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Alpha Edge, November 2016 - Black belted

Indian markets hit turbulence with two ground breaking news recently. One was of partial demonetization announced by Prime Minister Narendra Modi to rein in black money, which in our opinion is one of the boldest move by the current government and showcases the clear intent of the government towards bettering the economy. The second news that rattled the markets was of Donald Trump winning the US elections defying the polls that clearly gave Hillary Clinton the lead before US went in to voting. With the new developments, going forward we expect the volatility to continue or even rise warranting market participants to be on their toes. 

Globally, last month, markets around the world ended the month in negative due to rising anxiety w.r.t. the US presidential elections and perceived shits in global central bank policies and generally rising inflation expectations. With economist world over questioning efficacy of the recent monetary policies it seems like the central bankers too are re thinking their strategies. Last month we saw a change of tone from ECB. And in a surprising move Bank of England and Bank of Japan chose to hold their interest rates steady. In totality it will be tough months ahead globally as markets brace for US presidential, higher interest rates given the probability of a Fed rate hike in December is increasing, add to that the reducing intensity of rate cuts going forward.

Back home, we saw mixed numbers as IIP was still in negative territory although latest manufacturing PMI and service sector output strengthened. We did see rate cut by RBI at the beginning of the month. Rate cuts have become more of a sentiment booster rather than anything else. We have seen 150 bps of rate cut until now since Jan 2015 with fundamentals barely showing improvements. Another gauge of demand in the country is the credit growth to industrial sector which is still low showing excess capacities and unwillingness of private sector to take loans for expansion until demand picks up and current capacities are fully utilized. W.r.t. Q2 FY17earnings we have seen few companies come out with their results and many beating estimates. IT and banks has so far disappointed. Unlike the expectations with respect to the NPA issue of banks the worst doesn’t seem to be over. Overall volume growth is still lacking and now with commodity prices recovering, margins may again get squeezed warranting a growth in topline to drive bottom line.

 

With the new demonetization decision taken by the government we expect chaos to follow for some time before things fall into place. In the meantime, this development could hit consumption, especially rural consumption, given the large part of the transactions are cash based. This could mean further delay in the earnings recovery that we were hoping contributed by revival in rural consumption given good monsoons after two years. However, kudos to the government for taking such a bold move and Belting black money where it hits the most.      

 

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Alpha Edge, October 2016 - Better be quick..!

As we end the September quarter, both, the equity and bond markets continue to be resilient and trading near to all time highs. Even though we experienced high volatility thanks to the multiple events be it the Fed meeting or the Geo political uncertainty faced towards the end of the month, we saw markets coming out unscathed and move higher. However, any temptation to be complacent could be challenged by forth coming events we see ahead, not least being the US presidential elections or the Fed meeting post that.

Globally, as we enter the eighth year of recovery after financial crisis, growth seems sluggish in most of the corners compared to pre-crisis levels, add to that, the political uncertainty that we have witnessed lately. We live in a world where the answer to every problem is loose monetary policy. There are $13 trillion worth of bonds floating promising negative returns if held till maturity. This has the potential to disrupt traditional business models which encourage savings or investment and question the solvency of the same. The latest case being the Deutsche bank which is trading at 10% of the value which was assigned during pre 2008 crisis . The slump in the market cap of Deutsche bank reflects the impact of negative interest rate policies. Saving the economy by killing the financial system does not sound like a prudent solution. Does it?

Coming back home, growth still eludes us. We saw poor IIP numbers coupled with lower than expected inflation numbers which built an expectation of an RBI rate cut and the mint fresh Governor obliged. Markets have been resilient in the face of lot of uncertainties lying ahead. It seems to have gobbled up every single good news and kept bad news at bay. Liquidity seems to be fighting away all concerns on the ground, but for how long? Yes, India is one of the most stable countries thanks to its reliance on domestic consumption and a comfortable current account. We have seen progress w.r.t. new policy announcements like the GST bill or the bankruptcy code, which would lead India in the right direction and improve ease of doing business. India’s growth story still remains from medium to long term. However the stretched valuations currently shows how the future growth that may come due to GST, 7th Pay commission, government spending and cuts in interest rates has been priced today. The concern currently is the lack of private spending which shows there is still lack of demand. Hence, what the markets going forward would like to see is performance of India Inc., especially uptick in volumes.

The situation we currently see is one of asymmetric risk. In this case we believe that if everything turns out well the upside potential is limited; if the outcome is negative, then the downside risk is greater. In such situations with no large positives to look forward to, it is better for investors to look at tactical allocation by taking some money off risky assets and keep their strategic allocation aside until such time passes. The positives of India being the only alternative is gaining ground nudging the valuations into a bubble territory. Unless of course, corporate results start to go through the roof too. They better be quick!

 

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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, 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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Liquef-action : Alpha Edge – April 2016

I wish you all a better financial year of FY 17. I sincerely hope that the subdued expectations all around has room for positive surprises due to the many small things which are falling in place.

Our key calls for the markets in FY 17 are:

1. A range bound equity market at best.
2. Long short /Absolute return seeking strategies will continue to outperform relative return strategies
3. Muted returns from duration play on Fixed Income
4. Higher Gold prices in rupee terms
5. Stagnant residential real estate prices
6. An increase in commercial rental yields
7. Stronger dollar and weaker EM currencies
8. Stagnant to lower commodity prices

We hope that we are way off the mark on all the above counts and that can only mean that

1. Global demand has revived even despite its current low probability
2. Domestic earnings revival is led by rural demand and the 7th pay commission effect and outweigh the possible slack on the exports side of the economy
3. Inflation collapses and / or Government meets with its fiscal deficits leading to higher bond prices.
4. Personal savings revive enough to bring forth household leverage, that’s required to revive the demand for real estate.

Our Model Equity portfolio, Growth Opportunities Portfolio has managed to safeguard the principal since inception while outperforming the benchmark by ~9.33% since 1st January 2015. In December 2015 quarter stocks in the Growth Opportunities Portfolio on an average delivered ~20% earnings growth vis-à-vis -12% of BSE500 index. Going forward, under stable market conditions we expect the portfolio to continue its outperformance given the higher earnings growth differential.

Request you to pass it on whosever can benefit from it.


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