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The Shot Heard Around the World

Jan 23, 2017

“That was no presidential speech; that was a veritable declaration of war.” – Handelsblatt, German Media

“Has there ever been a new U.S. administration that began by spreading unease, not expectations, throughout the world?” – Japanese Media

“The Trump administration will be igniting many ‘fires’ around the world. Let’s wait and see when it will be China’s turn.” – Chinese Media


A Dark & Gloomy Inauguration

Change minus the hope. Throw out the old play book on globalism, populism, capitalism and free trade. New rules are here.

Acceptance speeches are normally a time of platitudes, graciousness, hope, and optimism. President Trump was dark, gloomy yet determined as he launched a scathing attack, portraying the American middle class as a “victim” of international partners (read China, Japan, South Asia) and vowing to make America great again. Threatening in tone. Cold and calculating in logic. Change minus the hope. Here were some choice quotes:

  • “It is the right of all nations to put their interests first.”
  • “We made other countries rich while our wealth was dissipated.”
  • “Buy America, Hire America.”
  • “Radical Islam will be eradicated.”
  • “We will build roads, tunnels, bridges and infrastructure…create jobs…make America great again”

Trump’s track record

Trump succeeded in real estate by being a hard negotiator. In 1989, on the verge of bankruptcy, he managed to renegotiate a sweet deal with bankers. His efforts to redevelop Atlantic City in the vision of Vegas were unsuccessful. Only by exploiting the weakness of his banking partners did Mr. Trump avoid bankruptcy and emerge stronger.

Strength In Marketing & Negotiations

Mr. Trump’s strength appears to be marketing and negotiation. He successfully used his image and brand to promote preconstruction developments around the world. Did Mr. Trump actually manufacture anything and does he understand manufacturing? No. Did Mr. Trump build anything? Not really. Most of the projects were owned by the developers that subcontracted the work.

Global Trade On Notice

Mr. Trump appears to believe he can bully his way through the world economy, and the rest of the world will bow down to his tough negotiating tactics. If so, trade wars lie ahead. As Ludwig Mises warned, protectionism is a form of war.

Protectionism also forces the U.S. consumer to buy goods at higher prices. So we will see how that works out. Further, we would expect inflation to rise in the U.S. Yet again, a burden will be placed on the U.S. consumer.

Interesting times indeed.

A Study on Sectoral Impacts to Performance in India Markets

From time to time, we review portfolio strategy and update studies. We have spent a fair amount of time focusing on asset allocation and bottom up equities. We have clearly been remiss in not devoting adequate attention to sectoral strategy.

We seek to answer the following key questions:

  • How important has sectoral allocation been to returns since 2010?
  • How good are signals on sectoral allocation?
  • What are the implications for portfolio management?

Let us begin by taking a look at relative returns within sectors in India since 2010. We use the NSE sectoral indices for our data.

Private Banks Vs PSUs

The private bank growth story versus the PSU bank value story was a key sectoral decision. Fund managers are mesmerised by the value proposition of PSU banks. We have been very clear on our positioning, which is private bank growth stocks all the way.’

Private banks have returned 16.1% CAGR since 2010, or 183.8%. In contrast, PSUs returned -1.8% CAGR or -12% during the same period. So even if you had gotten your asset allocation call right during 2012 and 2014, if you had chosen PSU banks, you are sitting on a dismal return.

Private Banks Delivered a 16.1% CAGR Since 2010
While PSU Banks Delivered a Negative Return


Investing in Infrastructure Was Another Losing Sectoral Bet While FMCG Continued to Shine…


Infrastructure Vs Consumption (FMCG)

Another key decision that popped up time and again over the past few years was whether to invest in infrastructure stocks.

Investing in infrastructure delivered a negative return since 2010 of -4% CAGR, whereas FMCG delivered 16.1% CAGR.

Commodities & Metals Vs. Autos

Doubtless many investors were exposed to Commodities and Metals, particularly in 2014 where a false breakout occurred. Again, owning the value creator rather than the commodity supplier made sense. Leaving the fundamentals aside, the Metals index delivered a -8% CAGR, or down 45% absolute, while Autos rocked the return, delivering 16.3% CAGR or 188% absolute return.

Despite the Recent Rally in Metals and Sell-off in Autos, Autos Have Outperformed Dramatically


Export Focused Versus Domestic Growth

Another key call that faced fund managers was allocation to IT and Pharma versus domestic growth sectors. While Pharma lived up to expectations and delivered a respectable 15.5% CAGR, IT did not, delivering a below expectations return of 8.5%.

Investors Would Have Been Better Off Avoiding IT


Finally, MNCs Trounced Public Sector Entities


Realty Returns Were Painful

Realty returned -14.9% CAGR. Many investors bullish on Realty suffered.

MNCs Verus Public Sector Entities

The final example we would put forth would be MNCs versus PSEs and here, MNCs trounced PSEs by a large margin.

Key Observations

1. As clearly evidenced, there is a wide dispersion in sectoral returns, which has direct implications on performance.

2. Given the staggered timing of sector activity, tactical sectoral allocations can generate strong alpha for portfolio managers.

3. Sectoral positioning can also aid in enhancing bottom up stock selection returns by focusing on strong sectoral trends.

4. A diversification strategy or closet index strategy will generate inferior returns to a competent sectoral allocation model.

How Good Were Our Signals on Sectoral Allocation?

Surprisingly good. We will publish data on our sectoral allocation signals separately in coming days. What we can say with conviction is that sectoral calls are alpha generators and being in the right sector is akin to riding a boat with the wind behind your sails.

Sectoral Review for 2016

Our sector models in early 2016 were long Autos, Banks, Energy, Financial Services, FMCG, Media, Private Banks, Commodities, PSEs and MNCs. The model was negative on IT, Pharma and Infra. In the summer, the model generated buy signals on Metals, PSU banks and CPSEs.

Current Sectoral Model Over / Under Weights

Today, the model points to long Autos, Energy, Metals, CPSEs, Financials and underweight FMCG, IT, Media, Pharma, Consumption, Infra, Realty and MNCs.

Fixed Income

The critical question that comes forth is whether a 6.5% yield and a 1-2% real yield is an appropriate rate of return for a long term investor? We think the relative attractiveness of equities versus bonds is unquestionable over longer periods and equities are relatively attractive today. This is what our relative valuation models are suggesting. The gap in attractiveness is at lows, favouring equities.


Generally the end to a rate cut cycle is marked by visible signs of a pickup in growth. An argument could be made that signs of growth were emerging pre-demonetisation. Post demonetisation, however, with the rapid decline in manufacturing and services, it is difficult to make the case that the RBI is done with rate easing. On the other hand, the Governor took a surprisingly hawkish tone in the previous RBI policy meet, flagging global financial risks and inflation as concerns. With inflation continuing to be subdued, we are hard pressed to see aggressive easing given the RBI’s current stance. Rising rates in the U.S. and a hawkish Fed suggest further unlikelihood of an aggressive RBI. A revision to this stance would be likely only in the event of a negative surprise to growth in the domestic economy or the U.S. Our base case is a resumption of growth for the domestic economy and we are not of the opinion that there is a pressing need for rate cuts at this time. That being said, the RBI does have the room to manoeuvre with benign inflation trends.


One of the benefits of demonetisation is that transmission has finally begun to take place in earnest. A decline in interest rates will bring down the cost of capital for corporates and bodes well for corporate bonds and accrual strategies.


Domestic inflation remains benign, despite the rise in global commodity prices, the strong dollar, rising U.S. interest rates. Demonetisation makes it likely that the RBI’s target of 5% inflation in March’17 could be met with a good monsoon and expected slowdown in consumption. Were the economy to recover sharply in the second half, there would be a risk of an uptick in inflation.


The infusion of fresh deposits in banking system (post demonetisation) is likely to shore up demand for G-Secs by banks, which augurs well for bond prices. However, the narrowing of the rate differential is likely to keep the foreign investor on the sidelines. Marginal sources of domestic demand are also unlikely to be active participants. If the local growth shock from demonetisation appears deeper than expected, or if the Trump plan disappoints, markets may revert to a dovish interpretation leading to a rally in bonds. On the other hand, an aggressive step away from the fiscal deficit target or other surprises in the Budget could provide downward pressure on prices.


To summarise, we view relatively more reliable returns from accrual and yield to be safer and more attractive relative to duration strategies playing for a possibility of a last leg down on interest rates. We have always been content to not be greedy and go for the last 10% of a move, preferring a migration strategy at these times that shifts allocations as market conditions dictate.

Investors would do well to lock in instruments that offer relatively attractive higher yields today. Our preferred strategy remains accrual funds, a portfolio of select corporate bonds and / or income funds, select AT-1 bond portfolio. For investors interested in participating in duration, a dynamic bond strategy makes sense, particularly if the portfolio manager has displayed a track record of navigating volatile rate environments successfully. AT-1 bonds remain attractive, but it is essential that investors have a competent advisor to manage the selection of the portfolio.

Union Budget: Watershed Event?

A Basic Income Scheme for Rural India

Rural India has been hit particularly badly by demonetisation. We think Mr. Jaitley’s first order of business is addressing the pain of the poor, especially in light of approaching elections in U.P. and other states. The big idea here appears to be a universal basic income scheme or a more focused approach for the vulnerable segments. What hinders the universal basic income idea is the impact on the fiscal deficit. So we would look for a targeted scheme through digital delivery to people with no sources of income. The government has a decent idea of who the poor are through the census. The idea is gaining traction in developed economies and could be the shot in the arm the Modi government needs to ensure the continued commitment of the poor to their cause.

Infra Spending & Stimulus

Corporate India is desperately looking for an infra push. The trend we highlighted last year in our mid-year outlook, decongesting metros, is something that we would look for the government to address in its roads and highways budget.

Middle Class Tax Sop

The middle class has borne pain via demonetisation, a rise in service tax and the slowdown in the economy. We would look for a restructuring of the tax slabs with an eye to increasing the number of people in the tax rolls but making the tax structure fairer so that those in the middle class pay taxes, but pay a lower tax rate while the wealthy pay the lion’s share at the higher tax rates.

Job Creation

Although the government has undertaken reforms on an accelerated mode, little on the ground success appears visible. With half of the term over, and upcoming elections in key states, we would look to the government to give fiscal priority to job creation.

Senior Citizens Exemption Limit Increase

With the decline in interest rates, fixed income investors, particularly retirees are suffering. We would expect an increase in the exemption limit of Rs 3 lakhs for senior citizens.

A Fillip to Business and Consumer Sentiment

The onus is on the government to revive the sentiment and restore confidence through fiscal measures like tax concessions, keeping a higher fiscal deficit and spending to spur growth. Earlier, in the Union budget 2015, the government had indicated to cut taxes by 5% over four years in gradual manner. This year, the government might use the opportunity to cut corporate taxes by 2 to 3% to perk up corporate sentiment.

For investments, we would look for continued incentives for first time investors in financial markets. From an economic perspective, there is near unanimity today that the government needs to step up investments. Investors are calling for a pro-growth budget, an aggressive stance on raising the fiscal deficit or deferring the glide path, and a reduction in personal income tax rates as well as corporate tax rates.

Card Payments & Digital Infrastructure

In continuation of the demonetisation scheme, we expect F.M. Jaitley to include emphasis on digital payments infrastructure and initiatives to spur investments in digital infrastructure, incentives to move to digital and programs to spread awareness on digital transfer methods.

Relief for Export Oriented Sectors

Anti-dumping duties levied on imports to defend the domestic industry in the last year are set to expire over next two to three quarters. Also, industry bodies are seeking to address issues related to inverted duty structure (this structure impacts domestic industry as manufacturers have to pay a higher price for raw materials in terms of duty, while the finished product lands at lower duty and costs lesser). We would look for the upcoming budget to provide relief for export oriented sectors like textiles, chemicals, pharmaceuticals, steels, ceramic tiles etc.


The Next Step for Corporate India

A few announcements last week, by Cadila Healthcare, Zydus and Motherson Sumi, demonstrate the way forward for many of India’s emerging companies, and that is global acquisitions that will open up developed markets and expand opportunities. We think this highlights the rising significance of India as a market for global players and the recognition that Indian companies are now emerging on the global stage.

Protectionism Is the New Worry Markets Must Fight

If the markets needed a mood dampener to quell the animal spirits, Mr. Trump delivered it with his speech. The spectre of protectionism and trade wars will now loom over investors during the coming weeks and months.

We would submit that the U.S. is uncompetitive today because of its bloated insurance, legal, and medical costs. No country can survive $66 million lawsuit awards for a spilled cup of hot coffee on a woman’s knees. Mr. Trump’s bullying will succeed for a while, but in the long run will hurt more than help.

The good news for India is that we are a 70% domestic focused economy and alternative trading partners will emerge if Mr. Trump decides to go protectionist. India’s exports are a market share grab, except IT.

Early Take on Earnings for Q4 CY2016

Leaving aside the stinker from Axis Bank, private banks, housing finance and NBFCs – via Can Fin Homes, Muthoot Finance, Canara Bank, RBL Bank, IndusInd Bank, YesBank among others – have delivered surprisingly decent numbers. Our conviction remains strong. Mindtree confirmed weakness in IT.

Early indications are that the earnings season will not be as disappointing as has been feared. Clarity will emerge as we move forward, but we are heartened with some of the initial good reports.

MidCaps are the Top Performing Cap Class Since 2010, Delivering 202.8% since 2010


MidCaps Have Been Outperforming the Nifty 50 During the Modi Regime


A Tilt Back to MidCaps with Stability from Large Caps

While we hardly needed more data to confirm our bias, our study confirms that midcaps have delivered a 10.6% CAGR, while the Nifty 50 has underperformed bonds with a meagre return of 6.6%. Small caps delivered an equally lacklustre return of 8.6% a year since 2010.

Our favoured long term capitalisation remains midcaps, with a healthy dose of large caps to provide stability. Adding small caps to investor portfolios should be considered purely on a bottom up basis if necessary.

Technical Strategy

It was a range bound week for the Nifty while the broader market witnessed action, except for the latter part of the session on Friday when selling was seen in overall market to close at 8349 levels down by 0.61% for the week. The rally from late December 2016 low of 7908 is now facing resistance at 8460 levels; which is the 50% retracement of the decline from high of 8969 in September 2016 to recent low of 7908 level.

The index failed to move beyond the previous week’s high of 8461 and has formed a bearish shooting star candlestick pattern for the week at a resistance level. Momentum indicators have also turned from overbought levels on daily chart suggesting market is likely to see correction in the near term. FIIs turned positive in the cash segment to the tune of Rs 630 crores (provisional) on a weekly basis after five weeks of selling. In the derivative segment some selling was seen in index futures and call writing on the last trading session.

The Nifty options open interest put/call ratio touched high of 1.27 level, which is the higher end of the range and was last seen when September 2016 high was made. Also India VIX which a measure of volatility and has negative correlation to Nifty is turning up from 11 week lows. Highest open interest for Nifty Call option is at 8400 strike along with fresh addition of open interest on Friday suggesting market has overhead resistance. Going forward Nifty is likely to see correction in the near term with immediate support for the market seen at 8322 and then 8244 levels. On the upside index has resistance zone of 8400-8460 levels, sustaining above it on tradable basis it may touch 8560-8615 levels.