SANDIP SABHARWAL
Stocks,shares, finance, money, profit and the economy

As we enter into the 11th month of the new government, the initial feeling of Euphoria is giving way to some despondency and a feeling that nothing much has changed and there is no move forward.  While it is true that there are elements of policy as well as implementation that could have moved faster the fact is also that a lot has been done and the impact of the same will be seen on the ground over the next 3-6 months.

An economy is like a huge boulder, when it is moving in momentum it moves smoothly and without friction. However when it has been bought to a standstill, like what happened during the UPA regime then it is difficult to move it initially, however after an initial impetus has been provided then gaining further speed is relatively easier. I do believe that the government has moved on several directions and the impact of the same will be seen in terms of growth going forward.

Reasons for a slow pickup initially are as follows

Consumer growth is subdued- Consumer demand has continued to be subdued despite inflation coming off and there being a feel good factor. The reason for this is simple. We had a period of nearly 5 years when Consumer Inflation was more than 10%. This was also a period when economic growth was slowing down. In such a situation most people used their surpluses to consume. Consumer demand continued to be strong even when inflation and interest rates were high in the initial period and cooled off subsequently. Similarly even when inflation has come down and there is a huge stimulus due to lower crude oil prices the pickup in consumption demand will take time as people need to be more confident of the sustainability of the move. Salary growth has lagged inflation over the last few years and this is now having a delayed impact. Rural demand has also been hit due to poor weather and low agricultural commodity prices.

Investment demand pickup is low- Most companies today have excess capacity driven by a long period of below par growth. The only thing that can contribute towards a pick up in investment demand is the infrastructure sector. Given the issues around the Land Bill as well as various issues plaguing stuck infrastructure projects is has taken time to get things off the ground. However now we see activity in several sectors especially roads.  A lot of projects stuck due to regulatory issues have also got cleared. As the investment cycle starts we will see capacity utilizations across the board go up and the virtuous cycle will eventually lead to corporate capital expenditure pick up. We could have seen some faster movement in this segment, however nevertheless there is decent traction now and the impact should be seen in the second half of the year.

Banks are wary of lending and interest rates have been slow to come down- Inflation and inflationary pressures have come down substantially over the last one year. Some of it has been due to the crash in global commodity prices and the rest due to subdued demand in the economy as well as a high base of agricultural commodity prices in the previous year. Despite ample liquidity and RBI rate cuts banks have been slow to pass on interest rate cuts mainly driven by the poor state of their balance sheets. Private Sector banks have benefited due to the poor asset quality of PSU Banks and have been able to expand their Net Interest Margins. However the passthrough  is happening now. Contrary to fears about a potential spike up in Consumer inflation due to unseasonal rains it is unlikely to happen as extended cool weather as well as soil moisture will lead to higher summer vegetable production. Monsoons are the joker in the pack and we need to see which way they go. However lending rates are likely to maintain a downward trajectory for the foreseeable future. The worst of bank asset quality will also be seen in the current results season. This will set the tone for better transmission and an impetus to growth going forward.

Overvalued rupee has hit exports- An overvalued INR driven by optimism around India’s growth revival as well as an improved Current Account Deficit has hit exports big time. High interest rates relative to global rates combined with the overvalued rupee has made Indian Exports uncompetitive. This has hit the growth in the external sector.

The way forward

In my view a combination of the steps that the government has taken legislatively combined with the impetus on boosting investments will start showing in growth numbers in the second half of this year. As inflation remains low and interest rates trend down we will see that translating into greater consumer as well as investment demand.  Exports on the other hand will continue to be an area of concern.

The progress of the Land Acquisition Bill will be interesting to watch. I see it similar to Manmohan Singh’s conviction on the India-US Nuclear deal for which he staked a lot. PM Modi seems to be taking a similar stance on the Land Bill. A success here will be very positive. The other key bill is the GST Bill which could actually pass through much more peacefully.

The Bureaucracy is still slow to move as the amendments to the draconian provisions of the Prevention of Corruption Act are still be passed by parliament. This has been in limbo for several years now. Most people underestimate the impact of this on decision making given that several bureaucrats have been pulled up and charged despite no personal benefits over the last few years.

Taking into account the lead factor of 12-18 months I see a strong revival in the economy panning out just a few months from now. This will translate into higher earnings growth for corporate India and give a boost to stock market performance.  The markets have remained in a range for the last 6-7 months and are now more or less at the same levels at which they were in September 2014. That was also the time I had become somewhat wary about the way the markets were getting delinked to the economy. The current corrective move should provide a good opportunity to get into the markets to ride a better second half.

The Elephant has started moving, there is acceleration ahead.

We are at the end of the first quarter of 2015 and it has played out more or less like I thought it should. The NIFTY went up by around 2.5% this quarter. After an initial up move during the month of January the markets cooled off significantly. This was driven by reality of a slow economy and low earnings growth setting into the market.  This has been despite very strong global cues where we have seen most European Markets rise 15% plus and a strong performance by the US and Chinese markets. India to that extent has been an underperforming market. However if we take into account the fact that the INR actually appreciated in a quarter when most currencies sold off big time against the US Dollar in USD terms the performance of the India markets is not as bad.

The current quarter saw outperformance from Telecom, Infrastructure, select Auto and private sector banking stocks. A vast majority of PSU Banking stocks sold off sharply this quarter with the likes of PNB, BOB, Union Bank etc down 30-40%.

Markets look decently poised at this stage. Although there are chances of a further downside of a few percentage points the longer term outlook now looks better with low oil and commodity prices sustaining. The global risks also have moderated with ECB QE and the fears of Greek Exit from Euro zone getting built into the system. However, an actual exit if it happens will create volatility for sure. The Government could finally move ahead with legislative action during this quarter and we have also seen economic activity start in some segments of the economy, although a broad based recovery is still lacking. The Global economy is also slow but no longer decelerating, which is a welcome change from last year.

The pulls on inflation at this point of time are downwards on the commodity and manufacturing side, while food inflation could rear its head up again due to unseasonal rains and if monsoons are below par again. However this is not the base case scenario. The entire benefit of oil price and the follow through fall in prices of oil derivative products is yet to play out and will keep overall inflation low. Iran’s deal with the world powers and easing of sanctions on that country will keep the oil supply strong and prices low for the foreseeable future.

The April Quarter should finally see the impact of RBI easing flowing into the economy. RBI should most likely ease liquidity in some way going forward so that the economy benefits from the interest rate cuts. The government was also holding on to cash in order to meet the 4.1% Fiscal Deficit target (as government accounts are on a cash basis). We should now see significant liquidity release due to Government spending into the system.

The current results season is unlikely to be exciting and we could see specific pressure in PSU Bank results as there will be no trading gains and increased NPA recognition. However now one can be reasonably sure that we are at the peak of the NPA problem and from here we should see a phase of sustained recovery.

The year 2015 will be challenging as I pointed out during the beginning of the year, however there is a realistic possibility that the upside from the markets could play out much stronger in the second half of 2015. I will keep on monitoring and writing on that going forward. We will also identify ideas accordingly.

For the absolute short term RBI’s monetary policy on the 7th of April is quite crucial. RBI needs to take steps for rate cuts to percolate down into the system. Lack of any such measures could create a short term downside.

The next leg of the market up move is likely to be led by Capital Goods, Infrastructure, Banks and Telecom companies. Besides this stock specific opportunities on the mid cap side will be there for sure.

 

The last few weeks have reinforced the rate cycle assumptions that low global interest rates are here to stay longer and to that extent give a greater opportunity to RBI and the Indian Government to replug and accelerate the economy.

Low inflation globally has pushed Global Central banks in the developed world towards more and more easing. The US FED stopped pumping in liquidity into the global economy last year. However the multiplier effect of the same is still playing out. We all know that the Bank of Japan is also pumping in huge liquidity and the ECB has stepped in from this month. The impact of ECB bond buying (money printing) on global flows can be quite significant as unlike the money printing by the US FED, the ECB is starting at a time when bond yields across the Eurozone are at all time lows by a wide margin. Also with negative bond yields across the short end cycle playing out in many countries of Eurozone as well as Japan the likelihood on money flow out from these economies into high yielding Emerging Market assets is only increasing.

The US FED has also indicated slower rate increases in its last meeting.  The most important thing this time is that the cheap money that is sloshing around has not been used to pump up commodity prices given the growing surplus across commodities. Some part of the liquidity, especially in the US has gone towards a higher credit growth and lot of this money is flowing into global equity markets as well as global bonds.

From an Indian perspective the extended rate cycle is good in more ways than one.  When the US FED did its initial Quantitative Easing (QE1 & QE2) a lot of the liquidity went into speculation in commodities and pushed up inflation in India. However this is not happening now as growth is anaemic in most parts of the world and we also have a Chinese economy that is slowing rapidly. As such the tables have turned and the negatives of excessive liquidity have been nullified from an Indian perspective. As a result we have seen huge money flow into Indian Equity and Bond markets.

The opportunity is there today to attract huge FDI into India. Some part of this will flow in as primary equity into Indian Companies, however a lot more can come in via Private Equity, REITS, Annuity based infrastructure projects etc. The government in the recent past has shown some urgency in pushing economic growth. More needs to be done to get in sustainable long term FDI.

The impact of the collapse in crude oil prices is yet to flow into the Indian economy. The direct benefit is $ 40-50 billion i.e. equal to a 2-3% push to the domestic economy. On the other hand exports are suffering due to an uncompetitive rupee which has been stable at a time of carnage in global EM currencies. Although the RBI has the opportunity to accumulate Forex and push in INR liquidity into the market it does not seem to be doing that. RBI’s easing cycle has had little impact in terms of lending rates of banks. This can serve the dual purpose of inducing some INR weakness and also increasing system liquidity which will lead to lower lending rates. Being happy at a lower Current Account Deficit just due to a collapse in crude oil prices does not reflect long term vision. Exports need to move up and sustain the lower CAD. Make in India also becomes tougher with an overvalued currency as imports are much cheaper. As the economy revives and imports increase we could see the CAD move up again.

Overall lower global rates for an extended period of time give the opportunity to RBI to ease more. We should see further moves by the RBI in April which will push banks to reduce lending rates. The front loading of rate cuts is likely to play out strongly.

MARKETS

Stock Markets have corrected 6-7% from the top. Another 5-6% should take out the froth from the markets and create better investment opportunities. This could take the markets down to levels seen at the beginning of 2015 and would meet my expectations at the beginning of the year that the first 4-5 months of the year are unlikely to see any significant returns. However as things seem at this point of time the second half could be better than what I initially visualized. Will update more on this later as the correction plays out.

Raghuram Rajans last interest rate action has taken a lot of people by surprise. The jury is still out on whether the rate cut 40 days before the scheduled policy and at a time when the Union Budget was inflationary in general was called for.

As I seen things the main reason for the cut seems to be the fact that RBI now believes that the slow pace of the economy is unlikely to lead to a pickup in inflationary pressures in the near term. Moreover low global commodity prices are assumed to be here for a medium to long term. Although Rajan did speak about the quality of Fiscal Consolidation the logic for the same is just not there. In my personal opinion more money in the hands of States is more inflationary as States tend to be more profligate than the Centre. The other concern in the back of the mind of Rajan seems to be the strength of the INR. Since August last year the movement in EM currencies has been as follows

Brazil Real – down 30%

Turkish Lira- 20%

SA Rand-12%

Indonesian Rupiah-12%

Mexico Peso-16%

INR-3%

Besides this developed market currencies like Euro and JPY have also depreciated significantly against the INR. This is impacting our export competitiveness in a big way and lower rate differentials might lead to some fall in the value of the INR.

Now when I say that Rajan needs to cut on 7th April I am following his own logic where he believes that the economy is in slowdown, there is excess capacity and there is need to front load the impetus given to the economy. NPA strapped banks have refused to pass on the rate cuts to borrowers. However come April and improved liquidity we should see rate cuts percolate down.

In order to make monetary policy more effective now RBI need to cut again on 7th April. This will push a nearly 50 basis point cut into the economy at one shot. This will have a twofold impact.

  1. It will improve the balance sheets of debt laden corporate and improve their debt servicing ability. There are a large number of companies that have good operational performance, however tight liquidity and high interest rates have impacted their performance. These companies will see an immediate improvement in their profitability.
  2. It will make lot of new projects and investments more viable as rates come down by nearly half a percentage points. It will give a definite impetus to capital formation all across. Right from infrastructure to corporate capex as well as demand for housing loans, home sales etc.

The other strategy that RBI can follow if it actually wants rates to move down is to improve liquidity by OMO’s where it buys government bonds from the markets and releases liquidity. This will have an immediate impact of bringing market rates down. However it does not seem to be inclined to do so right now.

RBI’s thinking seems to be that core inflation is well under control and unlikely to come up in the near term. Fuel inflation will also remain subdued although food is another matter given the fact that seasonal reduction in prices has been lower this time and summers could see some sort of spike.

IN CONCLUSION

In conclusion the time for half baked measures is over in my view. Either RBI needs to follow its own logic and drive rates down enough so that it leads to a real improvement in economic performance or else its recent measures might come to nought. It needs to front load and then it can give itself a 4 to 6 month break before responding further to incoming data at that stage.

Markets seem to have got all the positive news it was looking for in the near term. The corrective move that has started can be sharp and swift. It will provide the base for a stronger move later in the year. PSU Financials as well as Technology stocks look most vulnerable at this stage. A decent sized correction will give good opportunities to pick up stocks in a year which is likely to be a stock pickers market.

As the budget speech started and Part I of the speech wound down I actually thought that it was Mr Chidambaram speaking and not Mr Jaitley. However Part 2 did wave me up from the slumber and increased the rating of the budget substantially.

THE GOOD

First of all the thing that pleased me the most. The rule for establishing where the permanent residence of a Fund lies will no longer be dependent on where the Fund Manager sits. This absurd rule had forced many Fund Managers managing investments into India to sit in Singapore, Hong Kong, Dubai, London etc. Now if the Fund Manager is in India it will not establish permanent residence and the taxation of Foreign Funds. This makes the life of Fund Managers like me who never wanted to move out of India easy and creates more opportunities. Now there is no longer any need to sit at high cost destinations away from on ground research to invest into India.

Also in line with changes to improve funds flow into India were the proposals to treat taxation of Real Estate Investment Trusts (REITS) at par with equity and allow pass through status. The other major change was with reference to taxation of Alternative Investment Funds (AIFs) where again there will be pass-through and moreover foreign funds can now invest into AIFs which will improve funds flow into these funds and provide greater opportunities for Foreign Investors investing into India.

The other positive announcement was the strong action of the government on Black Money where holding black money abroad and holding Benami properties in India now will become a criminal offence imprisonable with sentences upto 10 years. The government has shown its sincere intention to control black money generation and this will eventually lead to greater flows into Equities, Bank Deposits and Insurance.

Tax breaks on savings have also been increased with a further limit of Rs 50000 being allowed into the New Pension Scheme as a tax exempt investment.

The postponement of GAAR by two years and its implementation from 1st of April 2017 and will also be applicable prospectively on investments made after that date. This improves lot of tax ambiguity. There are also moves to reduce taxation on royalty payouts by domestic arms of MNCs.

The GDP growth next year is projected to be in the range of 8-8.5% which looks realistic as per the new series.  The proposed legislation on reducing red tape for setting up new establishments by formulating regulations to follow and not take approvals from various authorities is a big positive.

Combining FDI and FII into one single category of FPI is also positive as it reduces monitoring requirements, an artificial distinction between good and bad foreign money and simplification.

I do not want to get into each and every step but just focus on main points.

THE BAD

 

The negative impact of the budget is in terms of the increase in Excise duties as well as the substantial 2% increase in service tax which will be highly inflationary. On top of that there has been hardly any move on addressing structural issues which impact inflation especially food inflation. I am afraid that this will make food inflation raise its ugly head sometime in the near future. When the finance minister said that problem of inflation has been addressed structurally it is simply not true. You just got lucky due to the commodity price collapse. Brent crude prices have already moved up from $ 46 to $ 63 now and might see levels of $ 70 during the month of March driven by reduced OPEC output, disruption in Libya production as well as short covering.

There have been no major steps taken to improve the balance sheet of PSU Banks.  The contribution towards PSU Bank recap at Rs 7940 Cr is a joke. Given their balance sheets they need at least Rs 30000-50000 Cr this year.

The disinvestment target is too steep at Rs 69500 Cr when the achievement for this year is just Rs 26000 Cr, although the move to undertake strategic sale of loss making PSU’s is positive.

Although a long term direction has been given on reducing the Corporate Tax rate in the current year it has actually gone up. This is ridiculous given the slowdown in the economy. We need lower taxes now not at a time when the economy is roaring.

There is also no clarity on final GST rates which could create some volatility for the economy as 1st April 2016 approaches.

Overall there have been lot of announcements however no substantive steps to improve the growth of the economy in the near term.  At a time when we are undergoing growth slowdown this is a negative.

IN CONCLUSION

In conclusion I would say that the budget is directional good but does little to provide near term economic stimulus or momentum. The probability that in light of poor corporate performance and a likely bottoming of inflationary downswing that the markets will move substantially higher from the current levels is extremely low. The markets need to consolidate and possibly give up some gains over the next few weeks and months.  Can markets rise from here? Sure they can on momentum but will find it difficult to sustain. The attention will now shift from making the Ordinances into law via the parliament.

As I conclude the article new is coming in that Petrol and Diesel prices have gone up by Rs 3 per litre. The best of deflation is behind us; don’t bet on lower rates in the near term to drive the markets.

The action from here on will be stock specific where there is still potential of generating huge alpha.

BUDGET AND THE MARKETS, REALLY?

The annual season of pre-budget expectations and discussions around how this budget is going to be trend setting for the Indian Markets and the Indian Economy have been buzzing for the last few weeks now. After having watched Budgets being presented as I have been working in the field of investments for the last  20 years now there are two things that I can conclusively say-

  1. The impact of the Budget speech on the markets is vastly exaggerated.
  2. The trends in the markets are long term in nature and the Budget is an annual event. Normally events in a trend never have the ability to change the trend

That said, a vast majority of traders, Rating Agencies, brokerages etc give a lot of importance to the event. We can say that the annual Budget exercise could have been very important when we were living in a closed environment and India was a closed economy. Now that the economy is open and most of the products can be freely imported and exported and there is very little to do on the indirect tax front the Budget should be treated as just one factor among many. Just to take a recent example, the first budget speech of the current Finance Minister in July last year was considered to be a letdown with not too many takeaways. However did it impact the long term direction of the markets? It did not. Infact in the last 20 years the markets have fallen 11 times in the month following the Budget and risen 9 times.  

So does this indicate that the Budgets were good only 9 times in the last 20 years or were bad 11 times?  Moreover 6 times out of the 11 times it was negative the markets gave a significant positive return for the full year.

Now what should we conclude from this data. I believe that the Budget in India has become an annual exercise where the government of the day puts out its agenda and thinking for the economy. There are a lot of things said in the Budget speech which are supposed to be followed up and done by various ministries who work independent of the Finance Ministry. Implementation of the things spelt out by the government, the growth rate of the economy, inflation, interest rates, and global factors i.e. all the standard factors have a much bigger impact on the performance of the markets than the Budget.

There should ideally be no change in investment strategy because of the Budget. The trends in the economic growth cycle as well as stock market moves are long term in nature. Negatively perceived events create correction in Bull Markets and positively perceived ones corrective up moves in Bear Markets. Ultimately markets are slaves of earnings and if economic growth is strong and earnings beat expectations markets tend to do well.  These days there is another major factor that affects the performance of stock markets globally and that is the Quantitative Easing programmes of various central banks. With economy growth anaemic globally most of this money is flowing into bonds and equities and this event has become more important than any other for the performance of global equities in the near term.

Near term market outlook seems more dependent on Global factors related to the movement in Oil prices, the crisis in Greece and Russia as well as the expected pace of tightening by the US FED. My view at the beginning of the year was that the first half of the year 2015 is tricky for the markets and we should see a better performance in the second half. I still believe that we need to be cautious till April/May by which time we should have clarity on lot of things.

In conclusion trade or invest based on the Budget at your peril. It is unlikely to impact long term stock market returns in any way. 

It has been an interesting visit by US President Obama. To be frank my expectations about the outcome were not very clear however a lot seem to have been achieved which could lead to much greater investment into India and defence cooperation. Setting up of a hotline between the Indian PM and US President as well as the NSA’s is huge. Intelligence sharing is likely to help India prevent terrorist attacks and a clear signal on no tolerance towards terrorism is likely to eventual reduction in cross border terrorism. Operationalization of the Civil Nuclear Deal is positive and we need to see how fast investments can move on this.  The other important feature of Narendra Modi’s speech in the Joint Statement was a reiteration of the entire Swachh Bharat scheme where it does not only mean cleanliness in general but also the cleaning up of the environment. This could open up huge opportunities in the alternative energy; clean energy as well as a clearer move away from fossil fuels by India at a much early stage of development than other countries. The flipside is of-course in increased monetary cost of progress. Support for India’s position as a permanent member of the UNSC is also very significant.

Overall the working together of the two biggest democracies is likely to be a big positive for India for its security and development over the long run. When Narendra Modi started his focus on overseas diplomacy there was a critique of his focussing too much on External Affairs. However as it turns out both the external and domestic issues are being managed well. The longer term economic prospects and as a follow through stock market outlook is improving.

GREECE- Greece matters move in the short run as the leftists come to power. As a right wing thinker I should ideally not agree with what the Syriza party is talking of.

However the reality is that Greece has no option but to restructure its external debt and let go of the extremely painful and forcefully imposed austerity programme. The country’s economy has contracted 25% over the last 5 years, youth unemployment is 60% and debt at Euro 320 billion is 175% of GDP. There is no way out but a restructuring of the debt obligations. In all probability the creditors need to take a 40-50% haircut in order to get the debt back to sustainable levels.

Spending cuts and soaring unemployment have seen around 3.1 million people, or a third of the population, lose their social security and health insurance, leaving the country on the brink of humanitarian crisis. Almost third of Greece’s population now lives below the poverty line, while 18% are unable to afford basic food needs.

If a company in the US was in such a stake it would go into bankruptcy protection. However countries do not go down. They survive as it is a real economy and it involves real people. The creditors who lent Greece so much money should have known that they are taking a risk. There is no way that forced austerity at a time when unemployment is so high and the economy is contracting can sustain.  A 175% Sovereign Debt at the borrowing rates that Greece has is no way sustainable. The Eurozone will need to accept a haircut to move forward. If Greece moves out of Eurozone then it will be an outright default with no money likely to come back anytime soon. At this moment Greece has little to lose. As it is people are miserable and they might get more so in the near term by asking for a restructuring. However going with the IMF and Troika narrative will lead to pain for years.

Under the circumstances, in the near term Draghi’s money printing might prevent a major selloff. However as Syriza makes its intentions clearer after coming to power we should see volatility coming in.  This space will need to be watched carefully along with renewed violence in Ukraine where things again seem to be going out of control. 

Despite there being a huge number of both public and private sector banks in India the entire banking industry works as a big oligopoly. The interest rate transmission mechanism is very poor and transparency even more so despite several efforts by the RBI to improve the same. This is extremely high in the case of Retail Floating Rates given by banks where the transmission is 150% on the way up and 50% on the way down. For example statistics reveal that post 2008 crisis when RBI reduced rates by 525 basis points besides cutting CRR several times the average lending rate reduction by Indian banks was just 128 basis points.

I will explain via a personal example. I have a housing loan from HSBC. This loan started off at an interest rate of 7.25% in the year 2005. At that time the repo rate was 6.25%. Subsequently as the repo rate moved up to 9% the interest I was paying moved upto as high as 13%. I did not protest against this as this is a feature of floating rate loans. However when the repo rate was subsequently cut by the RBI to 5% in the year 2009 the reduction in rates was barely 1%. When I wrote to the bank chairperson the rate was reduced to 9.25% from 11.5%. They were as it is offering this rate to new customers but not to the old ones. A lot of people will not understand how this happens. It is by increasing or decreasing the discount they had on the Retail Lending Rate which was different for different customers. For example when I took the loan the RLR would have been 10.5%, so I was at a 3.25% discount to that. In the tightening cycle of RBI they increased the RLR to 16.5% so my loan got repriced to 13.25%. However when the RBI cut rates they did not reduce the RLR as much but offered higher discounts to new customers. and ripped off the older ones.

Subsequently RBI increased rates again and in this cycle my housing loan rate moved up disproportionately again and then the entire cycle of writing to the Bank Chairperson had to be repeated. Even after that My loan is priced at 11.5% today whereas ideally it should be less than 11%.

Public sector banks, due to their high Non Performing loans are not able to participate in monetary easing as they have to make continuous provisions for bad loans.The relatively professionally run Private Sector Banks are able to use this to maintain high Net Interest Margins and are not pushed to reduce rates by PSU banks which is something that should happen in ideal circumstances.

Monetary transmission is something that RBI needs to work on strongly. Rated corporate’s are easily able to take advantage of the lower rates by issuing bonds or Commercial Papers for working capital financing. Banks do not ostensibly reduce rates even for them but subscribe to these CPs and hence circumvent the entire Base Rate process of the RBI. It is the retail borrower who has to suffer. Floating rates need to be implemented in letter and spirit. However we still have a long way to go before this happens.

After being extremely bullish right through the phase prior to the start of 2014 and more specifically after Raghuram Rajan took over as RBI Governor I turned cautious on the markets in September/October when the markets were around 8000 levels. Infact I still remember being in a TV interview the day markets hit a peak of 8175 and to me that seemed to be a decent peak to give an 8-10% correction. The reasons were both domestic and global as global risks seemed to be growing and the pickup in the domestic economy was slower than expected. However markets continued to rally after giving two minor corrections and have reached a new all time high today. As such it’s important to look back and reconcile the view to what’s happening on the ground and what could happen going forward.

Narendra Modi’s image- I had written in April last year to ride the pre NaMo wave inorder to participate in the post NaMo wave. This came true as the new government came with a huge majority. The positivity created by the PM combined with the strong reputation of the RBI Governor seems to have placed India in a preferred position as far as foreign investors go. It seems most investors are willing to look past a few months to ride the India wave. The impact has also been strong domestically where domestic investors have poured in huge money into Equity Mutual Funds where the total inflows have crossed Rs 30,000 Crores.  The success of the BJP in subsequent state elections has also added to the positivity. It has also become clear over time that the government is focussed on getting the economy going as most issues impacted due to the parliamentary logjam have been cleared through ordinances. It might be debatable whether this is the right way to go, however investors have taken it positively.  Although recovery and action has been slow to start of investors seem to be playing for the long haul. I am also personally sure of the delivery from the government.

Crash of commodities, especially Crude- At the time when I gave the initial cautious view Brent Oil was trading at $ 95 per barrel. We have seen prices rapidly crash to $ 50. This obviously gives a huge impetus to India both in terms of contributing to a lower Trade Deficit as well as putting nearly $ 50 billion into the pocket of Indian Consumers which is a huge stimulus for consumption. However the crude price fall also has negative consequences for Oil Producing countries and a crisis in Russia or the Middle East could have global ripples. The bonds outstanding of US Shale producers are also to the magnitude of $ 550 billion where we could see some defaults. Normally such a crash in commodities would see its ripple effect across other Asset classes. However the Quantitative Easing programmes of various central banks have distorted the normal response. India is obviously one of the biggest beneficiaries of the crude crash. However it impact on global fund flows will be seen going forward. The negative impact for India could be in the form of lower remittances as well as lower investment by Oil nation Sovereign Wealth Funds.

US Dollar Rally- We have normally seen that a US Dollar rally creates a liquidity squeeze in Emerging Markets. The rally of the USD did create a selloff in a vast majority of Emerging Market currencies as well as their equity markets however India did not participate. This was a rare event in an era of interlinked global markets and funds flow. Additional stimulus by the Bank of Japan and expected QE by the ECB seems to have reduced the liquidity scare this time. While we saw many markets like Brazil, Russia and even South Korea move to years lows the Indian Markets held on. Given the likely policy divergence between the USA and other countries the probability is high that we will see a further rally in the US Dollar this year. This should reduce overall flows into Emerging Markets and is something we need to watch.

Sharp fall in inflation – The Consumer Price Inflation as well as the WPI fell rapidly over the last two months as a result of the crash in global commodities as well as the base affect of last year’s spike in food prices. As a result the RBI has started cutting rates earlier than expected. Now since the RBI Governor has always said that when the policy stance changes it will be directional we can expect a 100 basis point fall in policy rates this year. This should support economic growth in the later part of the year and was always expected. It is also likely that inflation will now remain subdued for a good part of this year unless we have a food price spike during the summer months. Rabi planting has been much lower than last year and could impact food prices at that time.

Risks remain- Risks related to global events, Central Bank policy failures as well as some sort of Sovereign crisis due to the commodity price crash remain. Concerns related to Chinese wealth management products as well as high Debt to GDP ratio also remain. The impact of cross currency moves on Indian exports at a time when the INR is becoming increasingly overvalued will also have an impact at some stage. There have been huge flows into Indian Debt last year and over the last few weeks. Unlike FDI this can also move out very fast.

Markets at the current levels now trade at near 20X current year earnings. At the beginning of the year the expectations were for a 15% earnings growth this year. The actual delivery has been much lower. The assumptions for next year are also in the region of 18-20% which looks to be a tall task as of now.

CONCLUSION

In conclusion I would say that the long term picture still remains very bright and with the interest rate cycle actually turning this will be the year where the stock specific approach will work very well. On the other hand it is also true that for the short run both the Indian markets as well as global markets seem to be priced for perfection with no scope of disappointment. We have now had a 17 month up move in India without a single negative 5% month which is a record of sorts. Normally a rise in markets is followed by earning upgrades whereas we have actually seen downgrades this time. The results season in the US has also started off with disappointments. A major selloff in the US will impact other markets.

Despite record stimulus by Central Banks the economic growth globally still continues to be anaemic. The risk of a decent selloff sometime over the next few months remains.

On the other hand opportunities related to improvement in domestic macro economics, lower interest rates as well as in companies operating in areas where the Government proposes to focus on remains. We have seen markets rally 5% plus in January itself YTD which is almost half of the 10-12% I thought they would do this year. Let’s hope I am wrong and this turns out to be a much better year. I would hold my horses for now.

 

We have, in general heard of a large number of successful investors who have made lot of money by investing right over long periods of time. However we rarely hear of very successful traders. Some of the successful ones have done very well but that has been out of discipline and taking positions that they can afford to take.

Historically I have not been a very good trader myself as I have focussed on long term investing and have found it easier to pick out long term winners. However over the last few years I have also been trading and out of my empirical experience the key features to be successful in trading are the follows.

  1. Every trader needs to put a limit or value on the amount of trading that he or she will do per call. Now trading being very different from investing requires that emotions or long term view of a stock or commodity not being attached to a trading position. Since that is the perspective with which one starts operating I normally recommend that every trading position should be take with an equal value. What this essentially means is that you are totally taking out any biases from your trading position. For example for the long run one might be more positive on ICICI Bank rather than Reliance Industries. As such in the investment book one should buy more of ICICI and less of Reliance. However when one is trading on the two the positions should be equal.
  2. Now once a position has been taken Trading requires one to be disciplined on the STOP LOSS most of all. The reasons for this are that Trading essentially is impact by several short term factors which Long Term Investing can ignore. An example of this was seen last week when RBI unexpectedly cut interest rates. This created a huge rally in interest rate sensitive stocks. Now as a Trader if this event led to your stop loss getting triggered then please honour that stop loss. The other factor here is that even a very successful Trader will atmost have 70-75% of right calls. Now if there are disciplined stop loss levels which are adhered to then in a majority of cases you are making money and overall will make money. Stop Loss levels in trading normally should be a fraction of the Profit Booking levels.  As such if a trading position is taken at Rs 100 and the profit booking level is 120 then the Stop Loss has to be 95 and not 80. The logic here is simple; in trading you will go wrong several times due to unexpected events. These could be domestic, international, macro or micro. Under the circumstances it’s important that you exit the losing positions fast and ride the profit.
  3. So then how to operate on the profit side. Even on profits discipline is required. The reasons for this are simple. In the stock markets the more the price moves up the more confident are market participants on the direction of the move. Here again a trader needs to keep emotions away. Take the profits when they come. In some circumstances where you really do not want to do that and want to try to ride the move further it’s important to have a trailing stop loss. For example if a stock was bought at Rs 100 with a target of Rs 120 and the price moves above Rs 120 very fast and reaches Rs 125 then the trader needs to keep a trailing stop loss at Rs 120. Now if the stock rises further then it is great. However if the move falters that original profit level of Rs 120 is protected.
  4. Do not try to recover the losses by taking excessive risks; Now there will be lot of circumstances where a few trading calls would have gone wrong one after the other. This can happen in both trending markets (where calls are taken against the trend) and whipsawing markets (where the trend keeps on changing). In these circumstances when a trader has made losses one after the other the tendency is to take bigger positions, higher risk to immediately recover the losses. However this is the worst thing to do. It’s best to step back in such a situation, let things settle down and come back to trading with discipline.
  5. Profits made out of trading ideally should not be used to increase the quantum of trading positions but ideally to deploy the profits in longer term investments which will grow over time. I have seen several traders who have done well in short periods of time, increased their trading and as a result not only lost out the profits but also gone into losses. If your networth increases over a period of time the quantum of trading can be increased but with the same discipline which was there earlier.

I will now conclude this piece by adding that most of the people who ask questions from me or come for advice tend to veer towards doing more trading. Under the circumstances it’s difficult for me to build up discipline in everyone. As such the above mentioned rules could be helpful. Ideally the money deployed towards trading should be a smaller part versus that deployed in long term investing where, with the right picks it’s difficult to go wrong. For the trader the following saying is most relevant

When facts change, I change my mind . What do you do sir?J M Keynes