Musings & Happy Diwali

Before coming back to issues on the economy or the markets I just thought that I would write on an exciting tour I did over four days of the last weekendwhere we spent this time in doing a Tiger Safari in two of India’s national parts, namely Kanha and Pench. We stayed in the safari camps of Taj Safaris which had excellent arrangements and that enhanced the tour experience. It was really a great experience doing Safaris in open Jeeps inside the Jungle after getting up at 5 AM in the mornings. Given that it was just after the monsoons and the rains this year were very good the Jungles were extremely green with thick bushes and green trees all around. The experience of seeing a Tiger walking in the wild in front of you and on Elephant backs, seeing it getting ready for a kill in the Jungle is totally different from seeing wild animals in the Zoo where they are not as confident and secure. There was also no TV, no cell phone networks etc. which also made it doubly enjoyable.

The results season has more or less come to an end now and the results on an overall basis have been better than my expectations. Most companies have been able to control costs and pass on cost pressures to the consumers and have thus either protected or improved margins. For a large number of companies the operating leverage has played out well with strong volume growth also helping in spread fixed costs. The signals coming out of the corporate sector also seems to be quite positive for the medium to long term growth.

We have seen a large number of companies now reaching a situation of full capacity utilization or facing a scenario where they need to expand capacities for meeting future growth. This augurs well for the Capex cycle which has already started to pick up and should gain steam over the next couple of years. The only difficulty that large Greenfield projects are facing today is with regards to land acquisition and environmental clearances which can create real issues for large projects in the metals and power sectors. The capacity addition plans in these sectors could get deferred in case these issues are not resolved fast. The other bright spot of highways and road development also seems to be facing issues with regards to award of projects due to conflicts in views between different ministries and the planning commission.

The consumption cycle seems to be holding on well and should play out strongly in the future also given the strong hiring cycle and increasing salary increments. The only constraining feature here could be the stubbornly high inflation which has refused to come down despite a good monsoon and stable oil prices. The extremely loose monetary policy globally is feeding in as speculation into a large number of commodities where the phenomenon that we are seeing is that in whichever commodity there is any risk of a shortage the speculative elements build up extremely fast and lead to sharp price hikes. Today we are seeing that some commodities like Rubber, Sugar, and Cotton etc. are at multiyear or all time highs. The reason for this is not purely demand supply mismatches but the easy availability of low (NO) cost money courtesy Western central bankers. This has made the task of Emerging market central bankers extremely tough. RBI still is better placed as we do not have current account surpluses. For the countries that have such surpluses the risks are not only economic disruptions due to extremely high capital flows but also a likely spike in inflation due to commodity price spikes.

The USD carry trade has continued unabated with the promise of the US Fed to keep on printing more and more money. The risk to this strategy is the long term credibility of the Fed as well as the US Government that has constantly maintained a stance of favoring a strong Dollar. A constant weakness of the reserve currency of the world and the decline at the pace at which it has happened is disconcerting to say the least. That said, all things taken into account the USD looks extremely oversold and has become even more so over the last four weeks. As I have maintained earlier a reversal or correction is imminent for that currency and as that happens we could see sharp selloffs in the short run in commodities and equities.

RBIs credit policy did not have much surprises and as expected they have hit on the real estate sector where a bubble like situation had started to build up specially with the start of the pay only 5% now and rest on possession specially in Mumbai where prices have reached 2007 highs in some places and exceeded them in some others. With the number of luxury apartments being constructed in Mumbai the buyers at the rates at which they are selling will need to be imported from somewhere outside. I believe that RBIs measures are strong enough to cause some correction in high end housing. This can also create issues for some banks with higher real estate exposure.

Microfinance Institutions have finally been taken to task. The kind of mindboggling profits being made by these companies was not sustainable in any case and was mainly due to loose regulation for that sector. With the credit of the sector at Rs 18000 crores and annual profits being reported by the established companies in the sector at spreads of nearly 10% regulatory moves were imminent. If these companies have NPAs as low as below 1% then there is no way that such spreads should exist. Smaller loans are supposed to have higher costs associated with them and higher NPA’s. However if that is not the situation then profits should not be more than 5% of disbursements for the sector i.e. Rs 900 crores per annum at the current disbursement levels and not around Rs 2000 crores plus that exists today. I believe that PSU banks should float their own MFI companies to take advantage of the money to be made at the bottom of the pyramid. With their branch networks in rural areas and local knowledge they will be able to provide better social upliftment.

The domestic participation in the markets from retail investors continues to be limited with investors still in the pullout mode from both equities and mutual funds. The retail investors are in effect losing out on what I believe will be the strongest bull market that India as seen in history. As I wrote in a previous article I continue to maintain that we will see Sensex at a level of 100,000 before this decade is out i.e. by 2020.

The data on the flows into emerging market equity funds has slowed down in the last week. We need to see if the flows slow or this was an aberration in the week prior to the US Fed decision on money printing and incase the promise is to print huge amounts of dollars then flows can again pick up.

The issues with regards to the Sovereign debt crisis of the PIGS countries in Europe have gone to the sidelines with the rising Euro and buoyant stock markets. However the news flow does not indicate any improvement in these issues. Ireland has huge banking NPA issues and Portugal is facing deadlock in budget talks. Spain real estate and unemployment is still a big concern and Greek CDS spreads have been again moving up over the last few days. Countries like France have been seeing huge street protest on austerity and reform measures. As bud
get deficits get cut next year we will see more such protests across a large number of countries.

The good point is that the health of the corporate sector continues to be strong with positive results coming out across the board. This makes the downside on corrections limited to 10-15% and any such correction should provide strong entry opportunities for people on the sidelines. I continue to believe that the range breakout of the markets above the 18000 level of the Sensex and the 5400 level of the Nifty are regions of strong support on any corrective move and those will be the levels to watch out for buying into the markets.

Wishing all readers a happy Diwali and happy investing for the future, which looks extremely bright for India.