Category Archives: Economics made simple

RBI Monetary Policy, June 2018

Monetary Policy:

As the macroeconomic outlook becomes less transparent the monetary policy committee has only become more steadfast in its neutral stance. This leaves room for all possible outcomes and actions. The neutral stance has often been equated to a status quo for policy rates. So, the rate hike of 0.25% may come as a surprise to some.

Inflation has always remained at the core of policy decisions. Oil prices have already increased by 12% since April. More clarity on global oil prices may emerge after OPEC’s meeting later this month. Till date, price hikes have been passed on to the end consumer. Raw material costs have also spiked as a result of this. The RBI anticipates an upward inflationary trend and is working to manage this.

On the other hand, India’s growth story continues to remain positive. A normal well-spread out monsoon bodes well for the agriculture sector. Urban and rural consumption look healthy. Capacity utilization in the manufacturing space has improved. The resolution of stressed assets is ongoing and better provisioning norms are ultimately working in favour of banks.

Investment Strategy:

Rising bond yields should be viewed as investment opportunities rather than pain points. The RBI’s neutral stance does not provide a clear view of where interest rates are heading. Risks are elevated when there is less clarity. Asset allocation will play an important role in mitigating risks.

New Chair, Same Vision

Last month, Janet Yellen handed over the reins to Jerome Powell. He was initiated as Fed Chair into a chaotic market, as the US markets corrected sharply in his first week. There has been much speculation as to what kind of Chair Powell would make. On one hand, he’s seen as Trump’s man and on the other, his stance seems to mirror Yellen’s.

On the surface, the US labour market is near full capacity yet, inflation is below the 2% target, and economic growth is picking up. All this, despite the Fed unwinding its balance sheet and raising interest rates. But all is not rosy. Although unemployment is low, wage growth is yet to pick up. This could be potentially disastrous if inflation spikes (through government spending) or interest rates are continuously raised. Higher rates would put more strain on borrowers. Rising inflation without wage growth would make people poorer. Considering this, Powell has opted to follow a cautious approach to raising interest rates and will stick to the earlier target of three rate hikes this year.

The intention of the $1.5 Trillion tax cut is to promote economic growth. The near-term impact on growth is higher than previously anticipated. When it comes to policy, every action has its associated cost. The tax break automatically lowers government revenues. Decreased revenue will translate into higher fiscal deficit. Expenses towards Medicare, Medicaid and Social Security will widen the deficit. Yellen previously highlighted America’s debt as an area of concern, and a wider deficit will only add to it. A more optimistic theory believes that the economic growth will offset the deficit.

So far, Powell has proved to be cautious and is sticking to the plan.

The rain gods will rule.

Everybody knows it. Almost nobody does it. ‘Buy low Sell high’ wasn’t meant for the theorists. It was meant for just about everybody, you and me. Yet, we didn’t get it right. Staring at a gold price of Rs. 25875, one can’t miss the irony. Most investments in gold happened around the top. It was ‘Buy high’ all the way. The ‘Buy High’ phenomenon only gets even worse when we study realty. Talking to investors at the market bottom in equity, one gets a sense that most investors aren’t really getting themselves to ‘Buy Low’. Why? Because, investors are actually trying to be superlative. ‘Buy Lowest Sell highest’ is what investors mostly pitch for. This pitch mostly fails because all investors do is wait until it is the wrong time. Masterly inaction at the lows is what most investors achieve. Another clear reason is that investors have obviously failed to understand that the best time to buy equity is when it is not even giving any returns. All this means is that the returns are waiting to be made. Surely, one can’t profit by waiting at that time.

 A beaten down stock market can only be a happy hunting ground.

Invest speak:

Investing in sunrise sectors has been a double edged experience for investors. Sunrise sectors provide the highest growth prospects on one hand and tend to also deliver the most investment failures. The reasons are predictable. High growth tends to give early believers multi bagger investments. This early evidence brings in more capital and this act as ready fuel for further growth. Capital is freely made available at very high valuations to companies in sunrise sectors. As the sector’s growth accelerates, valuations expand rapidly and capital tends to chase investment opportunities. This lead to a hyper active deal street and sky high valuations. At some point of time, growth slows or snaps. Inevitably, companies in sunrise sectors are ill-prepared to handle adversity as they have only prepared few good times. This leads to a collapse of companies as they run out of capital and doors tend to close on any effort to revive fortunes. Investment failure is almost preordained. Except the industry leadership, most players end up losing big money. The gold jewellery industry is the most recent example of this trend. Investors must set higher standards of excellence and look to buy at more modest valuation when they buy sunrise sectors.

Start placing bets on monsoon based themes. It will rain profits.

Bridge the faith deficit now

The Indian investor was once identified with conservatism and savvy. He would always buy when assets sold low. He stayed out of bubbles. Gold was bought in small parcels when prices were attractive. Fixed income was a steady part of his investment book. He ventured into realty only when he felt the prices weren’t over done. He bought quality equity steadily when they sold low. He rarely speculated. Call it the Eighties’ investing. Today’s investor is a bubble hunter. He wants to be where the action is. Repeatedly, the investor has allowed greed and hype to dominate the mind. Investing has repeatedly failed for this good reason. Today, the hype stands busted in gold & equity. Realty waits to be busted. There can be no better time to return to the basics. The mind has to dominate fear and panic today. Only then, it will dominate greed and hype some day in the future.

Investment conviction about a bright tomorrow has to come today. It doesn’t work any other way. 

Investors have increasingly turned bubble chasers. The results have only been too predictable as investors have lost heavily in stocks and gold. The outcome in realty will be no different. When investors lose in one bubble after another, how will they react? Will they shun investing in risk assets and stick to bank deposits? Given the low interest scenario emerging, it is not a bright idea in the long term. With high inflation, real returns can be generated only buying risk assets. The trouble is investors shy away from risk assets like stocks and gold when they sell cheap. Investors tend to further panic when these assets get cheaper. Buying cheap is the panacea to most ills of investing. When high quality stocks sell cheap, investors must buy and put them away. It is a great time to correct behavioural weaknesses in your investing. If you want to be an intelligent investor, you must begin somewhere. We think that it is a good time now.

Great valuations vs bad macros – a leap of faith is the need of the hour.


Buy the future

Quick edit:

Watching people shop for gold reminds one of how diabetics think at the sweet counter. They know that the buying may turn bad but can do little about their urges. Between the lure of the metal and shopaholism, they hardly can differentiate what drives them. The knowledge that they will face transaction losses when they exchange old for new is simply forgotten. The connect between global confidence in economies and gold prices is something most buyers are blissfully unaware. Importantly, most Indians are ignorant of the fact that buying gold is a way of voting against your own country’s economic prospects. If our economy does well, gold buyers will be the first to be punished when exchange rates rise and the rupee sees better times. Logic and the gold buyer are never fellow travellers. But, the gold buyer has his own arguments. These alibis are always ready just in case someone questions them. ‘I have a daughter.’ ‘if it goes down, it will not lose too much’. ‘how much can I lose?’ . ‘in the long term, nobody loses in gold ‘. The problem with all the alibis is that, the buyer is not playing to win. At best, he is playing not to lose. When one buys anything with the intent of not losing, the price at which you buy is the only thing that matters. If the price is wrong, nothing will go right.

Things always become obvious after the fact – Taleb.

Invest speak:

When a sector which the market thinks is very dependable turns shaky, the only answer that the market comes up with is sectoral rotation. The markets pay a premium for certainty and when doubts show up, the premium vanishes. The markets will constantly look for certainty from new sectors and the premiums will shift there. How does the market identify which sector is certain to deliver? This is where the macroeconomic indicators come into play. The top down investors always look for trends to spot reasonable certainty of performance from a sector. When they see reasonable certainty, they manage to buy at modest valuations. The macros improve over time and the certainty also gains ground. At this point, the rest of the market rotates their holdings and buys into certainty at higher valuations. When the macros improve from a bottom towards better times, this rotation is what helps the markets recovery. One after another, sectoral fortunes improve and draw market attention. In the next few quarters, we will see this play out.

It is buying the future that counts.

When Havens fall !

Free fall Friday it was. And, how? A day when safe havens crumbled like they never really were safe. Infosys, gold and silver as a threesome make for odd company. But, they send out a message which investors can ill afford to ignore. Safe havens are safe only at a price. If the price is stretched, then the elastic expansion will reverse at the slightest panic. The flight of capital out of safe havens is the story of 2013. We saw this coming and for a good reason. Investors were over paying for safety on the one hand and undervaluing risk on the other. Today, Risk looks cheaper than safety and far more attractive. It makes better sense to gradually step out and buy risk rather than hide in safety. That is a signal you must take note of.

Safe havens are also price sensitive. Safety is never a given.

Invest speak:

The markets have clearly been treating private players and PSU’s differently in recent years. Despite stable earnings, good dividend payout and decent business visibility, PSU’s have clearly lacked market recognition and trade at a substantial discount to private players. The prospect of disinvestment has also contributed to the weak valuations of PSU’s. PSU’s which once traded at premium valuations now trade at discount valuations when they announce an offer for sale. Investors must remember that PSU’s have been growing through the most difficult economic times, with very little equity dilution. The promoter selling stakes will increase liquidity temporarily. Once the markets absorb this liquidity, PSU stocks will reflect business fundamentals and prices will once again recover.

Risk looks attractive. Buy it judiciously.

Strategise & Structure

Quick edit:

A new high or a new low are not mere benchmarks. They are milestones around which investors reinvent their expectations. A new high catalyses over exuberance and breeds optimists by the dozens. A new low triggers more converts to the pessimists’ camp. Gold hit a 10 month low this week and global optimism around the metal are clearly ebbing. But, India has her own behavioural asymmetry when it comes to gold. Investors actually believe that one can never lose money in gold. They don’t calculate or compare returns from gold with the relatively risk free benchmark which is their overwhelming favorite – The Fixed Deposit.  But, they always bring up the comparison between the FD & equity. 2013 seems headed for significant under-performance by gold vis-a-vis the FD. Like the proverbial ostrich ,domestic investors have been buying gold  regardless of the price or its trending returns. The pain will sink in only when things get worse.  The more informed investors have lapped up huge volumes of structured gold products like ETF’s and are sitting on losses that may only widen. Unlike the fall in equity, the fall in gold will create wider pain.

                  The memory of people in the stock market is very short.

Invest speak:

In equity investing,ordinariness comes with good reason. Investing on the basis of past performance ends up with very ordinary outcomes.  Or, the outcome could be even worse. To make your investing out of the ordinary, you need to rise above the past and the present. Investing is all about the future. To bet on the future isn’t really easy. You need to read economic prospects right.When economies are in a phase of turbulence, it often becomes a leap of faith.Yet, that is what investors should learn to make. When will a leap of faith work? When valuations are modest, growth is returning and investment appetite runs low. The markets seem headed into such a phase. Being in the state of mind to make that leap is what investors must focus upon now. But, how can an investor translate his faith into actions? This bothers investors no end. Should it be a quantum leap or, will small increments work? That depends on your risk appetite. Lower risk appetite is best served by investing in small increments in a consistent manner.

         Time to put strategy above tactics and look at the long-term opportunity.  

Keep riding the cycle.

Quick edit:

Is India really a poor country? If so, how do we explain just one temple having gold and precious stones worth 250000 crores in its cellar. How do we explain Indian imports of gold worth 5 lakh crores plus in three years between 2010 and 2012 when the USA was reeling under sub-prime impact and Europe saw one Nation after another going bust with central banks firefighting all the time? Questions like these probably highlight what we call the great Indian paradox. We are a Nation with an impoverished mindset. We remained expediently frozen in the politics of poverty alleviation because we believed only these fetched votes. Bad economics was seen as good politics by an Individual and adopted by a coalition at the centre. A renowned economist presided over a coalition that perpetuated bad economics for a whole decade while the Nation patiently watched. At the same time, a few states ruled by the opposition have demonstrated visibly that good economics and good politics could tango together seamlessly. What India awaits is to see how the people will weigh the two ideologies and cast their vote in the next general election. Progress is a fail-safe political pitch vis-a-vis poverty alleviation and most Indians know it inside. Progress is also the answer to poverty alleviation. The markets will definitely jump the gun when it sees such a trend emerge.

Cycles always prevail eventually – Howard Marks.

Invest speak:

Economic variables tell us how our economy is progressing. Given the current state, we constantly look for reinforcing positive signals. For the moment, inflation and interest rates aren’t sending the right signals. They probably will test us for a while before they head lower. The visibly bright spot is in the current account deficit (CAD) has shown two successive months of narrowing. This essentially means that if we could follow up with a few more months of narrowing CAD, other variables will start looking up too. The CAD is a strong signal of where we are going. A falling CAD means that our imports are dropping & exports are growing. This should help the rupee which has been under tremendous pressure during the past 12 months. Oil prices are another variable that is very crucial for the CAD. Falling oil prices will greatly change the macro picture given that oil is our major import.  We see early signs of softer oil prices. When oil falls, we will be able to fix inflation and interest rates decisively. Exchange rates will simply reset to the new reality.

Beating the investment cycle happens only after you take a small beating. You go down only to emerge on top of the cycle.

Build your books now

Quick Edit:

If there was a virus that is hurting the Indian equity investor, we could probably call it Macroanalitis. Terms like fiscal deficit and current account deficit have become so commonplace that one wonders why people never thought about these numbers earlier. The big picture is so scary that it is blinding the investor from seeing anything else. India’s macro is bad. No two opinions on that. But, the stock market always moves ahead of the present and into the future. That brings up the critical questions. Can our macros get any worse? Should we secularly punish equities as an asset class? Most of us will agree that the worst will be behind us sooner than we expect. In fact, the savaging of parts of the market is throwing up investment bargains by the day. In the case of many structurally well managed mutual funds, there is a strong case of undervaluation. The odds clearly look like this. The limited downside in valuations clearly supports the idea of taking on risk. What investors need to understand is that risk must be taken on in a phased manner. By doing so, one can effectively overcome timing risk and  market risk  while taking advantage of opportunities thrown up by undervaluation of equities. The call an investor needs to take is whether he is going to make his portfolio efficient by buying cheap now or  wait for the markets to get more efficient and pay a hefty price for it.

There is no such thing called an efficient market. There are only efficient investors.

Invest speak:

Contrarian investing is a much discussed subject. We all know that buying when there is blood on the street is the way to wealth. But, blindly buying when there is blood on the street could also leave you holding onto a dying animal. The risk on corporate governance is very material to the success of contrarian investing. When greedy promoters leverage their company, their promoter capital and everything they have to build their market capitalization, the risk they create increases geometrically. It is like a cascade of risk. When the promoter reaches a dead end, the show collapses. We call it the `Hyderabad blues’ after seeing several Hyderabad based companies follow this pattern of operating. The show stopper was of course Satyam. This brings us to the question of what goes wrong in these companies? One, leverage kills when it doesn’t create returns to support it. Two, excess leverage inevitably turns your business operations into a hedge fund. Three, leverage on the company, the promoter and the market capitalization will inevitably lead to the collapse of all three. The success of one company in India in protecting all three over the past three decades by following this model is possibly a product of the times they operated. Those times are over. Which is why we find many companies following the same model of governance simply sinking without a trace. Investors are left fuming, angry and despondent when they become victims of such companies. But, what you need to learn is to avoid such companies at any price. At times, the blood on the street maybe that of a dying animal that cant be revived. Some birds simply cannot take flight again.

Time to build your investment book with a longer investment horizon.