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Alpha Edge, September 2016 - This time is different...?

Another month with markets in a quandary over valuations of Indian markets seem to end. The month saw Equity markets continuing their uptrend with Nifty ending 1.7 percent higher for the month. FII’s pumped in almost $1.6 billion in the Indian markets for the month thanks to the freely available cash across the world.  

The world is struggling with reviving the growth and at the same time getting addicted to the steroid called credit while eagerly awaiting for what is called as the helicopter money. The worrying fact is that all of this has failed to produce the desired results and could lead into a liquidity trap, even as broad based markets are touching new highs and shrugging the bad news. Now with Fed stating that they are closer to resuming the hikes again, it could lead to a rationalizing of the overpriced markets around the world and we may see ‘flight to safety’ back in the game.

Despite the Modi euphoria two years back, the economic growth that we have witnessed can be best described as chugging along. This, despite several initiatives taken by the government. Although macro-economic factors are in a better shape as compared to 2-3 years back, the growth witnessed has been much slower than what was anticipated. The economy has been a witness to what we would call a two-speed recovery: Where consumption has done well, but investment has not. Public expenditure alone can only do so much to revive the economy. However, for the recovery to become more sustainable, the growth balance needs to shift more in favour of investment, mostly private investments.

Indian markets have been far from immune to the massive flows of liquidity coming from FII’s, thanks to the unconventional policies worldwide. Nifty is now within kissing distance of its all-time high as we come close to the end of a stretched earnings season. Nifty companies’ earnings (45 companies that have declared results) have fallen by 3 percent with a revenue growth of 4 percent. Markets entered the June quarter earnings season with higher earnings expectations, as the March results indicated hopes of recovery. However that doesn’t seem to be the case. We have seen Nifty touching new recent highs alongside downward revision in earnings estimate. This tells us that gap is widening between the prices and the fundamentals. There still are few positives to look forward to viz. effect of good monsoons resulting in higher rural demand, further increase in urban demand thanks to seventh pay commission and passing of the GST bill in the upper house and expectations of reduction in interest rates. The Indian market has largely discounted all the positive benefits well before the actual events (GST implementation and lower inflation leading to interest rate cuts). The current estimates of earnings growth is around 17 percent, which could only mean that we may see further earnings downgrade as markets come to terms with the reality.

In our opinion, the gap between reality (earnings) and perception (valuations) is eye popping, where the only game in town is to follow liquidity. SIPs are anecdotally pumping in around 4000 crs every month, mostly going into mid-cap funds. No wonder the Mid & Small cap index is above 50 PE and going strong. FIIs continue to pump in billions by the month. Justifying the moolah as world is staring at negative yields abroad with no low growth, whereas India is still yielding 7% while growing at 7.10%. Never mind the flattish EPS growth which Buffet always side will determine the prices eventually. We have no arguments with the market inching up relentlessly, just old fashioned worry enough, to step aside soon. We don’t think that it will be different this time.. because it never is !

 

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Alpha Edge, September 2016 - This time is different...?

Another month with markets in a quandary over valuations of Indian markets seem to end. The month saw Equity markets continuing their uptrend with Nifty ending 1.7 percent higher for the month. FII’s pumped in almost $1.6 billion in the Indian markets for the month thanks to the freely available cash across the world.  

The world is struggling with reviving the growth and at the same time getting addicted to the steroid called credit while eagerly awaiting for what is called as the helicopter money. The worrying fact is that all of this has failed to produce the desired results and could lead into a liquidity trap, even as broad based markets are touching new highs and shrugging the bad news. Now with Fed stating that they are closer to resuming the hikes again, it could lead to a rationalizing of the overpriced markets around the world and we may see ‘flight to safety’ back in the game.

Despite the Modi euphoria two years back, the economic growth that we have witnessed can be best described as chugging along. This, despite several initiatives taken by the government. Although macro-economic factors are in a better shape as compared to 2-3 years back, the growth witnessed has been much slower than what was anticipated. The economy has been a witness to what we would call a two-speed recovery: Where consumption has done well, but investment has not. Public expenditure alone can only do so much to revive the economy. However, for the recovery to become more sustainable, the growth balance needs to shift more in favour of investment, mostly private investments.

Indian markets have been far from immune to the massive flows of liquidity coming from FII’s, thanks to the unconventional policies worldwide. Nifty is now within kissing distance of its all-time high as we come close to the end of a stretched earnings season. Nifty companies’ earnings (45 companies that have declared results) have fallen by 3 percent with a revenue growth of 4 percent. Markets entered the June quarter earnings season with higher earnings expectations, as the March results indicated hopes of recovery. However that doesn’t seem to be the case. We have seen Nifty touching new recent highs alongside downward revision in earnings estimate. This tells us that gap is widening between the prices and the fundamentals. There still are few positives to look forward to viz. effect of good monsoons resulting in higher rural demand, further increase in urban demand thanks to seventh pay commission and passing of the GST bill in the upper house and expectations of reduction in interest rates. The Indian market has largely discounted all the positive benefits well before the actual events (GST implementation and lower inflation leading to interest rate cuts). The current estimates of earnings growth is around 17 percent, which could only mean that we may see further earnings downgrade as markets come to terms with the reality.

In our opinion, the gap between reality (earnings) and perception (valuations) is eye popping, where the only game in town is to follow liquidity. SIPs are anecdotally pumping in around 4000 crs every month, mostly going into mid-cap funds. No wonder the Mid & Small cap index is above 50 PE and going strong. FIIs continue to pump in billions by the month. Justifying the moolah as world is staring at negative yields abroad with no low growth, whereas India is still yielding 7% while growing at 7.10%. Never mind the flattish EPS growth which Buffet always side will determine the prices eventually. We have no arguments with the market inching up relentlessly, just old fashioned worry enough, to step aside soon. We don’t think that it will be different this time.. because it never is !

 

Click here to read the report

Alpha Edge, August 2016 - Mind the gap

We took longer than usual to collect our thoughts for this month’s edition. We wanted to write about GST that was to roll-out and it did. Analyze its impact which we have, making us take a slightly skeptical view of the timing and nature of immediate benefits. They are likely to be inflationary to begin with and delayed by more than a year from now. .

 

July was led by high optimism with Nifty ending higher by another 4.2%. Post the Brexit vote markets have bounced back surprisingly sharply contrary to the view that it would rattle world markets. Once again bad news became good news with market participants anticipating Central Bank intervention which ECB and Japan gladly obliged. This obviously benefitted markets across the world, especially the EM’s. A part of this came to India with FIIs pumping $1.5 billion into equities & more than $1 billion in debt. US Fed has once again maintained a hold on rates but a guided change which markets believe may not happen owing to the US elections scheduled in November.

 

From a domestic stand point, the recent rally has been based on three themes - recovery in corporate earnings, normal monsoon rains and passing of Goods and Services Tax (GST) bill. The latest earnings season is a mixed bag with significant & clear turnaround signs being not yet visible. Even though we are witnessing QoQ growth, the quality of it is uninspiring. The likes of other income & and lower costs, which are one time benefits saving many a case, while the more critical sustainable factors like volume and revenue growth are visibly tepid for now. Many results including PSU banks that are still struggling and marred by NPA’s may not change the total picture. Market is currently pricing an optimistic 17% growth built into the valuations which we think will be revised downwards, leading to de-rating of markets that may follow. Time & price correction ahead.

 

The highlight for now that remains the highly inspiring matter is the way the Modi government engaged the stiff opposition and saw the constitutional amendment through, w.r.t GST. With this, the pace of reform may finally gain momentum for which Modi Government was voted. While the GST implementation is a given, the timing of rollout may take about three more quarters and its benefits, some more time. Largely due to the herculean task of technology infrastructure that needs to be ironed out, center-state arrangements to be finalized & a host of implementation procedures that need to fall in place. All this is worth the benefits that await ONE unified market called India, for a long time to come.

 

The monsoon season kicked in a bit late but have made up for the delay. This could help in rural demand picking up which has been lacking for the last two years. However the benefits of a good monsoon and the 7th pay commission would kick in with a delay. Especially, rural households are expected to set their houses & finances in order first before a consumption binge.

 

Overall things seem to be improving for the economy in parts, however the heady days of all round growth of 2003 to 2007 is some time away. We are skeptical of the market mis reading the timing of this and pricing way ahead of time. Our market timing models are about to indicate a high degree of caution like in March 2015. Were those conditions to fully fructify, you can expect a mid –month flash informing you of the same. 

 

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Alpha Edge, July 2016 - Something's gotta give

June was once again a roller coaster of a month for equity markets with two key events - US fed meeting and Brexit. The Fed meeting was as expected - a non-event.  Fed played the wait and watch policy influenced by the Brexit vote that was yet to happen. On June 24 we saw a historic moment, when for the first time in six decades a country voted to opt out of the EU. And the result was a ‘Redemption day’ where the world pressed the panic mode as the result of the vote was stunning and unexpected. However a near six sigma event fizzled out in its severity as world markets started anticipating a continuation of a soft central bank policy. This is one reason why markets brushed aside a critical event to rally as if nothing had happened. This dependency on central bank’s support may be dangerous as is by each episode of monetary easing that is leading to diminishing results, soon to approach zero impact. But that day may be sometime away.

 

Moving to the macro-economic picture, a big global red flag is a China slowdown and what-if they depreciate their currency massively. As a manufacturing hub to the world, they have done a lot in the last eight years to compensate for the near lack of perceptible growth momentum to the world it was serving. Their choice of tools have caused credit to explode to unproductive assets, making interest servicing difficult to those who borrowed. As a sideshow this created bubbles in real estate and then in stock markets. Sensing trouble, global investors are pulling out of China in a big way. If China recovery is delayed further, China may be forced to devalue and probably by a big quantum. Asian currencies as a result can turn volatile and upset many equations. Especially if it coincides with the 25 billion dollar FCNR outflow from India around September.

 

Back home we saw disappointing IIP numbers and a delayed start to the monsoon which recently picked up, bridging the rainfall deficit gap considerably. On another note, Mr. Rajan’s decision to not opt for a second term set alarm bells ringing. Strangely, the markets quickly brushed aside the doubts about continuity of the big monetary battles of taming inflation & cleaning up of the NPA problems of banks and rallied hard. Going forward all eyes would be on the monsoon session of the parliament where the expectations would be of passage of the GST bill. Earnings wise, Q4 of FY16 saw much better numbers signaling a recovery, but the numbers would whittle down if banks & Oil refiners were taken in to account. News papers` headlines conveyed a selective picture. We do feel that the trends are signaling for earnings recovery this year. Our concern is that it may not be broad based. Recovery could be limited to few sectors aided by Consumer-led themes continuing to drive earnings on the back of the Seventh Pay Commission payouts and possibly good monsoons. These two are the pillars of all hopes of a continued rally in markets.

 

 We believe something’s going to give in soon. Either broad based earnings have to pick up - evidence yet to surface, or stock prices correct reasonably – recent counter intuitive rally has us scratching our heads, or interest rates fall in India – which we doubt will be significant for another quarter or so, despite global rates scraping the bottom. In light of this, we strongly recommend fund strategies with flexibility to move across, both in Equity & Debt. Until one of the three gives in, focusing on absolute returns than beating the markets, is a desired virtue, in a world where economic theory is being turned upside down, negative interests rates et al.,

 

 

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Alpha Edge June, 2016 - The guessing game

Dear Investor,

 

The markets have almost gone up 17% from Feb lows and in the last three months we have seen a spectacular rally in equities. This is the time when equities are back to new ‘recent’ highs and so are the analysts with their prediction of a ‘new bull run on its way’ and even higher targets. But given the scenario, it requires a brave soul to completely believe that. Even though the domestic economy seems to be recovering slowly, markets are expected to follow global cues in the short term, as foreign institutional investors with deep pockets play a major role in the markets here, and they take their cues from the global economy which is weak at the moment. This, leads us to the question ‘whether this rally will sustain’?

June is the month of two key global events taking over and a lot of confusion along with it. Brexit & Fed rate hike. Brexit is one animal that the markets have not been able to figure out, but consensus believes that if it happens it would result in a much higher volatility as compared to status quo. Going by the general opinion polls, it seems like a close contest with voters slightly leaning towards a Brexit. With regards to Fed, the general tone has become more aggressive towards a rate hike, with probabilities of a rate hike as early as June increasing. However, the markets don’t seem to be factoring a rate hike based on the data points trickling in. Hence, an actual rate hike may temporarily unsettle the markets globally. Whereas, we believe, the situation for Fed is all the more complicated thanks to global events like Brexit, China slowdown and Brazil, which is suffering from one of the deepest economic recession in a long time along with an extremely difficult political situation. With many reasons for concern about the global economy and with likely US domestic uncertainty ahead of the U.S. presidential election, one has to ask, what is the Fed’s rush to hike interest rates now?  

Back home we saw ‘cheer’ in terms of the GDP numbers that came in at 7.9% for Q4FY16. The data, however, seems to be inconsistent with few high frequency indicators like the IIP, which was barely positive in Q1. Our concerns about the quality of the numbers continue. Concerns over measurement aside, momentum does seem to be improving and combined with recent legislative gains in the recent state elections, provide reassurance that the economy is headed in the right direction. A normal monsoon, which seems to be a certainty, would be the major game changer for the economy which is suffering from aftermath of two consecutive drought season.

As far as the latest earnings are concerned, we have seen better numbers this quarter compared to previous quarters led primarily by margin expansion. More companies have beaten estimates, but that is also a function of low expectations for the quarter. The numbers look much better minus banks which are marred by NPA issues and affected by higher recognition of bad loans. These days, good news seems to travel faster in to prices. Recent headlines such as ‘worst over for earnings’, ‘good monsoon’, ‘global commodity prices reviving’, rate hike fears abating etc. have quickly percolated into valuations which once again indicate that such good news has been discounted. Hence, based on valuations we are little cautious for shorter term and believe there is less probability of valuations expanding from here, unless we see more good news specially in terms of earnings surprising on the upside. It would be prudent to invest in a staggered manner in equities until people play ‘The guessing game’ on Brexit, Fed rate hike or earnings recovery.

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