the divestment receipts from the budgeted figure of Rs 1.75 lakhs crores. We may not even reach the half-way mark unless BPCL divestment and LIC IPO happen.
5. We can also assume some slippage in expenditure particularly on account of Covid. The Government has so far not cut capex spending. It has been prudent in other areas. This is not the year in which spending will end up being lower than estimates.
6. In summary, we are still looking at a positive surprise of Rs 2 lakh or more on the deficit. The figure could be higher depending on the choices of the Union government in terms of spending.
7. We can end FY22 with a budget deficit in the 5-6% range as against the projected figure of 6.8%. While much higher than the 3.5%-4% zone where the government was continuously tested by the markets till FY20, this deficit number will make India a stand-out. Fiscal discipline is not even a point of discussion for most governments around the world.
8. There is therefore no reason to believe that interest rates in India or inflation are about to spike up though there can be some increase in the short run due to global factors. We are clearly seeing a divergence between the developed world and India as the former has negative real rates now and India does not.
Once the current bout of FPI selling eases and the Omicron scare (hopefully) is behind us, watch out for a lot of positive comments.
1. The three year low is not in absolute terms but refers to the 35% level which is relative to the budgeted number. This fiscal, the Government had provided for a huge budget deficit and that becomes the reference point.
2. Nevertheless, such an expansionary fiscal approach is par for the course. Governments all over are resorting to the same.
3. In this context, the revenue buoyancy in India is a huge positive. This shows that the cyclical recovery has momentum on its side and pretty good momentum at that.
4. We believe revenue buoyancy has more to go on both the GST side as well as the direct tax front. The key is for the government to keep spending on capex as that will ensure that for the gamble taken by throwing fiscal caution to the winds, payback by way of growth offsets the negative effect of a fiscal drag.
4. The fiscal deficit will end up at a level which will be well below the budget estimates (as % of GDP). Going into the second half of this fiscal, there will be two positives - one, the numerator (tax revenues) will go up further from here. Second, the denominator (nominal GDP) will also go up.
The above is a great situation for India, subject to the caveat that we are in these extraordinary times when concepts such as fiscal prudence have been given a wide berth. Is it too wide for comfort? Will inflation become a problem?
These are going to be the questions that the market will have to come to terms with on the macro-front in 2022.
1. All the points that characterise the Unicorns in what is different about them now are causes of concern for investors in the secondary market (as many of these are lined up to IPO).
2. The revenue multiple is perhaps the most serious cause of concern. At the levels which are highlighted, the path to profitability is a distant dream. Investors should take note.
3. The low founder holding is a matter of some concern but given the capital requirements for these businesses at growth stage, which they are in, founder holding cannot be expected to be high. But then, that is no reason for minority financial investors to give them a wide rope on valuations. Minority investors are well advised to mind their interests and nothing else.
4. Increasing B2C footprint is perhaps reflective of the large target market in India and the fact that technology brings scale benefits. Admittedly, scale benefits are back ended. However, how far out is the same and when the unit economics will justify optimism are important questions to ask.
5. Presence of a large number of institutional investors is a mere data point and this should not be viewed as a panacea for all (or any) of the challenges for minorities. Yes, they may be expected to bring better governance et al. Whether it is actually happening is open to debate.
What is to be noted for sure is that the institutional investors are also in this for returns and the pressure on them for returns is no different than their ilk in the listed equity space. Their holding periods may be different and risk tolerance is a whole lot different. It is also pertinent to note that they usually play a high-stakes game where one or two huge success stories can off-set a lot of losers. This is not at all true for the typical investor in the listed space.
In summary, none of the data points are virtues for the investor in the secondary market. The listed space can be very unforgiving when things don't go well. The line in the sand is blurred in good times. Just follow the dictum - what is exciting for the country's entrepreneurial ecosystem and one set of institutional investors need not be good at all for another set of investors- and certainly not at all times. Keep the focus on which side of the bread is buttered- for you and you alone.
1. The word bubble has created a fair bit of confusion in the context of the boom in stock prices. In the past, the so-called stock market bubbles have ended in serious busts entailing severe wealth erosion. Examples include 1929, the tech bubble of 2000 and the 2008 financial crisis. Many have argued that such a denouement is unlikely in the current scenario. And therefore, this cannot be called a bubble. We would submit that there is no need to use the term bubble and brood over the definition of the same.
2. It is clear that the extraordinary rally in stock prices over the past 18 months has resulted in valuations getting stretched. This brings about risks which investors need to be aware of.
3. The other point is about the long-term impact of technology and how the same has changed/is still changing the world for the better. This is not in doubt and for large measure, this has altered the productivity contours in a positive way. The comparison with the housing bust and boom seems to suggest somewhere that any shakeout in the technology space is likely to be an opportunity as eventually, the space will get to be much bigger
4. The point on interest rates is very pertinent for India as well. The mean reversion in valuations is likely to settle at a new mean much above the previous one if interest rates stay lower for longer. But the level is hard to quantify right now.
5. Though the discussion on technology is about the US, the technology led productivity gains are just beginning to show up in India. It could be argued that the current period of overvaluation seems to be a harbinger for a longer period of productivity led growth. That is a really optimistic and comforting thought for India when the market has broken into a new high and is trying to find its feet there.
Optimism is in order. However, how high is too high - and what kind of correction will be a mere correction as against a bust; These are going to be difficult questions. Just as difficult as defining what a bubble is. Which is why it is useful to do frequent reality checks when the rate of change in asset prices far exceeds the long-term averages.
1. Equity markets are flashing amber in some ways if not Red as yet.
2. The massive IPO pipeline has been a clear risk factor for the sustenance of the bull market in 2021 and into next year. The market is beginning to tire out a bit earlier than one would have anticipated.
3. The IPOs where stocks are quoting below issue price are not really the big ones or amongst the most sought after. However, we have to watch the progression here as many high profile (and bigger) IPOs are in the pipeline.
4. The lacklustre listing of these IPOs comes amidst the fall-off in market breadth. This is a worrying sign.
5. On the other hand, we have seen IPO listings below issue price in 2015-2019 and the bull market could not be stopped.
6. In previous instances, massive IPOs have coincided with market peaks. While nothing needs to repeat in the same way, greed and fear have been permanent drivers of market metrics. Overvaluation of proposed IPOs on conventional metrics may be brushed aside as inability to comprehend the new market order. Fair enough. Complacency on the entire issue of pricing itself is a warning sign.
Time to be cautious.
1. It is perhaps the first time a large UNICORN is listing through an IPO
2. It is the first time a company from the digital/ecommerce space making losses and having such a large market cap is listing in India.
3. It is also a large fund raise from primary markets in India
Some possible implications for our markets and for investors
1. Investors in secondary market will need to figure out how to go into the price discovery mode for large digital plays who lose money so to speak. They will have revenues but often don't have profits yet. Various new metrics such as price-to-sales, unit economics, time to profits, growth momentum and other lead indicators about the future will be in play. It is never correct to say that the market lacks logic. The market has a good mind of its own. However, it is fair to say that the markets can misprice these assets for a certain period. We don't always know which way.
2. One example where there were disastrous consequences for investors was when UTI Mastershare and later on Morgan Stanley Growth Fund (both mutual fund schemes) were listed. They were trading at multiples to NAVs for a long time. Yes, multiples to NAV. The simple logic that the NAV already reckons the price of stocks which in turn discount the future earnings stream of the underlying companies did not wash at all for a good while. The double counting went on till many lost a good bit of their savings. This happened in the nineties and of course, the immediate pushback will be that today it is different. We hope so but do not have reasons to conclude so. We need to be watchful
3. On the positive side, we can certainly benchmark these digital age assets with brick-and-mortar companies that are in project implementation mode. As per conventional accounting standards, the latter do not declare losses. Pre-operative expenses including interest on debt is capitalised till commercial production starts and some of these projects have long gestation periods. During that period, the enterprise value of these companies stays rather high in relation to revenues (revenues are usually Zilch in these cases).
Conventional accounting standards do not allow such accounting to mask the lack of cash flow from operations for the new age businesses and hence digital assets appear to be expensive. In fact, one can also argue that these digital companies are more or less fully funded with equity capital and hence the capital structure inherently mitigates risks. Moreover, companies like Zomato are operational and have revenues and more importantly, they have millions of customers and hence actual experiences which can be analysed. Forecasts are based on actual business getting transacted even as we discover the price.
4. More recently, there has also been the experience of the insurance companies listing without accounting profits backing them up. The outcome for investors has been very good in many of these cases.
We therefore believe that there is no merit in using the word " bubble " in a casual manner. That said, there are some points to ponder
1. Not all Unicorns preparing for the date with the secondary markets are business models that can scale up and have entry barriers. Some of the business models are in so much of a flux that risks are in abundance
2. The overall expected supply is also somewhat unprecedented for a market like India notorious for lack of depth
3. The oversubscription for Zomato has been the maximum in the institutional investor category. Does it mean that these investors know a lot or they have the maximum FOMO(Fear Of Missing Out)?
4. Low " sponsor commitment " (All sponsors are so much in the money that they are way past the phase of carrying meaningful financial risk in an absolute sense) is something investors need to be wary of. This lack of alignment with the newly minted minorities will stare at us soon.
Finally, inherent earnings ability is unlikely to go out of fashion for financial assets. That is all they offer and need to be priced on. Profits will matter. It will be about discounting the future - both from the perspective of waiting period (time value of money) and the quantum of future earnings (so called returns on invested capital).
Welcome to the future of new age investing.
1. The memories from the taper tantrum of 2012-13 are still lingering. That said, there is one fundamental difference right now. And that is growth.
2. The pressure to normalise rates comes from the scare of inflation and this inflation is not coming by taking up inflationary expectations. This is coming from input costs going up as demand looks to come back.
3. The pandemic has set the stage for a growth phase. The pandemic is much like a war. Post war reconstruction creates as many opportunities as it creates imbalances and risks.
4. While we recognise that the market can correct and perhaps correct a good deal, we believe that if growth is what lies ahead, this correction will be another opportunity for investors.
5. The rebalancing towards equities is not done yet. US interest rates are well below the 2019 levels of 3%+. As an asset class, equities are not nearly done yet.
6. While we have consistently argued that valuations need to moderate for the expensive stocks, that can also happen with some time correction and earnings recovery
7.The global markets may be entering a normalization phase rather than a new bear market. However, this can cause pain and investors need to tread with caution. This is no time for momentum investing.
8. The one positive fallout from rates trending up is that the notion of No Cost money is out of the window. Risk should be priced right. Zero and lower rates are never right whatever be the context.
9. For India, inflation is headed up and rates may only trend up. This may not be good news for equities in the face of it. If growth is what is driving this, the earnings effect tends to be more pronounced.
10. India is ending an earnings drought. Earnings growth eventually tends to surprise on the upside. This shakeout may prove to be the big opportunity that the second covid wave never provided.
1. This is a proposal from the new Biden administration seemingly directed at America's giant technology firms which have been using a maze of subsidiaries across the world to lower effective tax rates by moving profits. Direct impact could be on countries such as Ireland, Singapore and Hong Kong apart from known tax havens such as Cayman Islands.
2. In the aftermath of the pandemic where there are rumblings over the need to raise resources to take care of the debt induced by this crisis, this proposal is causing ripples across global financial markets. Coupled with the tendency of Democrats to push up taxes, this proposal is not likely to go off the table. However, the mention of a 15% minimum in this piece from WSJ seems to be a bit of a dilution from the earlier number of 21%. Given the fragile global economy and the power the markets seem to wield over policy, these sorts of proposals will likely face headwinds every step of the way.
3. For India, on the face of it, Indian tax rates are higher than the 21% number itself. Though for new industries, India has extended a concessional 15% rate. There is much talk about these policies not being in the best interests of developing nations. The direct impact for India looks somewhat low.
4. The big impact is of course on the valuation of companies across the world. Higher taxes would be earnings negative and that is saying the obvious. Will this, if implemented, halt the equity rally on its tracks? Will the elevated valuations of tech companies come under fire? Is Nasdaq already beginning to bake some of this in?
Given the rich valuations in India, which have moved consistently above 1-2 standard deviations above mean for the last few years, and have started to lift the mean itself, any move which affects global markets will not be great for Indian equities. We need to watch this closely.
1. The Government announced a steep cut in small savings rates before the by-now-familiar rollback happened - within 24 hours.
2. On the face of it, state elections are being blamed for the rather unnecessary episode. However, it brings to light the difficult choices before a political economy in the aftermath of a nasty pandemic, deep recession and the accompanying pain.
3. The cut in small savings rate is what would be ordered by someone looking to remove the distortion in rates caused by the unwillingness of successive governments to straighten out the distortion in interest rates. Tools such as this and SLR create a situation where Indian interest rates are sticky on the downside even when global rates are next to nothing. In a manner of speaking, sticky rates have a small role in preventing inflationary expectations from coming down (even though we would not want to stretch that argument too much).
4. On the other hand, the lack of a good social security net ensures that savers (who are in millions as against borrowers who are in lakhs or less) exert pressure on the political economy to keep rates on instruments like small savings rates at a higher level.
5. There is some merit in extending such a safety net, particularly to the elderly in the population and by keeping suitable caps. There are caps in place right now but such caps are available to all and not just the retired.
Political football is inevitable in this scenario.
The move towards lower taxes and a globally competitive Indian economy demands that interest rates (cost of capital) go lower. That is difficult given the high fiscal deficit in India and inflationary expectations which refuse to go below a level of say 4%. The move proves the point that cost of capital has not and is not yet ready to go down in India across the board,
For the equity market, the point to ponder is this.
If cost of capital is sticky, how can valuations alone
stay up?
If equity valuations are indicative of much lower interest
rates for longer, then the expected equity returns should
trend down.
This episode should cook up some food for thought. Even if it was much ado about nothing on the rates.
1. The rise in yield in India coincides with a similar move in US bond yields and indeed global yields. US 10 year paper saw a moderate improvement in yields to 1.34%. Though this is lower than the levels prevailing in 2019, it has come a long way from the lows of under 60 bps in the middle of 2020 and is now almost at the levels prevailing when the world entered the pandemic. Japanese yields are positive which is saying something.
2. These yield levels, whether in the developed world or in India, have not shown any signs that they are headed up to a different and higher level. Far from it. The policy bias does remain in favour of lower yields for longer and that should be clear.
3. This exposes the limitations to policy action. Policy is no panacea. In India, the extraordinary level of deficit is uncharted territory. Policy has waded into that because of lack of options. Something's got to give. If deficits are this high, bond investors will demand their due and deserve that too. Negative savings rate does not lead to utopian outcomes in a capital starved economy.
4. The latest movement in rates should act as a wakeup call for investors who have taken the view that the arithmetical and simplistic negative correlation between lower yield and higher valuations can be extrapolated till - well - the people propagating the same become rich enough to pivot. There is no other logic to that sort of positioning. Meanwhile, Buyer beware.
5. For the government, the key is that the big capex spending announcements are translated into action quickly. Time is of the essence here. When markets are forgiving, it makes sense to take advantage of the same. If capex spending is ramped up, the cascading effects on employment, productivity and growth and consumption driven by such growth can follow, hopefully in that order.
1. In the latest report which gives an assessment of the health of the banks and the financial system, RBI has raised a concern that the bank NPAs will keep rising till September 2021.
2. We have to keep in mind the fact that the RBI commentary is based on its assessment of reported NPAs. Such recognition and reporting has been affected by the moratorium extended by RBI and then the Supreme Court intervention on this issue.
3. The real stress happened in March-July 2020 when the economy suffered its worst contraction in decades. As of now, when this report has come to the public domain, things are on the mend and hence the data and inferences given in the report cover a stress that happened at least two quarters back.
4. The stock market tends to look forward and therefore, the eyes of the market may be on the period after the above stress is recognised.
5. This is particularly true for private banks. And more so for banks that raised capital and have made Covid provisions. If the stress is broadly taken care of by the provisions and the capital raised gives the necessary cushion, the focus will be on the lower credit costs that one can expect in the post pandemic period.
6. The RBI report itself projects a much lower stress for the private banks as against the public sector banks. If we go by the numbers for the private banks and the capital buffers created by many amongst them, it stands to reason that the market should put this behind and look ahead. Which is what it seems to be doing.
However, in this crisis, different entities may be impacted very differently and that is what we should watch out for.
1. The GDP data for Q2 released recently points to government final consumption expenditure having contracted by 22% year over year as against a 16% growth for Q1. The report on spending by various ministries is in sync with the data on GDP.
2. While government borrowings have gone up by 68% till November, spending is on the slow lane. The missing piece in these numbers is the state of revenue mobilisation. Given the extent of contraction in economic activity, tax revenues have been hit and hit badly. Tax revenues should show improvement as we go towards the fiscal year end. By how much is one key question. It will also be interesting to see whether the removal of spending caps would spur expenditure.
3. The government has been reluctant to give a big demand stimulus which of course would have dented the already precarious revenue position. What we are seeing is the lack of options that an emerging market government is faced with at the time of an unprecedented crisis.
4. Reforms may be one way out. We are talking about reforms that are seminal and not tentative. Some signs of that have been visible in the moves on the farm sector. A lot will depend on how these reforms are accepted by the segments of population impacted by the same.
5. One interesting thought here. The economic recovery in India has been sans any big bang stimulus. This can turn out to be a big positive as the economy is coming back to life on its own steam and not with the help of props. This will be a big positive if the recovery sustains.
6. One unintended fallout of the above is that the weaker spots in the economy (such as the informal sector and small entities) will find the going tough. This will be an additional positive for stronger players and even has the effect of boosting short term growth and giving a fillip to profit recovery. The negative feedback loop from weak end demand from the vulnerable segments is the risk to watch out for. However, in the short run, it looks clear that the market's view on the strong getting stronger is playing out.
1. The profit recovery in India in Q2 FY20-21 has been a bright spot for Indian markets
2. Note that the profit recovery has been ahead of sales recovery. Sales are down more than profits on a year over year basis. The margin improvements have been palpable and across sectors. This has been led by excellent execution on costs, particularly from the best in class.
3. A more granular study of the resilience in profits shows that one part of the margin improvement has come from cuts in discretionary spending, due to work-from-home as well as the lack of competitive intensity. The other source of resilience is the raw material costs easing. To some extent, both of the above are not sustainable. More pointedly, the second. Some of the efficiency gains will stay. At least for good companies. Watch out for sustainable margin improvements from FY20 levels. Margins may not sustain at the levels of Q2 FY21. They may still improve over a 2-3 year period.
4. The concentration of business leadership has another implication. A disproportionate share of the fall in economic activity has emanated from the smaller firms and the unorganised sector. This has affected the bottom of the pyramid which is a demand driver in India. Therefore, watch out for the demand trajectory settling down at a lower slope and/or a flatter gradient as compared to the pre-Covid expectations. Once again, this points towards further consolidation.
1. Real rates are negative in India by a country mile now.
2. While this is an unusual year and hence any prognosis may force us to eat our words, the gap is glaring. Note that in the period between 2010 and 2013, real rates were negative and India paid a heavy price. The stock market too took it on the chin.
3. The hope is that this year, the CPI is high due to temporary factors. The hope is that food inflation will ease and so will that of manufactured goods. How can high inflation be consistent with low demand ? Logical question but then India seems to be the odd man out
4. Our reservation comes also from the fact that a majority of the system is incentivised to look at the rosy side of the picture while underplaying the writing on the wall.
5. Note that India is about the only major economy where inflation is an issue with a recession at hand. Not a good sign.
Does it not point to structural rigidities on labour ?
Does it not point to the fear of higher deficits ?
Does it not point to supply side issues cropping up when
demand eases ?
In other words, productivity in India could be dropping off quickly if demand drops.
Will there be a V-shaped recovery in all of this ?
All of the above make for serious food for thought.
1. Vaccine nationalism is fully in play as we go towards the business end of getting the World immunised against Covid 19
2. The wealthy nations will obviously look after their interests. Understandable. We in India need to be guarded in our hopes for a vaccine, particularly on the timeframe within which this is feasible
3. That said, India seems to have done a good job by securing a fair quantum of vaccines considering that the " vaccine hoarders " on the other side are countries with per capita incomes 20 to 30 times that of our country
4. India will leverage its long term potential of being a large market for the vaccine , and not just for 2021.
5. While it is too early to comment on the prospects for the vaccine, India has production capabilities and given its large market potential/size, it will have advantages. This is a positive.
6. The only point the markets should note is on the timeframe for vaccines to be rolling out. Even in developed countries, logistics issues and constraints on production are issues.
For now, markets seem to be in a mood to discount the possible end to the Covid saga. India may come out ahead in the distribution challenge as it has a reasonable record on public health initiatives. Many Indian states have delivery systems which make the basic cut. We will watch out for winners from this exercise, while being a bit cautious on the timelines.
1. The low-interest-rate regime has implications for equity valuations everywhere. High valuations in Indian stocks is, therefore, in part explained by low interest rates at the investor level.
If we consider the impact of inflation, we might be tempted to think that Indian equities benefit even more as Indian inflation is not falling in tandem with low rates. This seems to imply that you get low yields for savers (investors) along with not-so-low pricing for producers (companies of listed stocks). In India, the dichotomy is all too apparent between the haves (the companies on the winning side) and the have nots (those that lose out). The widening of the valuations is, therefore, defendable. But, only to some extent. If you started out at a quality premium (which is prevalent for years), the widening of the premium can only lead to bubbles - though the equity bulls chasing the Club Premiere don’t quite want to accept this.
2. Low interest rates for investors do not automatically mean lower cost of capital for companies in India. The government is crowding out private investors. G-sec rates, though lower than last year, are over 250 basis points above the RBI policy rates. And over 200 basis points above what banks pay depositors. CPI is above all these rates, at least for now. We have a serious, negative-real-rate scenario for investors in safe fixed-income avenues.
While it is pushing up demand for equities, it is not bringing down cost of capital for borrowers. Least of all for borrowers who are most in need of capital.
This scenario is good for high-quality banks. They are getting access to inexpensive deposits and their interest spreads are buoyed by what rates the government is borrowing at. If they can control asset quality, this is indeed a good time for the well-run banks.
3. Low interest rates also lead to an inevitable situation where expectations from all asset classes will taper down. Equities are not out of Mars in this race to the bottom. Expectations of equity returns can - and will - come down.
4. Then there is the secondary and tertiary impact. Highly efficient producers will win the first, second and third rounds by thrashing losers by the double dhamaka of higher market share and lower costs (lower inflation for global commodities, low rentals etc). The losers in this game are losing purchasing power and it is a steep slippery slope. In the Nth round, the nemesis of lesser overall incomes will catch up with the table-thumping top line trip that the market leaders/market favourites are on.
The macro is not so irrelevant that it will never catch up.
We find this to be an extremely insightful commentary on the impact of the pandemic on the economy from a seasoned economist and policy maker.
Our take on the impact to the stock market and investment outlook:
Pent-up demand:
This is playing out from June. Whether it will run out shortly or drag on for a bit more, the effect of lost incomes will catch up and that is not good news for consumption-related sectors
Urban job losses, under-employment, impact of reduced remittances from cities to rural areas - all of these are consumption negative. Market has so far ignored this aspect.
There may be a few strange phenomena at work for the now and here:
One, for a part of urban work force that can work from home, savings may have gone up and, hence, room to buy some discretionary items has opened up. This may be one reason behind the demand boost for some categories, including cars. The pent-up demand should wear off and the income effect will take over. Early consumer behavior trends show that it is not as if everyone is waiting to rush out and shop. It is clear that Covid has to be controlled first.
Secondly, some companies are gaining share as they are obviously better prepared, better funded and better run. Could be the case for Asian Paints, Titan, Britannia or Hind Unilever. Useful to remember that the long-term story on these names is not just about wiping out competition, but expanding markets. The market growth was already tepid before the pandemic. This is not a great set up for sky-high valuations to sustain.
Deficits:
Fiscal deficit will go up. To 12% of GDP or 15% of GDP
If the government does not spend, the GDP for FY22 will also be at risk. If the government spends too much, monetization of deficits will see an erosion in savings and purchasing power
When this reality sinks in, we expect pressure on the Indian rupee
We have, in our April 2020 newsletter, warned about the impact of the impending GDP free fall. Now, FY22 growth is going to be at risk. The optics may be deceptive - if we have a steep 12-15% drop in FY21 GDP, FY22 will see a possible growth of 10-15%. Even that growth will not be enough to take us back to FY20 (pre-pandemic) levels. To be clear, the FY20 GDP growth itself was at a multi-year low. The nominal GDP before the pendemic was trending below expectations. Yet, that will prove difficult to scale by FY22.
In summary:
We expect sequential improvement. But don’t miss the optics. The fall was too steep.
Watch out for medium-term pain points for domestic demand.
The recovery will be non-uniform. More power to the strong.
Valuations matter. They cannot keep expanding against slower growth.
Interesting article in The Mint that speaks about the cash flow woes of smaller firms - on account of dealing with larger outfits - during the ongoing Covid pandemic. This supports our view that the current environment is skewed in favour of larger players at the expense of their smaller counterparts, who are clearly finding the going tough.
How does this narrative translate into an investment insight for us? We interpret this development as a signal to construct portfolios that have a larger-cap bias, with a preference for market leaders. Even within midcaps, stick to established and more liquid names that have demonstrated an ability to possess either pricing power or a bargaining advantage with their ecosystem of customers/suppliers.
The longer this pandemic lasts, the higher is the probability of increased mortality among smaller names, as they crumble under the weight of disappearing growth, diminishing staying power [read as balance sheet strength] and funding-related challenges. Small may not be beautiful in the current times, after all.
Our Comment
1. RBI is likely to be guarded in its monetary policy approach from the point of view of signaling. It cannot afford to be seen as soft on inflation.
2. Monetary policy can do previous little to alleviate food prices. The intervention has to come from the supply side (government - and even here , the weather factors are not controllable)
3. The CPI came in at 5.43% ex-vegetable prices. The underlying inflation momentum looks very much benign
4. If there is a market reaction based on the impact on monetary policy as a result of this CPI print, we believe that will be a case of the wrong reasons driving a correction which may have been overdue otherwise.
5. Tomato prices are already easing. While it is hard to predict food prices . the disproportionate impact of food on overall CPI will itself come in for debate.
In our view , it is a case of an unintended distortion which needs to be viewed in perspective. For clear comparison , China has seen episodes of pork prices driving up the CPI. It neither affected the direction of growth nor did it hold the monetary policy hostage.
We disagree with some of the narratives from analysts. India’s inflation differential with the US has narrowed and is likely to remain in a lower range as compared to the 40 year history. This is the bigger trend. The rest is noise.