Why, What, When, If

Why are some Emerging Markets underperforming – in the current year till date we have seen developed markets do better than EM’s in general. The reasons have been signs of recovery in the economies of these countries, extremely low interest rates and the huge under ownership of equity that has built up over the last few years. It was my view that we will see the US and German markets move to all time highs and then other major EM’s will also follow. What also works in favour of EM’s going forward in contrast to what happened post November 2010 at which time huge money printing by the US FED had started in a big way is that the incremental impact of money printing on commodity prices has moderated and also the fact that inflation is in control in most EM’s and is moderating in countries like India where it was a big problem over the last two years. Secondly growth outlook has also bottomed and a recovery cycle is imminent. As such although we have seen poor performance from countries like India YTD, the way forward is much more positive where we should now see a cycle of EM outperformance start again. That is not to say that DM’s will not do well, they will also perform but not outperform.
When do I watch business channels – Normally never? The only time one gets value out of watching these is when you have people who have their own views speaking and those who make rules, monetary policy, fiscal policy etc. Ex of that the opinions given by most other does not matter at all. The views that are given are generally the consensus of that time and in the direction of the trend. For example, how many people did you see on TV advising you not to invest in gold till a year back, even now finding such people might be difficult. However as the trend is clearly established on the downside, maybe a year from now everyone will be advising exit out of gold but by that time prices might be down a further 20%. The only time that I watch business channels is when people like Draghi, Bernanke, Warren Buffet or the likes are speaking as in these cases the thought is original and they are in turn thought makers. The main problem of some of the in your face anchors is that they only want to listen to what they want and are rarely interested in other peoples thoughts. The worst thing for investors is the technical analysts who given advise on trading on 1, 2, 3% kind of moves. Is that what investment is all about?
Over the last few days specifically there have been two instances where if you were watching TV to form a view you would have thought that the world is going to come to an end after the Italian elections and also the US Sequestration. The truth was that these were opportunities created in the bull market. The fact is that no country of the Euro zone can afford to walk out, especially a country like Italy where the Debt: GDP is over 125%, there is no growth and unemployment is very high. A Euro exit and back to the Lira will lead to a collapse in the currency, runaway inflation and very high interest rates. This will lead to further economic stress and eventual bankruptcy. In my view the forced spending cuts were the best thing to happen to the US. How does anyone know that the cuts that the politicians finally agree to are the best ones? These cuts will veer towards pleasing their vote banks in most circumstances. As such forced and moderate fiscal adjustment is not bad at all.
What people should have watched is was the press conference of Mario Draghi after the monetary policy meeting today where clear thoughts were put out and questions were addressed frankly and to the best of his assessment. There was no politics and no hiding behind rhetoric. What came out was that the worst is clearly over, credit conditions are improving significantly, the ECB’s balance sheet is coming down very sharply and that creates an opportunity for the ECB to come in if the crisis rears its head again. Although Euro Zone growth outlook will continue to be moderate for some time to come the worst of the crisis is now behind us. The sharp decline in the value of the Euro versus the USD in the recent past will also act as a stimulus for the zone. However given that the policy rats in Euro zone are higher and the money printing is much lower to contracting the probability that the Euro will rally is much higher. This is generally positive for risk assets.
Will growth recover faster than expected in India – This in my view is a high possibility given the fact that we are likely to see moderating inflation, lower interest rates, some investment revival and a pickup in government spending going forward. In the current financial year the government of India increased spending by just around Rs 100,000 Cr. In FY 14 spending is projected to rise by Rs 2, 40,000 Cr. This spending increase combined with a controlled Fiscal Deficit situation will lead to a very rapid recovery in all probability. The key is to watch RBI action and also the impact of improving investment sentiment driven by government policies as well as the Investment Allowance provision in the budget that increase the Return on Capital invested for new projects substantially.
In the current financial year growth got dragged by all three segments of services, manufacturing and agriculture. Monsoons this year are projected to be normal by all global watchers due to absence of El Nino, which was not the case last year where Agri production got impacted badly. Incrementally all three segments of the economy should improve going forward.
If commodity prices remain subdued – Incremental reduction of money printing and an improving economic outlook will be two pulls on commodity prices this year. Commodity prices have remained elevated despite poor demand outlook over the last two years due to huge investments by hedge funds and commodity funds. As ultra low interest rates no longer remain over the next two years these huge positions might not be sustainable. On the other hand improving economic outlook will lead to better physical demand. Which side will win is the important thing to take a view on. Today we see that the demand/supply position in Crude oil is in favour of prices coming down; however rampant speculation has kept prices at high levels. Like we have seen in the case of gold, prices can be kept high due to financial investments for prolonged periods of time but not indefinitely. Similarly we see huge accumulation of stocks of cotton by China (equal to one year’s consumption), rice in Thailand (more than one year’s export), Rubber by SE countries (equal to several months consumption) etc. A lot of agri commodities saw a spike last year due to drought conditions in lot of areas of the world. If this does not repeat we should see a moderation in global agri commodity prices. Usually as money chases performance, the higher returns of commodity funds attracted investors in droves over the last few years. Incrementally as equity does better we should also see a shift. As such the overall inflation pressures due to high global commodities should moderate over the coming year.
Why were people so critical of the budget – The two most common headlines that I saw on the commentaries on the budget were “A Missed Opportunity” and “Not a game changer”. Well, what was the budget supposed to do; create a V shaped recovery? Except for the fact that the budget did not have any concrete ideas on increasing financial sector savings rest of it is clearly growth oriented. The immediate reaction of the stock markets should not be used by people to take a view on the Budget; however this is what normally happens as comments like “Thumbs down”, “uninspiring” etc play on the minds of people giving views. If the government in some way can inspire industry to invest again by removing bottlenecks and leaning on the RBI to bring interest rates down we clearly have a good game on hand.
If inflation differential could explain currency movements – A prominent theory being propounded these days is that the INR should be much weaker due to inflation differentials built over a period of years. The fact is that it is growth outlook that drives currency movements over long periods of time. If inflation differential argument worked then all EM currencies would always be depreciating against the USD as the inflation in EM’s is consistently higher than that in the US. Poor perception of the economy leads to depreciation and a positive outlook to appreciation.
MARKETS

Indian stocks seem to have started a recovery after the severe beating over the last two months. The damage to the broader market has been severe which is not reflected in the performance of the benchmark indices. SMALL & MID cap stocks are now the cheapest since the year 2002. Investors who now take bold calls on companies from this category will do very well over the next couple of years. It is not a few stocks but a huge universe of stocks that can be bought from this category of companies. Investors can take their pick from the companies and managements they are comfortable with. However these kinds of valuations and this kind of value might not repeat for a very long period of time going forward. This does not mean that these stocks are going to run away. The apathy is so severe that the markets will give enough time to accumulate. My view on the index for this year remains at 15-18% rise; however I am much more bullish on Midcaps given the abnormal valuation gap that exists today. 

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