Celebrate the Journey – Stop worrying about the potholes on the way!
“In economics things take longer to happen than you think they will, and then they will happen faster than you thought they could, and they go much further than you thought they could” – RudigerDonibusch
Today in India, everything starts and ends with NarendraModi. Yes, he is the right man, at a right time, in the right place. If that’s what we believe, taking a bigger picture of what can happen to our country over next 3 to 5 years or let’s say even bigger picture over next 5 to15 years is better than getting stuck in a daily chorus like -will RBI cut interest rate this quarter or next? Will parliament pass the reform bills during this session or next? What is in a store for Union Budget? Will labour and other Big Bang reforms come now or later? The list and debate is endless.
We all know that governance and its outcomes are a continuing long term process. It cannot be achieved in artificial time slices. Even a company cannot be built in a day or months. It takes years or even decades of hard work and dedication for one to build companies that lasts. We also know that while one can earn some money in stock market by daily trading but wealth can be created only by investing for medium to long term. Similarly, it will be prudent for us to see “Stock India” from that perspective. We believe that the Modi government is doing a fine job, making very encouraging type of comments, policy directions and bringing about an overall qualitative change. With more and more states going BJP way, one will find greater homogeneity in terms of continuity and uniformity at both state and center level. Expect better deliveries and hard actions in coming months and quarters to take us to higher growth trajectory. It’s a beginning of new era for India. Invest from that perspective. Invest in “Stock India” from 3 to 5 years perspective.
We at Quest,cannot predict the short term movements in the stock market. It depends on so many extraneous factors beyond our control like geo-political environment, state of global economy, oil and commodity prices, deflation in Japan and Europe, slower growth in China, etc. Also, it is even difficult to predict a lot of factors which are nearer to our home like inflation, interest rates, trade and budget deficits, FII inflows, etc. on a short term basis.
While there is every possibility that markets can correct and consolidate for a bit – given the extent and duration of the current up-move, but the outlook for Indian financial markets over the coming few years remains very exciting
Everything going for India – India’s time has come:
For the last few years, there had been absolutely no interest in India. The picture could not have been more different this time. But, there is genuine interest and excitement around India once more. Everyone has rediscovered India’s growth potential, and it is once again a secular story to buy and hold.
This excitement is understandable. India is one of the best performing equity market in the world – year to date (Market cap of over USD 1.5 trillion), up about 28 percent in dollar terms. It has also outperformed the emerging-markets benchmark by about 32 per cent. In a world of secular stagnation, deflation and limited earnings growth, India is moving to a different beat. We are a large domestically driven economy, with growth accelerating, inflation and interest rates falling and corporate profitability below its mean – poised to improve. India also has very little exposure to a possible China debt bust or a collapse of the Yen. Both these issues are weighing down most of the other large emerging markets, whether the North Asian countries or Brazil or South Africa.
Modi working with 2 to 3 years perspective
The first eight months of Modihave been about goodwill garnering. He has done it in ample measure inside the country and on foreign land. He has proven himself to be a pragmatic leader. Unfortunately, he inherited an economy that was in doldrums due to mismanagement by predecessors. Over the last 7 to 8 months, the government has unveiled a sting of measures including lifting of state controls on pricing of diesel, plans to put up coal mines for bidding, a signature initiative ‘Make in India’ to turn India into a manufacturing powerhouse, remove bureaucratic sloth and to make the country more investor friendly and aid it’s economic recovery. Upto 100 per cent FDI in many areas of Railways have been allowed, from 26 per cent to 49 per cent in Insurance and Defence and FDI in the construction sector have been eased. Quite often simultaneous incremental changes can become transformative.
According to Mr. Modi – “For the first six months, we were focused to make India healthy; a person who is unhealthy cannot derive benefits from exercise. The ‘exercise’ would begin now”.
It is for the first time in the history of Indian government, Modi has been asking his ministers to perform with highest level of honesty and professionalism. The new Cabinet seems to have about half a dozen competent ministers who are manning critical areas. Modi’s style is such that he possibly doesn’t need more than half a dozen efficient ministers in critical areas of governance. By and large, the highly centralised PMO continues to play a pivotal role in all major decisions whether it is deciding on the gas price, diesel price decontrol, signing of WTO agreements, crucial defence purchases and so on.
A look at the allocation of portfolios to 26 cabinet ministers clearly indicates that Modi has broadly classified his colleagues into two categories. The first group comprises those he considers to be performers, to whom he has assigned important ministries like Finance, Commerce & Industry, Power, Railways, Defence, Home and Foreign Affairs. The Second are those he has inducted to correct regional political and social (caste & community) balances. The ministers in the latter category have been given Lalbatti (red beacon) cars, a chamber, a bungalow, personal staff and letterhead to give them the impression of importance, but they don’t really have any effective work to perform.
Inflation and interest rates
Global disinflation has finally caught up with India’s high-cost economy. Global commodity prices have fallen and fallen sharply. The exchange rates of commodity-producing countries are still weakening. And these are usually a reliable predictor of commodity prices, which are down 50 per cent since end-June. Conversely, a sustained rise in value of US dollar would continue to depress commodity prices. The carnage may be far from over. The fall in inflation will be sharper in coming months, as imported inflation has significantly moderated with oil prices declining and rupee remaining stable.
India might witness even faster disinflation if global energy prices continues to slide. Almost a 50% fall in crude price, iron ore and most commodities is biggest economic event of the year.
Global liquidityand India Image
With the world economy on a wobbly footing again – Japan receding into recession, a stalled Europe and China slowing down – India could find itself in a sweet spot. In the absence of an instant boost to global demand, we could see even greater easing by Japan, China and Europe and prompt the US Fed to postpone its own rate rise. Investors are now convinced a dogged fight against deflation is under way around the globe.
As RBI GovernerRaghuramRajan puts it – “A few months ago, the biggest external risk was capital flows, now I see growth as the biggest external risk”
The more important than the global flows is the domestic investor base. After selling in an uninterrupted manner for more than five years, domestic institutions have now received inflows of more than $1 billion a month (for the last four months). I would not be surprised to see annual inflows of $15 billion from domestic investors over the coming years. This is very important as it makes our markets far less dependent on foreigners, and also provides an offset to any selling which might be driven by global shocks. While India is over-owned among its traditional investor base, there are many high potential new global and domestic investors who are underexposed and their sustained flow will continue to support our Indian market.
What can go wrong?
Modi – a one man show
Apart from risks of threat to his life, there is a risk of “flood of promises and a drought of action”. Prime Minister Modi has yet to show some concrete results. The extraordinary interest in the foreign policy, his fascination for technology, his ever-growing appeal within the middle-class and the feeling that India has found a leader who will take the country to a greater height are all reminiscent of the heady days that marked the beginning of Rajiv Gandhi’s tenure and his appointment as India’s “Mr Clean”. Alas, we judged him too early. The point here is this: eight months is a very short period for assessing a PM. Modi has been extremely lucky. However, progress so far has been modest.
However, on the face of it, it looks that Modi has the right intentions, integrity and ideas to fulfill his promise of ‘Achhe Din’.
While it is too early to read into the actions of few ministers/MPs of BJP/RSS regarding the agenda of ‘Saffronisation of India’ or ‘Hindu Rashtra’, let us not forget the demise of a highly acclaimed VP Singh government which was due to MandalCommision debacle. Unless Mr. Modi steps in very fast, this could unnerve both domestic and foreign investors.
Taking control of the situation, RSS chief has already advised its cadre, not to create hurdle for the Modi government that deflects his attention from the goal of good governance.
Euro-zone and Japan are slipping back into recession and China’s slowdown continues. US economy is no-where close to trend-line growth. After Japan’s QE, markets expect Euro-zone to follow suit. QE always weakens the currency. We might see potential currency wars by various countries in order to boost exports. These are best avoided for the sake of global stability. The other worrisome factor being, even after six years of 2008 crash, so many countries continue to opt for QE, which tells us that their economies are still not in good shape. However, we are in the midst of a risk-on trade and in the near term, it is likely to continue, given the fresh rounds of liquidity infusions from different countries. The risk-off trade may come sometime in next 2 years.The big ‘stress test’ for India may come in 2015 when the US Fed starts hiking rates and when China devalues its currency. Also, sharp fall in oil and other commodity prices can affect the wellbeing (solvency) of few countries like USSR, Venezula, etc
From India’s point of view, given our growth story, these QE supported global liquidity will come to India which in turn will fund our current account deficit. Also global growth crisis means low oil and commodity prices which will reduce our inflation. Thus, India may be in a win-win situation.
QuestPMS performed very well during the quarter October to December, 2014. The composite performance table below givesour absolute performance vis-a-vissmallcap, midcap and largecap indices over different time periods:
Our performance has been extremely good specifically when compared to all indices. In absolute terms, while all small and midcap indices have given negligible returns, QuestPMS has more than doubled our client’s initial investment after all expenses and fees. In fact, the performance at individual level is much better as overall PMS performance got negatively impacted due to untimely redemption (and booking of losses) during depressed period by quite a few of our clients.
Looking at the strength of the current portfolio, we expect it to appreciate to a decent level in next 3 to 4 years. We expect the underperforming infrastructure sector to do extremely well in the coming years. Currently, infrastructure, engineering and related companies comprises almost 37 per cent of our portfolio.
More than 50 per cent of our AUM is made up of Kotak Bank clients. Their consolidated performance over last three and a half years has been stupendous. The composite performance table of all Kotak Bank clientsin XIRR based method is given below:
Our new strategy ‘MULTI’ has done phenomenally well in a short period since launch. While most indices have remained stagnant during the period, Multi has posted an absolute return of 13%.
We expect the average EPS for our portfolio companies to grow at around 27-30% over the coming couple of years and the forward (Mar-2016E) PE works out to around 12.5 times. We expect margin expansions in these companies on the back of incremental capacity utilization on the one hand and reduction in raw material prices on the other hand.
It has been our stated policy to use Quest profits for various charitable activities that includes runningthe Quest Foundation, which is involved in carrying out spiritual activities like managing Iyengar Yoga classes and discourses on ‘Bhagwat Gita’ by Chinmaya Mission. Quest Foundation and Quest Foundersare also involved in various charitable activities including educational, medical and general aid to poor and needy.
The company has for the year till date contributed Rs6.19Crores towards Quest Foundation and other charitable activities.Quest Foundation is funded only by Quest Investment and its founders and no outside contribution is being solicited. With Quest profits increasing, we expect to step-up these activities in coming period.
According to PricewaterhouseCoopers’ consultancy report released recently, India has the potential to realize 9 per cent average annual growth and can become a $10 trillion (from $2 trillion currently) economy in next 20 years. We have witnessed such growth phases in the past for countries like USA, Japan and China. But for that to happen a lot needs to change, including the ease of doing business and changing mindsets. The fact of the matter is that we now have a government that is really talking about how to make it easier to do business in India. How they put the reforms in place will give investors, the clarity and certainty that they are looking for, in order to put their capital in the country.
While it is early days, India certainly has a chance, particularly under this government, because apart from having structural benefits, this will be the first government in last 30 years which will have full majority in both Houses of Parliament sometime by middle of 2017.
Enormous wealth creation lies ahead of us and I don’t think we should get swept away by the minutiae of what is this quarter, next quarter in terms of earnings. Directionally this country is a super tanker, which has changed course, it is on course for 10-15 years of an irreversible journey – with the demographics that we have, the entrepreneurship that we have and now the government in place. We strongly believe India’s time has come. It is the beginning of a new era. It is time to create WEALTH rather than make some MONEY.
I wish you all a promising and fulfilling year ahead. Let us welcome the New Year, with new hopes, aspirations and spirits.
December 31, 2014.
DISCLAIMER: This communication does not constitute or form part of any offer or recommendation or solicitation to subscribe or to deal with QuestPMS. The views expressed by Ajay Sheth, Portfolio Manager QuestPMS are his personal views as on the date mentioned. These should not be construed as investment advice to anyone. This communication may include statements that may constitute forward looking statements. The statements included herein may include statements of future expectations and, are based on the author’s views, observations and assumptions and involve known and unknown risks and uncertainties that could cause the actual results, performance or events to differ substantially or materially from those expressed or implied in such statements. The author does not undertake to revise the forward looking statements from time to time. No representation, warranty, guarantee or undertaking, express or implied is or will be made. No reliance should be placed on the accuracy, completeness or fairness of the information, estimates, opinions contained in this communication. Before acting on any information contained herein, the readers should make their own assessment of the relevance, accuracy and adequacy of the information and seek appropriate professional advice and, shall be fully responsible for the decisions taken by them.