In Review – Week 04, 2023

The last week may well be remembered as Adani week in the Indian markets (or is it going to be this week – time will tell). Key market trends for last week. (1) The Indian Govt interest rates increased, but this happens almost every year before the budget. (2) Foreign investor flows into the Indian debt market remained moderately +ve. (3) Corporate/ Credit spreads have increased moderately in Jan23 so far, per our analysis. However, they remain at very low levels historically. (4) Western market interest rates also increased – China rates were flat. (5) Gold, the risk off commodity, has had a smashing start to the new year 2023. (6) India market volatility increased sharply on the back of Adani, yet only back to normal levels (15-20). US/ EU are also at normal levels. (7) The Indian equity markets reported sharp losses last week. However, take out the extraordinary losses in Adani group stocks and the rest of the Indian market may well have gained! (8) Foreign investor flows into the Indian equity market turned moderately -ve. (9) Global equity markets reported sharp gains led by US/ China – Japan joined the party last week. (10) Energy was weak – moderate losses in Crude Oil – US NatGas flat but Asia LNG declined sharply. (11) The currency markets were relatively stable – Yen/Rupee were moderately weak.

References (writeups during past few weeks) :


Determined MENA Thematic portfolio P2

Why the alternatives dont play

Investing is simple, but not easy.

When we told you about our new thematic last week – Indian companies with steady/ robust domestic business but with large international business, notably in the MENA (Middle East, North Africa) region, because we are in an energy upcycle – what is the first question that popped into your head (or should have). Why this complicated approach – if you expect Energy prices to remain high, you would also expect Energy sector to do well, and so invest in the same directly – because, investing is simple, but not easy. Well we have been writing about the Energy sector for 4 straight years, given it is the principal component of the Commodities asset class – and we did invest in the Indian Energy sector in early 2022, when the Ukraine-Russia war broke out, with disastrous consequences! Figure 1 explains, with the help of the Nifty Energy Index. You see, the majority of the Energy companies in India (marked in Red) are net Energy importers. Reliance is also an importer but also exports majority of its refinery products, and has become more of a conglomerate operation with its domestic retail and telecom arms. That leaves ONGC, and Oil India, which are Energy producers and ‘theoretically’ should benefit from rising Energy prices/ Energy upcycle. Btw these are the companies that we invested into – with disastrous results – Figure 2 shows how these companies managed to underperform the Nifty/ Nifty Energy Index in the year 2022, when Energy/ Oil & Gas prices skyrocketed. So what happened – Govt of India Regulations happened. The GoI put a windfall tax on domestic crude oil, effectively capping the price at US$70 for ONGC/ Oil India, in mid-2022. The stocks fell sharply, as the international crude oil price has been higher throughout 2022/ytd-2023. They have recovered recently, led by higher Gas prices, which GoI is proposing to cap next!

The other obvious alternative is to invest in the MENA markets directly. Good luck doing that. We can confirm there are no mutual fund options available in this respect. Direct investments are also non-trivial given India’s foreign exchange regulations, although they are possible. Yet even if possible, the biggest challenge is limited research/ information/ understanding of the market, and corporate governance. Let us just summarize it this way – better the devil you know than the devil you don’t.

The Corporate Debt portfolio Jan23 update

Seeking Superior Safe Net-of-Tax returns

We had re-launched our Corporate Debt portfolios in July22, seeking 5.5-6% interest rates along with tax arbitrage (lower tax rates). First up, the performance over the last 6 months, presented in Figure 1. The portfolio returns have been absolutely on point – kindly note the returns presented are annualized and hence last 6-month returns will be half of the reported numbers. Notably the two major risks in debt funds – (1) Interest rate risk and (2) Credit/ Default risk – have been well managed by the portfolios. Hence we are not suggesting any changes. But what has happened in the last 6 months is that ST 1-2 year Govt interest rates have moved up further – from 5.5-6% to 6.5-7% (Figure 2). This will benefit existing investors/ clients as well – w/o the need for any fresh investments/ changes to existing funds – and we now expect gross returns to be around 6-6.5%, over 3 years.

Of course, investors can seek to take advantage of the higher rates by investing afresh – Figures 3-4 present the details. As highlighted in our launch writeup, the gross returns are not very different from Bank FDs. Where Debt funds score is tax arbitrage (effective tax rate of 5-10% after 3 years, vs 20-30% slab rates for interest on Bank FDs). Debt funds with higher interest rates are also available (7+%). However, we still do not believe that it is the right time for taking on too much risk – there is no point in shooting for 1% additional interest rate only to be saddled with a 4-5% capital loss! Hence we would strongly advise against this. The basic risk management framework is presented in Figure 5 – we continue to focus on ST high quality PSU/ Corporate debt funds. The debt portfolios are available with both DSP and UTI mutual funds.

In Review – Week 03, 2023

Key market trends for last week. (1) The Indian Govt interest rates were mixed. (2) Foreign investor flows into the Indian debt market were +ve but inconsequential. (3) Corporate/ Credit spreads have increased in Jan23 so far, per our analysis. (4) Western market interest rates were also mixed – Japan rates declined sharply. (5) Gold, the risk off commodity, has had a smashing start to the new year 2023. (6) India market volatility dialed back to below normal levels (15-20)! US/ EU down to normal levels. (7) The Indian equity markets reported mixed trends last week. (8) Foreign investor flows into the Indian equity market were inconsequential. (9) Global equity markets were mixed, with US/ EU -ve and China/ Japan +ve – China has had a smashing start to 2023 (10) Energy was mixed – moderate gains in Crude Oil – US NatGas and Asia LNG declined sharply. (11) The currency markets were relatively stable – Yuan/ Yen were weak.

References (writeups during past few weeks) :

Determined MENA Thematic portfolio P1

Playing on the Energy upcycle

MENA – Middle East, North Africa

Let us summarize the launch of our new Thematic in a few words – we are looking to invest into Indian companies with steady/ robust domestic business but with materially large international business, notably in the MENA region. But before we get into the meat of the arguments – a quick summary of what we expect the Indian/domestic market to do in the medium term (2-5 years) – NOTHING (much). Figure 1 explains, with the example of the period 2007-13, when the Indian market was awfully range-bound and literally didnt go anywhere for a period of 6 years! The key driver (we believe) was India’s large Energy import dependence and high prices of Energy during this period. WTI benchmark Crude prices were consistently within USD80-100 at the time. To be sure, the big driver of the sharp initial decline in the Indian markets was GFC (Global Financial Crisis). Yet the global market had started recovering from the same in 2010. But the Indian market remained static till 2013 before finally rising in 2014 (led by Crude price declining to USD50 by the end of the year, as well the change in Govt at the Center in India). We cannot and are not predicting the next crisis of the order of GFC, but expect the Indian market to be subdued (sub-10% returns) over the next few years – it will be a quintessential stock pickers market. And we have already seen 2022 as the 1st milestone – average WTI benchmark Crude was upwards of USD100, and the Indian markets went nowhere.

Of course, the key assumption behind the above expectation, and the Determined MENA portfolio – continuation of the Energy upcycle. Well we can write a PhD on this topic! In all likelihood, we probably have (1, 2, 3 and 4 are just examples). Our confidence is primarily driven by two factors – (1) Climate Change agenda, and (2) Russia-Ukraine war. Fundamentally, any commodity price is driven by demand-supply dynamics. And the supply side is driven by capex. Figure 2 has the details of global crude oil capex, which declined post 2015 along with Crude prices, as is to be expected. Enough supply had been created during the 2008-14 cycle and subsequent capex was only maintenance/ replacement. Yet Crude demand has continued to grow, by about 1mbd (mn barrels a day). Yet 2022 is the watershed year – average Crude prices went to USD100, indicating very finely balanced demand-supply curve, still O&G companies did not invest in capex. Why – Climate Change agenda, which is preventing O&G companies investing in LT projects. To be sure, Crude demand is expected to peak by 2030-35, but that is still at least 8 years of demand growth (2023-30) that needs to be satisfied from somewhere. In fact, we specifically waited for this dataset to be released before launching the Thematic. Further, Russia is the 3rd-largest producer of Crude in the world (down from 2nd-largest a year back – Figure 3). Although it has found alternate customers for its Crude supply in the wake of Ukraine war and EU sanctions, the issue is prices. The price Russia is getting for its Crude is at US$30-40 discount to benchmark – aka around US$50. If anything, that is a disincentive to supply and given more EU sanctions to come, we expect Russia supply to decline further. Finally, forget Crude, Natural Gas has a bigger demand-supply problem given even export-import infra needs a lot of time and investment/ capex.

So why MENA? That is a rather simple one. 8 out of the 12 top OPEC+ countries belong to this region (Figure 4) – not counting the likes of Oman, Qatar and Mozambique, also large Energy producers. The CIS countries – Russia, Kazakhstan et al – will be under the cloud of the Russia-Ukraine war (for god knows how long). But then why not include the US – which has emerged as the largest producer of Oil & Gas within the short span of the last decade. Simply because US economy is so dynamic and advanced as to not be dependent on one industry (certainly not O&G). MENA economies, maybe with the exception of UAE, are quite dependent on Energy, notably exports. However, they are learning from UAE, and looking to use their Oil & Gas dollars to diversify their economies. Figure 5 shows how 4 out of the 10 fastest growing economies in 2022 belonged to the MENA region (yeah India is also in the mix – thats good news). And we expect this to continue in 2023, which will be the focus of this Thematic, to be further explored in Parts 2-5.

SIP returns tracker Jan23 update

As markets stabilize, so do SIP returns

We must caveat today’s writeup by noting that there is very little new to be said wrt SIP investments that we have not said already in these pages before. Hence if you are a legacy investor/ client, you may well skip it. Of course, given Determined investments started in 2019, some of your SIP returns may have started to mirror the 5-year returns we present in the tracker (and if they dont, please reach out to us). The learnings are quite relevant to new investors/ clients, if you have joined us in 2022.

In this writeup, we focus on Equity and Equity-oriented Hybrid funds (5-10 year mid-to-long-term investments). The SIP performance of DSP and UTI mutual funds, our partners in crime, stabilized (Figure 1) in 3Q22 (July-Sep22) and 4Q22 (Oct-Dec22). After the sharp 10+% decline by June22, the Indian Equity markets recovered 15% by Dec22, ending the year on a mild +ve note. Given SIP returns are a function of the Market Cycle at any point in time, they also recovered from the June22 lows. Not as strong as 20% MT/ 5 year returns in Dec21, which were a direct result of the strong market upcycle in 2H20-2021, but also not as bad as the Mar20 downcycle. Right in line with the 10-15% LT/ 10 year returns that can be expected from SIPs. Aside from keeping in mind this recurring volatility in ST returns, a few timeless lessons. (1) Equity/ Share funds/ SIPs are ideal investment vehicles for the long run (10+ years) – discipline combined with compounding and solid returns (10+%). (2) SIPs within a few months of each other can also have very different returns, as can be seen – set the right expectation (10+%) and treat the upside as a bonus. (3) Hybrid funds are more suited to the medium term (5-7-8 years) – the key tests being -ve returns (NEVER in 5 years) and high probability (80+%) of 7+% returns (Figure 3).

Global Investment tracker Dec22 update P2

India – rising manu PMIs, declining manu output

As highlighted in our primary global investments writeup, the global composite PMIs and their constituents – manufacturing, and services – have been declining. India has been an oasis of calm and strength during this period of turmoil with not just expanding PMIs (>50) but strongly expanding PMIs (>55). And we agree on the services side, since majority of the metrics we are seeing are indicating India services growth remains robust. Yet the puzzle is on the manufacturing side, since majority of the metrics we have seen, especially in 2H22, indicate growth has been moderating. Figures 1-2 illustrate this dichotomy. The proxy indicator is suggesting accelerating growth, while the official statistic (India manu output) is indicating a sharp decline in 2H22. The India manu output statistic has always been very volatile and hence it is best to look at 3m average data. The only material difference between the proxy indicator and the official statistic is Govt capex, primarily in the Infrastructure sector. But Govt capex has grown at a face pace in 2022 and if anything, should be supportive of stronger performance by the official statistic. The alternative statistic (India industrial production) also presents a similar picture. So how do you explain the divergence – the answer is we cant (not today at least). You have to look at both the indicators, and many more (that one can find), and by doing so come to your own conclusion. Out multi-factor models suggest the picture on India manufacturing to be mixed – neither as strong as manu PMI suggests nor as weak as manu output suggests (the latter is also notoriously prone to large revisions historically). India, although not as bad as the global economy, is not as resilient as it is made out to be.

Another example. We have highlighted previously that India Bank Credit growth has gone from strength to strength in Apr-Sep22. This has been given as an example of India’s strong economic growth during this period! Yet look at Figure 4. Indian corporates have historically raised money from banks and foreign markets. Except they have not been able to raise anything from foreign markets during this period. Suddenly, what has been marketed as a strength starts to seem rather like a weakness. We continue to analyze the Indian economy slowing down, more as the services sector rolls over some time in 2023E.

In Review – Week 02, 2023

Key market trends for last week. (1) The Indian Govt interest rates declined, except ST 3m rates that continued rising. (2) Foreign investor flows into the Indian debt market were inconsequential. (3) Corporate/ Credit spreads have increased sharply in Jan23 so far, per our analysis. (4) Western market interest rates declined last week – yet in the East Japan rates have started rising. (5) Gold, the risk off commodity, had a smashing start to the new year 2023. (6) India market volatility dialed back to below normal levels (15-20)! US/ EU down to normal levels. (7) The Indian equity markets reported moderate gains last week. (8) Foreign investor flows into the Indian equity market turned large -ve (US$1+bn). (9) Global equity markets were broadly +ve, led by US and China. (10) Energy was mixed – sharp gains in Crude Oil – US NatGas declined sharply, down to normal US$3-3.5 winter range. Yet Asia LNG prices at US$25-30 remain way above normal. (11) US Dollar Index declined sharply last week – strength in all other major currencies.

References (writeups during past few weeks) :

Still going nowhere…

L15M – nothing; N6M – ?

Dear investors, wish you and all your loved ones a happy and healthy new year 2023.

The Indian Equity market has not gone anywhere in the last 15 months now. Sure a lot of market moves daily/ weekly, which is great for traders. Sure a lot of action in individual companies/ stocks, which is great for stock pickers. But as Figures 1-2 show, the net result at the market level is still ZERO – not great for all other investors. Having anticipated this kind of range-bound trend in Dec21 itself, even we could not imagine that it would last as long as it has. Although we had warned that that it was going to be a painful wait, and our patience would be tested. And we still analyze the same – we do not see the Indian Equity market going anywhere in the next 3-6 months. But the drivers of this trend have kept on changing over time. In the previous note, we had warned that slowing global economy (US/ EU/ China) is going to weigh down on India. But then we noted yesterday that global economic growth prospects improved in Dec22, led by China (abandoned its zero-Covid policy) and EU (Energy crisis has abated). Yet, against all expectations, foreign investors pulled out US$1+bn out of Indian markets in the first 8 days of 2023! The simple explanation is there are getting out of India, to invest in China/ EU. The more complex explanation is the Indian economy is much more closely linked with US than EU/ China – and the US economy slightly worsened in Dec22, as US interest rates continued rising. Yup, that is the confused/ mixed world/ markets we are living right now. The good news – nothing lasts forever, and this too shall pass, and a new direction/ trend emerge – be patient.

Global Investment tracker Dec22 update

Recession? What recession?

What do you do Sir? When the facts change, we change our mind. That is, when we are not on the holidays. Before we get into the nitty-gritty of today’s writeup, we just wished to highlight that the facts of the global economy changed dramatically in Dec22. Hence this writeup, which serves to cover the global economy and markets – past, present and NT future – will feature a wide divergence in views. The reader is well advised to keep this in mind, as also that actionable ideas remain scarce.

The story of 2022 has been the story of the global economy and markets in doldrums [since we have enumerated it ad nauseum in these pages, we will not repeat the same]. Suffice to say, that the >20% decline in all three major markets (US, China, EU) in 9M22 reflected on the sorry state of affairs (China market from an already weak 2021). The trillion-dollar question is – what changed in 4Q22, notably in Dec22. Figure 1 presents the market performance, which reported strength across the board. China led the gains, with Hang Seng up 15%, followed by EU/ UK/ US. Take note the DM markets especially feature a lot of global MNC companies. What changed is two major drags on the global economy, were pulled back within a matter of days. (1) China pulled back from zero-Covid, in the middle of its most severe Omicron wave no less, paving the way for the 2nd-largest economy to get back to its potential in 2023E. (2) And the energy crisis in EU abated, as warm weather reduced NatGas demand (Figure 2). This also reduces the broad pressure on global Energy prices (Crude, Coal). The China/ EU markets read the changing dynamics quickly and have gone further in Jan23. Markets such as India, which looked like a safe havenonly 3m back, were left behind (even further in Jan23, strengthening the case for portfolio diversification).

(1) The past – the 3Q22 GDP growth, although it hardly matters now. It continued to reflect the slowdown trend of 1H22. US/ EU/ India/ UK all weak. China trend improved but only because the 2Q22 Covid wave subsided. More imp, the bottom half of Figure 3 shows how the US/ China/ Japan/ India economic growth had peaked in 4Q21/1Q22 vs pre-Covid (PC) trends, and has been weakening since. (2) The present – 4Q22 PMIs. Continued to lose momentum, indicating the GDP growth slowdown will continue in 4Q22. However, look at the small, almost negligible, uptick in Dec22, led by China/ EU. Take note the uptick is despite the largest economy US PMIs continuing to be in free fall. And this is why we track them. India remains the only and wide outlier – the India PMI vs other delayed but more robust data have seen wide divergence lately, which we wish to discuss, but not here. (3) The future – who knows?! We were most certain on the EU recession led by its energy crisis last time – how well did that work out (negated by warm weather, no less). The US – rising interest rates due to high inflation – seems the more viable case now. Yet China is on the other end of the spectrum – economic reopening post Covid likely to be as +ve for China markets as it has been for everyone else (US/ EU/ Japan/ India, you name it). We are playing the China reopening theme through Commodities [China is largest consumer] rather than directly. Yet the EU energy crisis abating may well be in the price, given the Stoxx600 Index benchmark already hit 450 levels – we wont chase.