Are we in a structural bull market?

Reference : “Market at New high… What Next?” – October 30, 2013

In our earlier blog we clearly mentioned that there is huge upside to the market. We also believed that at every higher level consensus in the market will emerge. As we speak we all have started believing that “Ache Din Aane Wale Hain!!!”. That cheerful sentiment can be felt in the market as well.

In the middle of the gloom and doom in August 2013, we all debated endlessly about the political future of India. Market was hesitant too in taking decisive position before elections. We all debated whether once again we may end up with a fractured mandate at the centre. 

On February 14, 2014 things started turning around. Market started moving up in anticipation of a strong mandate. Out of favour stocks and sectors started outperforming broader markets. In just a few months the Sensex moved from 20000 to 24000 before election results. May 16, 2014 onwards which was election result day clearly took the market into a different orbit.

It’s common sense that someone investing today cannot benefit from yesterday’s move. Lot of good things have already got factored into the price by then. The market cap of India is already up from 60 Lac crores to 90 Lac crores which is a 50% growth in investor wealth in a matter of months. This explosive move in the market was because of very high level of underinvestment and lot of pessimism.

A strong consensus is building that we will start seeing improvement in growth rate and fundamentals. This, the experts say, will help us get high valuations and profits for corporates. In short consensus on the street is that we are in a structural bull market but we have a very different take on the subject.

In our opinion a few basic things are required to start a structural bull market – low inflation, low interest rate, high liquidity and low confidence. We are far off from low inflation and low interest rates. Currently we are seeing some level of comfortable liquidity because of strong dollar flows. Confidence has gone up but was at rock bottom a few months back which created a backdrop for strong rise in equities.

If this is not a structural bull market then what next? How will asset classes fare in this new environment?

Equities – In our opinion lot of good news is in the price. We have seen people aggressively allocating money to equities which indicates that risk perception is reducing amongst people at large. Retail participation in daily volume on both the exchanges have gone up and we are also expecting large supply of equities hitting the market and taking advantage of this bullish sentiment.  In this new reality we can only see flattish market or gradual upward or downward move in the immediate term. Market will wait for inflation and interest rates to fall to create a strong structural base. In short we believe we may face an extremely stock specific market with broader indices trading in a tight range.

The risk to this thesis is that world liquidity can get into Indian markets and create an equity market bubble.

Debt – In our opinion a lot of bad news is in price. People at large are worried about the inflation scenario. Participants are exiting long term debt funds and today it is the most hated asset class. As per our observation all inflation levers are cooling off. People are highly invested at the short end of maturity while long duration market is extremely light. This is the perfect scenario for investors to get a huge upside.

The risk to this thesis is that if global liquidity gets into the Indian market it’ll create an inflationary environment as the RBI will strongly intervene to keep currency at 60.

To summarize most of us are extremely conservative on debt side by owning short end of maturity and extremely aggressive on equities by investing in high beta trade. We would urge investors to just flip the trade.

Market at New High… What Next?

Reference : “Market Preparing Itself To Scale New High” - December 10, 2012

From December 2012 till date market has made multiple attempts to make new high in the midst of very negative news flows. As we speak we have crossed 21000 on Sensex after a lot of toil, frustration and disbelief.

There were two big black swan events in the market which spooked sentiment on the street. First was the sharp depreciation in rupee and second the reversal of interest rate cycle. In Budget Blog we clearly mentioned about risk on both fronts. After both these events we started believing that the worst is in the price and market will move upward. We are extremely happy with our investors behavior who believed in us and stayed the course against common wisdom.

Now the big question in all our minds is what next? We would like to share our perspective on the market…

1.       Valuations – in our opinion market is extremely cheap. Earnings have not grown in the last 5 years due to currency fluctuation, commodity price fluctuation and government policy interventions. Most of the companies have been resilient in this market and mindfully allocating capital. In every fall weak companies tend to lose competitive advantage and business shifts to stronger players. This will help some of the stronger companies to take advantage of up cycle where earnings tend to grow faster than economic growth because of better utilization of capacity.  Foreign investors have clearly recognised this opportunity and invested heavily in the market at the cost of domestic investors who have largely stayed out.

2.       Sentiment – on this front we have hit rock bottom. Majority of domestic investors are in denial about the recent rise and are highly underinvested in equities. In the last 5 years of savings in India a major bulk has gone to real assets like gold and real estate with the allocation to equities having been reduced dramatically. In any asset class when it is hated the most, it ends up giving a big move. In our opinion equities at new high will make people at large look at it and create more consensus towards it.  

3.       Technical – smart investors have made big investments in the market. With all the bad news we have witnessed huge selling across the board which is getting absorbed by such investors. Once selling becomes light, market will find it easy to move upwards. Market has consolidated beautifully over the last 6 years. On every incremental good news market will start making higher top and higher bottom. Also conviction amongst people will increase and participation will increase.

4.       Long term story – in the bull market of 2003-2007, we all believed that equity is the best asset class to beat inflation and in the long term equities tend to outperform all  asset classes. This theory still remains valid but the general belief in it has vanished. From 1978 to 2013 markets have multiplied 210 times inspite of multiple elections, wars, natural calamities, bad governance, etc. The next 30 years will definitely be better than the last 30 because of the rising aspirations of every Indian. There is no better way to play this story other than equities.

We would request all of you to look at your allocation and correct your underweight position on equities.

Finally I would like share this video with you… Did you know - 

http://www.youtube.com/watch?v=YmwwrGV_aiE

Debt Crisis

In continuations to our earlier blog – “Converting Structural problem into cyclical problem” (March – 2013)

As we speak MF Industry is under tremendous pressure with its position in debt market. We have built our largest book of more than 1 Lac crores in long bonds. Our exposure to corporate debt is highest in recent past. Markets have become illiquid with yield spikes. Yield curve has shifted upward by more than 100 BPS on long duration and more than 200 BPS on short duration. Yield curve is once again inverting. Ominous signs for economy. We are staring at sharp decline in economic activity.

It was a black swan event triggered by RBI move to make money expensive in this country. We have been running real interest rate negative for last 3 years. This has built huge speculative activity. People are leveraging and buying house, Gold and spending as value of money is sharply declining. At the same time people at large are speculating in currency, commodities and Bonds. After a long time Reserve Bank has come forward and made real interest rate positive.

Effect of Positive real interest rate

•  Cost of money will go up
•  Will provide incentive to saver and hence capital formation in this country
•  Speculative activities will come down
• It will also channelize money in more productive investments. It may have big impact on residential real estate. Demand may come off sharply.

Our Recommendations

• Investors will have to digest extreme volatility in the market
• Stay away from funds investing in private corporates specially in shorter durations (Accrual Product). Sharp decline in economic activity will increase demand for money by corporates to manage working capital cycle.

We would advise clients to create buckets for different time frame investments and invest in very high quality assets.

Time Frame	Product
Less than one year	Arbitrage Funds / Liquid & Liquid Plus
One Year to 2.5 Years	Bank Debt Funds. Industry at large is expected to launch Bank CD FMP this will create huge demand for Bank CD’s. We would advise clients to build position in advance. Money is expected to move out of short term and duration products. Which will reduce demand for corporate paper at the same time working capital will ensure supply of corporate papers.
More than 2.5 Years	Long term Gilt Funds. This is most liquid part of the market. Idle for FII’s to move in and move out. Crisis in debt market will ensure that more and more people will move towards Bank FD’s. Due to scare of NPA’s banks will find more comfortable to invest in G-Sec. Yield curve is inverted and may remain for some time.

Warning

1.      Avoid Short term funds

2.      Be cautious of underlying securities in debt funds

3.      Avoid Accrual products

4.      Match your investment horizon with very safe and liquid asset class

5.      Smart investors always tend to prefer higher quality asset

We would urge investors to show lot of calm and open mind to new ideas.

Budget 2013

Converting Structural problem into cyclical Problem

In the last 3 years we have seen a tight monetary policy and loose fiscal policy. In the last 3-4 months of fiscal 2012-13 we have seen that the government has tightened its belt on fiscal side by curtailing expenditure and reducing subsidies. In Budget 2013 the government is trying to move in the same direction. This will result in a very tight fiscal policy if they are able to achieve 4.80% fiscal deficit. We would like to put our thoughts on various key concerns for the economy –

1.      Inflation –

As per RBI & IMF estimate, WPI for March 2014 is targeted at 7.0% to 7.20%. We would like to go with that estimate as we think reducing subsidy in oil will increase inflation. Also high current account deficit will put pressure on rupee and eventually keep inflation slightly elevated in the 7.0% range.

2.      Interest Rates –

In our opinion we don’t expect a sharp fall in borrowing cost for fiscal 2013 -14 as RBI will be more worried about current account deficit and currency. We expect a cut of around 50 BPS to 75 BPS for the fiscal. Also RBI will find it difficult to transmit cut in interest rate into the real economy.

3.      GDP Growth –

As per CSO estimate and budget estimate GDP is expected to be at 6.10% to 6.70%. Our house view is that in a period of fiscal consolidation it is challenging to spur growth. In our opinion we may undershoot growth numbers for the fiscal.

4.      CAD –

Current Account Deficit (CAD) is at a historical high and may remain at an elevated level due to a very high import bill. Gold imports may come down due to lackluster price movement and fall in investment demand of gold. High CAD will keep currency vulnerable and volatile.

5.      Fiscal Deficit –

The government is focusing on controlling fiscal deficit at 4.80% of GDP level. There are certain moving parts in this budget. For example spectrum auction and disinvestment together are expected to garner almost 90000 Crores. This may be difficult to achieve. Also revenue growth of around 18% may be difficult if growth decelerates. But there is certain flexibility in planned expenditure which can be curtailed to achieve a 4.80% fiscal deficit.

Asset Market View

1.      Equity Market –

In a period of reasonably high inflation and low growth – high quality stocks that can protect margin will outperform. We would advise clients to stick to high quality stocks in this period. In the next 2-3 quarters we expect cyclical slowdown and deep cyclical stocks may disappoint investors. This will make strong bottom for these stocks. We would advise our clients to finally look at these stocks in the next 2-3 quarters and start loading them up in their portfolios.

2.      Debt Market –

Currently we have an inverted yield curve. Short term rates are in the range of 9% plus and long term rates are at 8%. In our opinion yield curve will start flattening out after April. We would advise our clients to split their debt book between short term and long term bond funds.

(Imp – In the entire hypothesis commodity prices including OIL can act as beta. Any fall in OIL & commodity prices can change the whole equation)

Market preparing itself to scale New High

Reference – “Investor’s Delight” on December 12, 2011

From December 12, 2011 to date it’s been a rewarding year for equity investors who have remained patient. The broader indices have delivered double digit returns during this time with most of the high quality businesses delivering returns in excess of 25%. FII’s  were net buyers to the extent of 1 Lac crore plus whereas domestic investors were net sellers and clearly showed lack of faith in the Indian equity market. As we speak we are just 7% away from a new high in NIFTY. The markets have also consolidated in the last few years where most of the weak hands have now been replaced by stronger ones.

Since the high of January 2008, FII’s have invested close to 2.75 Lac crores whereas MF’s have been net negative to the extent of 34000 crores. We have also seen sector rotation where high cash flow generating businesses have made new highs while leveraged businesses have touched new lows. As on January 2008 Reliance Industries and ITC were valued at 4.57 Lac crores and 73000 crores respectively. The same in today’s date stands at 2.66 Lac crores and 2.36 Lac crores.

With every bull market phenomenon we are seeing new leadership in the markets. Consumer, Pharma, Cement, Private Sector Banks and Media & Entertainment are the sectors showing this new leadership. The markets made a low on December 20^th, 2011 and have since been climbing a wall of worry. There were no significant positive news flows between December  2011 to August 2012. In this period of gloom and doom the FII’s were consistently absorbing supply made available by domestic investor’s redemption and we've come to a point where after the reforms announcement in September 2012 the market is gearing for some momentum.

There is a classic difference in return expectations of FII’s and domestic investors. The returns available in developed markets are very low and hence they’re making a beeline to buy Indian businesses which offer better growth. This is in contrast to domestic investors who have made decent returns in gold and real estate in last many years. Their expectation from equities are bench-marked to returns from such alternative asset class. We expect this mismatch to continue and will force domestic investors to sell equities to FII’s.

In our view we may be just 7% from a new high but the journey till then will not be smooth. We are anticipating large domestic selling which means that volatility may increase once we get close to the new high. This is the time for the investors to correct the skewed asset allocation in fixed assets like gold, real estate and fixed deposits. Our allocation to equities has been negative for the last 5 years and its time we take a fresh look at the asset allocation and correct underweight and overweight positions. This will help us to participate in Indian equities if market scales new high. 

Growth Dynamics

We are hearing constant news and views on growth trajectory of Indian Economy. We at JAIN INVESTMENT strongly believe that there is no strong correlation between growth and equity return. One of the best example is INDIA & CHINA. In last decade China has grown at the rate of 10-11% and India has grown at 7-8%. Index return of India in last decade is 13.29% CAGR and China is -4.14%. Following table depicts GDP of India & Index return in last 30 years.

Year	GDP in $ Billion	Growth in GDP	Sensex Return
1980	189.6
1985	236.6	4.53%	18.25%
1990	326.6	6.66%	23.43%
1995	366.6	2.34%	38.03%
2000	474.7	5.30%	4.95%
2005	834.2	11.94%	5.68%
2010	1684.3	15.09%	21.46%
30 Years	7.55%		18.11%

Investing for Dividend Yield

“Sales is Vanity, Profit is Sanity & cash is Reality” – Anonymous


The quote above has been a backdrop of the dividend yield theme. Investing for dividends is a philosophy in itself. Lot of us believe that to make money in stock markets one should invest in great businesses with equally great management. The rationale behind great management is prudent use of capital. We all focus on profits and growth in profits of a company while very little time is spent on finding how much cash is generated out of profits and what the end use of this cash is.


Let’s take Nestle India as a case in point. It is in existence since many decades in India and is one of the most innovative companies in terms of product launches and has a near dominant position across product ranges. Nestle has been the most prudent user of capital for many decades. In the last 10 years they have grown sales from 1900 crores to 7500 crores at a CAGR of 16.15%. PAT has grown from 200 Crores to 960 crores at a CAGR of 19%. In the last 10 financial years it has made a total after tax profit of 4700 crores. Nestle has paid 3200 crores as dividend which is about 68% of their total profit of 4700 crores. Nestle shareholders have been rewarded handsomely by getting 64% of  their capital back in the form of dividends while the stock price has multiplied from Rs. 520 in 2002 to CMP of Rs. 4500.


We can find great businesses with great management around various sectors in India like Auto, Auto Ancillary, Chemicals, Engineering, Consumption and Banking. The mindset of most of the investors in India in the era 1975 to 1990 was to constantly invest in businesses which made prudent use of capital and gave regular dividend to investors. Dividend yield was a powerful concept way back then because capital was scarcely available.


In the year 1991 when the doors to liberalization were opened for foreign capital and competition capital became available more easily. The focus then shifted from prudent use of capital to rapid growth by using financial leverage. As the cost of capital started decreasing companies started showing higher ROCE (Return on capital employed) along with rapid expansion in profit. As India moved to 8% plus GDP growth the focus of investors too shifted from dividend paying companies to high growth companies.


In the year 2010 as the cycle started turning again, the cost of capital started increasing and capital became scarcer. Focus shifted back to cash flow generating business and in the last two years we have seen re-rating in all the cash flow generating businesses with high quality management.


Mutual funds in India started launching dividend yield funds way back in 2003. They didn’t get enough recognition from 2003 – 2007 where capital cost was going down and GDP was witnessing rapid growth. Since 2008 the dividend yield theme started getting focus wherein such funds have delivered positive returns since the peak of 2008 whereas for the same period the index is down by more than 25%.


As we speak the dollar has depreciated by more than 25% in last one year. This will have an inflationary impact with the result that the cost of capital may go up sharply. In this high inflationary environment dividend yield stocks will benefit most because of their healthy balance sheet, good management and gradual easing off of competitive pressures. For investors who have been in the market for a long time and have tracked management and businesses closely they will have the necessary know-how to cherry pick such stocks. For beginners or novice investors Dividend Yield Funds offer a good investment vehicle to participate in high quality cash flow generating business. 

Performance as on May 29, 2012
	Compound Annualized
Scheme Name	1 Year	2 Years	3 Years	5 Years
BNP Paribas Dividend Yield Fund - Growth	-3.02	3.51	15.02	8.71
Indices
S&P Nifty	-8.81	-0.76	3.90	3.05