In Review – Week 41, 2021

Global Covid vaccination rate continues to progress well, with 150mn doses during last week. Key market trends for the week. (1) Govt interest rates were mixed with long term (10y) rates rising but short-to-medium rates falling. (2) Foreign investor flows into the the debt market remained marginally -ve. (3) Corporate/ Credit effective interest rates rose moderately in Sep21, largely led by base Govt rates. Corporate/ Credit spreads have been largely flattish so far in Oct21. (4) Global interest rates were also mixed last week with US/ EU falling and China surprisingly rising. (5) Gold, the risk off commodity, gained moderately last week. (6) The Indian/ US market volatility rose but remains well within normal levels. (7) The Indian equity market reported robust gains during the week, Nifty50 index crossing the psychological 18K mark. (8) Yet foreign investor flows into the Indian equity market remain mixed at best. (9) The US/ EU markets also reported robust gains during the week, recovering fully from past losses. (10) Energy markets were mixed – strong Crude Oil, weak NatGas (but also look at the sharp increase ytd/ yoy). (11) USDollar index weakened a bit, Yuan strengthened a bit and the Rupee was largely range-bound last week.

References (writeups during past few weeks) :
https://determinedinvest.wordpress.com/2021/10/17/the-black-gold-oct21-update/
https://determinedinvest.wordpress.com/2021/10/10/determined-equity-income-portfolio-oct21-update/
https://determinedinvest.wordpress.com/2021/10/03/macro-asset-allocation-portfolio-notes-sep21/
https://determinedinvest.wordpress.com/2021/10/09/global-investment-tracker-sep21-update/
https://determinedinvest.wordpress.com/2021/10/02/the-india-equity-risk-sep21-update/
https://determinedinvest.wordpress.com/2021/09/25/covid-on-the-backburner/
https://determinedinvest.wordpress.com/2021/09/17/inflation-remains-inevitable/

The track of Global covid cases (weekly) can be picked up from the following link…
https://www.ecdc.europa.eu/en/geographical-distribution-2019-ncov-cases

The Black Gold Oct21 update

The two times when to buy Commodities

The cure for high prices, are high prices.

Well the Energy markets have officially gone cuckoo. The global Covid sixth wave has come and gone in the last quarter, leaving Energy (Crude Oil, NatGas) prices much higher in Oct21 (US$80+) than they were in July21 (US$70). US NatGas prices have risen at an even crazier pace but at least there are some good reasons why. So what are we doing right now – we are staying on the sidelines (no different from the last update) but also not in sell mode yet – pricing has gone ahead of our expectation (US$65-80) and we are waiting for some correction (maybe 1H21). As macro investors, we use a number of macro constructs to decided on our investment strategy – one of them, relevant to commodities, is the Cost Curve. Typically (in normal times), commodity prices operate around the Cost Curve which represents 80-95th percentile of its supply. The first time to buy commodities is when prices are materially below this level (largely due to temp demand destruction). The 90-95th percentile on the Crude Oil Cost Curve is around US$60. Hence the opportunity to buy Energy assets as Crude Oil prices crashed to sub-US$30 in 1H20. Yet the history of Energy (and Commodity) markets shows there are times when prices completely blow out the Cost Curve – these are called Commodity Cycles/ SuperCycles. Coordinate Energy price hikes (Crude Oil, NatGas, even Coal) aside, we dont believe the world is ready for the next Energy cycle.

References (writeups in the series) :
https://determinedinvest.wordpress.com/2021/07/18/the-black-gold-july21-update/
https://determinedinvest.wordpress.com/2021/04/18/the-black-gold-apr21-update/
https://determinedinvest.wordpress.com/2021/01/04/the-black-gold-dec20-update/
https://determinedinvest.wordpress.com/2020/09/27/the-black-gold-sep20-update/
https://determinedinvest.wordpress.com/2020/07/03/the-black-gold-june20-update/
https://determinedinvest.wordpress.com/2020/04/01/the-black-gold-mar20-update/
https://determinedinvest.wordpress.com/2019/05/31/the-case-for-black-gold-closed/
https://determinedinvest.wordpress.com/2019/01/20/the-case-for-black-gold/

• The state of the Energy markets. Figures 1-2 present the state of the US Energy market (Crude Oil WTI benchmark, NatGas Henry Hub benchmark) over the last few months. The direction has remained +ve despite the sixth global Covid wave hitting major economies (US, China, Japan, UK) during the quarter. Crude Oil prices did dip during the quarter down to US$60-odd levels at one point yet recovered strongly to cross US$80+ in Oct21 from US$70-75 in July21. The rise in US NatGas prices has been even crazier – from US$3.5-4 in July21 to US$5.5-6 by Oct21, much ahead of even the winter benchmarks – but there are some valid reasons for the trend. It started with the extreme cold winter in parts of US in Feb21, resulting in excess demand and lower inventory for NatGas compared to historical averages. Supply remained limited as producers were still reeling from 2020 prices being much below benchmarks (summer, winter). However, global NatGas demand (notably China, Europe) recovered much quicker from Covid vs expectations, resulting in strong exports from the US, further falling inventory levels and resultant higher NatGas prices. The global Crude Oil demand-supply balance continued to remain favorable. Nonetheless, the gap has closed down from 3mbd in 4Q20 down to sub-1mbd in 3Q-4Q21E. Given continued OPEC+ supply normalization, the demand-supply balance is quite fragile – it ‘may’ continue to remain balanced or ‘may’ even flip (more supply than demand) in 1H22E. That is not an ideal investment environment at least in so far as Crude Oil is concerned.

@aeberman12

@aeberman12

• Macro Window – Commodity Cost Curves. A Commodity Cost Curve essentially represents the Cost of Supply of various producers (either at company level or at country level) of a Commodity. Figure 4 presents for the global Crude Oil Cost Curve. We have used relatively skinny versions of the Crude Oil Cost Curve in our past analysis. Basically it sums up a Commodity market (Crude Oil in this case) across all producers and countries of production. The most efficient producers (lowest cost of production) come first and the curve progressively moves towards less efficient producers (higher cost of production). Economics 101 suggests price of a commodity (or any good/ service) will settle at a level where demand meets supply. Hence commodity prices move around on the Cost Curve, depending on where the demand is at any point in time. Yet more specifically, typically (in normal times) commodity prices operate around the part of the Cost Curve that represents 80-95th percentile of the supply. For Crude Oil, this would be US$57-62 (a slightly broader range US$50-70 is more apt). This brings us to the first case when to buy commodities – if temp demand destruction pushes prices much below these levels. Medium term, there is high probability that either demand comes back or there will be supply destruction (less efficient/ higher cost producers getting out of the market) to reestablish the demand-supply balance. This was the situation in the global Crude Oil market in Mar20, when we introduced Energy assets into our portfolios.

IMF

• The second case to invest in Commodity markets – is more complex. It is very clear the primary Energy markets (Crude Oil, NatGas) find themselves in a situation very different from the one we described above. To take the example of Crude Oil, which has gone from around US$50 (fair price) in early-2021 to US$80+ now (almost hitting the top end/ 98th percentile of Cost Curve). Yet this also is not an entirely unusual situation. Crude Oil routinely traded upwards of US$100+ levels during 2008-14, much ahead of its Supply Cost Curve which used to top out at US$60-70 prior to this period. Two elements explain this – (1) A structural consistent increase in demand, which pushes the level of demand outside the boundaries of the Supply curve. Take note the Cost Curve features existing supply sources, and new supply may take 2-3-4 years (new projects) to come online. This is what happened with Crude Oil in the time period above (China demand). (2) A structural durable hit to existing supply – this is why Crude Oil pries tend to jump if there are tensions in the Middle East, which constitutes 30+pc of global supply. We have seen a live example of this in the Iron Ore market last 2-3 years (but will not discuss in the interest of brevity). This is the stuff Commodity Cycles/ Super-Cycles are made off. And there are talks of US$100 Crude Oil price again in the air (or a new Energy cycle). Yet our assessment indicates differently. In fact, Figure 3 indicates 4Q21E demand will be much below pre-Covid peak (4Q19). And prices have reached current levels only because OPEC+ has done a great job of controlling supply (Saudi, Kuwait, UAE, Iraq all have plenty of ready supply; also Iran but constrained by US sanctions). Hence we are on the sidelines, waiting for some correction (maybe 1H21 ?). Maybe 2023E-24E will be the time to assess the potential for a new Energy cycle, but not 2022E !

The Psychology of Money P9

Being Reasonable

Behavior is hard to teach,
even to really smart people.
Especially to really smart people.

References :
https://determinedinvest.wordpress.com/2020/12/31/the-psychology-of-money-p1/

Credits :
The Psychology of Money, by Morgan Housel (if you like what you see in these pages, do consider buying the book – you will not be disappointed)

Academic Finance is devoted to finding mathematically optimal investment strategies. Yet the fundamental opinion of this book and author is, in the real world, that is not what people want. They want an investment approach that determines how well they sleep at night.

Harry Markowitz won the Nobel Prize for exploring the mathematical tradeoffs between risk and return (the modern portfolio theory).

He was once asked how he invested in his own money, and he described it as such…

“I visualized my grief if the stock market went way up, and I wasnt invested in it. Or if it went way down and I was completely invested in it. My intention was to minimize my future regret. So I split my contributions 50-50 between the stock market and bonds.”

It was that simple. Two things are important here.

One is that ‘minimizing future regret’ is hard to rationalize on paper but easy to understand in real life. A rational investor makes decisions based on numeric facts alone. But investing has a social component thats often ignored. A reasonable investor makes decisions with co-workers who you wish to think highly of you, with a spouse you do not wish to let down, and judged against realistic competitors such as your friends and neighbours.

The second is that this is fine. Jason Zweig, who conducted the interview with Markowitz, later reflected…

“My own view is that people are neither rational nor irrational. Rather we are human. We dont like to think harder than we need to, and we have unceasing demands on our attention. Seen in that light, there’s nothing surprising about how the pioneer of modern portfolio theory (Markowitz) built his portfolio (with little regard for his own research !).”

Markowitz was neither rational nor irrational – he was just being very reasonable with his money and investments.

That, is the Psychology of Money.

In Review – Week 40, 2021

Global Covid vaccine doses crossed the 6.5bn mark with EMs (India, Brazil, Indonesia, Turkey, Mexico et al) leading the charge now. Key market trends for last week. (1) Govt interest rates rose moderately last week, tracking global cues. (2) Foreign investor flows into the debt market turned marginally -ve. FTSE review of inclusion of Govt of India debt into its global debt indices was pushed to Mar22. (3) Corporate/ Credit spreads largely flattish thus far in Oct21. (4) Global (US/ EU/ China) interest rates rose moderately last week. (5) Gold, the risk off commodity, was flattish this week. (6) The Indian/ US market volatility was well within normal levels (15-20). (7) The Indian equity/ share market recovered smartly from its losses the prev week. (8) Foreign investor flows into the Indian market remained mixed and relatively modest. (9) The US/ EU markets reported moderate gains and could not fully recover from the losses of past week. (10) Energy markets were mixed – sharp gains in Crude Oil vs flattish Natural Gas (but much above expected levels). (11) Global currencies (US$, Yuan) were quite but Indian Rupee depreciated sharply vs global reserves.

References (writeups during past few weeks) :
https://determinedinvest.wordpress.com/2021/10/10/determined-equity-income-portfolio-oct21-update/
https://determinedinvest.wordpress.com/2021/10/03/macro-asset-allocation-portfolio-notes-sep21/
https://determinedinvest.wordpress.com/2021/10/09/global-investment-tracker-sep21-update/
https://determinedinvest.wordpress.com/2021/10/02/the-india-equity-risk-sep21-update/
https://determinedinvest.wordpress.com/2021/09/25/covid-on-the-backburner/
https://determinedinvest.wordpress.com/2021/09/17/inflation-remains-inevitable/
https://determinedinvest.wordpress.com/2021/09/11/the-corporate-debt-risk-sep21-update/

The track of Global covid cases (weekly) can be picked up from the following link…
https://www.ecdc.europa.eu/en/geographical-distribution-2019-ncov-cases

Determined Equity Income portfolio Oct21 update

Robust payouts and cap gains

The Determined Equity Income portfolio delivered 10+% gains in 3Q21, split between 1.7% dividend earnout and 9.1% cap gains. The dividend earnout has seasonality benefit in 3Q but with 4.6% earnout in 9M21, it has already beaten our full-year expectation and well on course for 5.5+% earnout in the full year (2021). PS – this is better than interest rate on bonds of equivalent quality (AAA high quality corporates) – hence our objective is met. We do not take credit for cumulative 20+% cap gains, which are a function of the market, only for recognizing in early-2021 that the market was not ready for a correction and will likely continue to move higher. Our long-term cap gains expectation from the portfolio remains 5-6%, given high dividend payout companies are typically (1) slow growth and/or (2) cyclicals (stock prices can be highly volatile). And we will keep on our original commitment (and hope you will too) to discontinue to portfolio as interest rates in the economy (RBI/ Govt/ High quality corporates) go back to normal. Nonetheless, given the strong cap gains, even stronger performance of a few companies, and thereby sharply reduced dividend yields (1-1.5% in few cases now), we have pruned the portfolio. Tata Chem (90+% cap gains) and HPCL go out – nothing comes in. We would have loved to include Tata Investment Corp (it fits) but the stock has gone up 20+% since our last evaluation less than 2 months back.

Disclaimer – Equity/ share market investing involves risks – notably the loss of principal. The discussion on any individual stock below is not a recommendation to buy/ sell the same. Any discussion on individual stocks below does not preclude their inclusion/ exclusion in the portfolio (dubbed Determined Equity Income Opportunities).

References (writeups in the series) :
https://determinedinvest.wordpress.com/2021/08/19/the-tata-group-index-fund/
https://determinedinvest.wordpress.com/2021/07/03/determined-equity-income-portfolio-july21-update/
https://determinedinvest.wordpress.com/2021/04/04/determined-equity-income-portfolio-apr21-update/
https://determinedinvest.wordpress.com/2021/01/05/determined-equity-income-opportunities-portfolio/

Global Investment tracker Sep21 update

Covid gone, yet new Risks emerge quickly

The last 6 months have really been a tale of two halves wrt equity/ share market performance. Performance was robust in 2Q21 (Apr-June21) across many markets – led by US, India but even EU, China and UK were solid. What followed was very muted 3Q21 (July-Sep21) across almost all markets – barring India. One couldnt argue that global markets had run up too fast too soon, and were due for a pause, given India had led the recovery from pre-Covid levels. Few reasons – (1) the sixth Covid wave which hit way more geographies (US, UK, Japan, ASEAN et al) that it should have. (2) China practically shot its markets in the foot with an all-out campaign against its New/ Tech and Old/ Industrial companies. (3) EU, strongly coming out of its Covid rut (in 1Q21), reported an Energy crisis late-3Q21. China was the laggard with the Tech-heavy Hang Seng Index reporting the sharpest decline. The economic growth trends in 2Q21 (comped with 2Q19) were a mixed bag – China led and US followed. Yet markets are forward looking – China will clearly weaken in 2H21 even as US will strengthen. India was already back on growth path in 1Q21 and will again in 3Q21, joined by EU, UK – Japan will follow suit in 4Q21. PMI (leading indicators) reported slowdown throughout 3Q21 led by Covid and China – market wisdom indicates peak PMI post recession is also peak markets, but we will wait for another quarter to sit on that judgment. For now invested primarily into domestic and US markets (hardly surprising) with EU on the watchlist – sadly the latter is always a case of two steps forward, one step back (Energy crisis, Geopolitical risk).

References (writeups in the series) :
https://determinedinvest.wordpress.com/2021/08/07/whither-china/
https://determinedinvest.wordpress.com/2021/06/13/global-economic-tracker-june21-update/
https://determinedinvest.wordpress.com/2021/03/15/global-investment-tracker-mar21-update/
https://determinedinvest.wordpress.com/2021/03/12/the-buffett-indicator-revisited/
https://determinedinvest.wordpress.com/2020/09/14/global-investment-in-times-of-crisis/

• Global Investment tracker – weak 3Q with India only exception. Since we are presenting the update after Mar21, we need to discuss both 2Q21 (Apr-June21) and 3Q21 (July-Sep21) performance. 2Q21 was a period of optimism with strong vaccination momentum driving economic reopening around the world, except India. Yet India had also successfully controlled its second (or third) Covid wave by June21, and led the performance charts along with US. But there was plenty of cheer to go around – EU, China, UK. Japan was a laggard – we have discussed the structural challenges of Japan economy previously, coupled with strong equity market recovery already since Dec19 kept a tab on further gains. Strong vaccination momentum and continued easy liquidity was supposed to keep the story going in 3Q21 at least. But it was not to be. Covid itself presented as a challenge with a sixth Covid wave impacting multiple geographies (US, Japan, UK, ASEAN). We have already discussed the China situation in great detail in our current affairs update. Yet the surprise was EU, witnessing the strongest economic momentum during 3Q21, but felt the pangs of economic reopening late-3Q21 led by supply chain challenges and an Energy crisis. Having shut down majority of its coal plants in favor of renewables, EU faced a multitude of challenges – (1) weak wind conditions, (2) low NatGas inventories and (3) limited imports from US/ Russia. Between China and EU, the global equity markets sank late-3Q21 with India only exception.

• Global economic growth – mixed in 2Q21 but momentum in 3Q21. The global economic momentum was a mixed bag in 1H21. Take note that we would rather focus on the bottom half of Figure 2, which compares 2021 data to 2019. China reported the strongest economic growth in 1H21 but we have already highlighted (a) there is very limited correlation between economic growth and equity market returns and (b) economic momentum will surely weaken in 2H21 led by CCP actions against New/ Tech as well as Old/ Industrial companies. And the forward-looking markets are already reflecting the same (notably the Tech heavy Hang Seng index). US did well for itself recovering back to an economic growth trajectory in 2Q21 and the momentum will continue in 3Q21, the Covid wave notwithstanding. India had also recovered back to economic growth trajectory before the Covid hit in 2Q21, but will be back again in 3Q21 (Corporate India has indicated a faster recovery from Covid in 2021 than in 2020). Yet it is EU that is likely to deliver the sharpest economic recovery in 3Q21, also basis the PMI data (which we discuss in the next section). Yet any recovery to back to renewed economic growth (US, India) has seen reopening pangs (supply chain constraints, resulting in inflation) and EU has not proven to be an exception. Japan will follow suit in 4Q21.

• Global composite PMIs – cementing their worth as a leading indicator. Figure 4-6 present the Global composite PMI trends, including breakdown across key components (manufacturing vs services, et al). Although Global composite PMI remains in expansion mode, the strength of expansion waned in 3Q21 after peaking in 2Q21. We have already discussed the reasons why. Yet PMIs yet again proved their worth as a leading indicator of economic activity/ markets. Market wisdom indicates peak PMI (post recession) is also peak markets. China epitomized the same this time around given weakening economic momentum/ PMIs post 4Q20 has implied range-bound (Shanghai Comp) to outright declining (Hang Seng) markets. And the trend has been repeated in Global markets also. Global PMI peaked at 58.5 levels in May21 (2Q21) and has thereafter steadily declined to 53 levels by Sep21 (3Q21). Yet one major contributor to the decline (sixth global Covid wave) is clearly ‘transitory’ hence we do not believe this is the time still to sit on judgment on the market direction. Further, even as Covid has receded to the backburner, new Risks have emerged. Inflation is primary among them, and Price PMIs are running much ahead of Output PMIs (resulting in lopsided nominal economic growth, driven more by inflation than volumes). Yet what is different in 3Q21 vs 2Q21 that rising persistent inflation is not starting to filter into interest rates. Thus, the market outlook has turned mixed rather quickly, post the Covid peak.

• Bottom line – sticking with what we have. Our broad investment thesis from the Mar21 update has not changed. We remain invested in domestic and US markets, although this is hardly rocket science (majority of the portfolios – does not mean consensus is always wrong). EU makes for very interest read given the strongest growth momentum during 3Q21 and will be next to return to economic growth trajectory after China, US and India. EU has few structural challenges similar to Japan (although not the same quantum). Further, lately it has been a case of two steps forward, one step back – we will discuss the Energy crisis elsewhere (and few economists did see it coming but timing ?). And the structure of the European Union has not settled (Brexit) and new issues keep cropping up (see below).

https://www.reuters.com/world/europe/polish-court-ruling-plunges-eu-into-new-crisis-eu-ministers-say-2021-10-08/

Macro Asset Allocation portfolio notes Sep21

3% returns, 8% under-performance

Our Macro Asset Allocation portfolio delivered 3% returns in the previous quarter and 32% cumulative returns (since Dec19; 7 quarters). This would be a fantastic performance on an absolute basis, yet the portfolio under-performed Nifty500 benchmark that delivered 11% returns in the previous quarter. (1) A balanced portfolio (60:40) will fundamentally under-perform a pure risk benchmark (Nifty500) by a little over time. Our equity/ risk asset positioning has been fine (65+%) but the divergence between equity/ risk asset performance has turned out to be very large this quarter. S&P500, Energy and Metals returns have been 1%, 1% and -12% respectively, compared to 11% return in the Nifty500. Hence the risk side of the portfolio has itself under-performed Nifty500. The weight given to the International portfolio is not excessive (21% vs 47% to Nifty500). Metals performance has been disappointing but explainable – indirectly impacted by China. (2) On the low-risk/ safety asset side, the Debt/ Arbitrage performance has been stable. Gold has been weak again this quarter and remains one of the few under-valued assets globally. There has been some macro headwinds (rising US Dollar) but the strength of our conviction in Gold remains intact. Even as Covid threat and economic impact perceptibly declines, other conventional risks to the global economy have arisen (Inflation, US tapering of easy money, rising interest rates). India will not and cannot remain insulated forever, and the biggest risk is economic growth.

The India Equity/ Risk Sep21 update

Strong earnings momentum, but o/w mixed picture

A short update. Caveat – this update is different from the previous one in one crucial aspect. Given the hit to earnings in 4QFY20-1QFY21, we had made large adjustments to (historical) data to allow a proper analysis in the previous update. We have reverted back to the raw data for analysis in the current update (2QFY21-1QFY22 earnings). Regular readers will recall we analyze the Equity/ Risk across two frameworks. (1) Earnings growth – P/E framework, which presents a somewhat mixed picture. Nifty50 earnings growth has been on fire recently (+90% yoy in Sep21). This is one variable that needs to be adjusted given Sep20 earnings include the impact of both 4QFY20-1QFY21 (Covid lockdowns). Yet even 2-year earnings growth (Sep21 over Sep19) reflect considerable strength at 20+% CAGR, double the normal 11% growth. Yet the other side of the equation (P/E valuation) is quoting at a 30% premium to historical levels – hence the mixed picture. (2) ROE – P/B framework, which presents a decidedly negative picture. The sharp improvement in earnings growth has pulled up the ROE levels yet they remain 8% below historical levels. Further the other side of the equation (P/B valuation) is quoting at 20+% premium to historical levels. The fundamental-valuation frameworks thus present an overall mixed picture. Earnings momentum is generally a better predictor of near term market direction, rather than valuations. This momentum is also being supported by low interest rates (led by RBI actions) – but that is another side/ window of the markets equation. On balance, the fundamental-valuation side is indicating high and rising risk.

References (writeups in the series) :
https://determinedinvest.wordpress.com/2021/07/08/the-flaws-in-the-narrative-or-not/
https://determinedinvest.wordpress.com/2021/03/21/the-india-equity-risk-mar21-update/
https://determinedinvest.wordpress.com/2021/03/19/investors-leave-the-blues-behind-mar21-update/
https://determinedinvest.wordpress.com/2019/11/27/the-india-equity-risk-nov19-update/
https://determinedinvest.wordpress.com/2019/09/20/great-for-market-less-so-for-economy/

In Review – Week 38, 2021

Global new Covid cases rose to 4mn last week – the increase from last week is primarily due to data issues and trend remains down. We would stop tracking global Covid cases from next month, barring any major developments. Global vaccine doses crossed the 6bn mark. Key market trends for last week. (1) Govt interest rates rose moderately last week, tracking global cues. (2) Foreign investor flows into the debt market remain low but +ve. (3) Corporate/ Credit spreads rose moderately last week and so far in Sep21, basis our analysis. Yet with spreads so much below normal, a modest increase does not really mean much. (4) US/ EU interest rates gained moderately but China declined given Evergrande credit crisis. (5) Gold, the risk off commodity, was flat this week. (6) The Indian/ US equity market volatility both declined last week but hide what happened during the week. Sharp increase Monday as Evergrande crisis (US$300bn debt/ loans) erupted but then consistent decline. (7) At any rate, the Indian market gained robustly even as US/ EU gained more moderately. (8) Foreign investor flows into the equity market moderated but remain +ve. (9) Energy markets were mixed – Crude Oil gained sharply as global reopening gained momentum; NatGas flat. (10) Currency markets also seemingly quite but hiding the volatility during the week.

References (writeups during past few weeks) :
https://determinedinvest.wordpress.com/2021/09/25/covid-on-the-backburner/
https://determinedinvest.wordpress.com/2021/09/17/inflation-remains-inevitable/
https://determinedinvest.wordpress.com/2021/09/11/the-corporate-debt-risk-sep21-update/
https://determinedinvest.wordpress.com/2021/09/03/equal-weight-nifty50-index-fund-2021-update/
https://determinedinvest.wordpress.com/2021/08/27/the-conviction-to-invest-for-long-term/

Determined Apparel+ Opportunities portfolio P4

The Exports equation

The last writeup in this series is focused on Apparel+ exports from India (of course we will track the portfolio on a quarterly basis). Listed India Apparel+ exporters have been on fire, with most stocks already up 50-100pc over their pre-Covid levels. Two drivers. (1) US/ EU Apparel+ demand growth has traditionally been 2-3% given these are mature markets. Currently these markets are growing at 7-8% CAGR (over 2019 base), which is extraordinary. (2) China dominates the global Apparel+ exports (>1/3rd share). Yet US/ EU retailers have realized their dependence on China and are diversifying their vendor base (dubbed the ‘China+1’ strategy). India has not benefited much so far, but the recent US decision to ban imports of China cotton from the Xinjiang region, is very +ve given India has very strong position in the global cotton supply chain already. Further, the Govt of India has launched a PLI (production linked incentive) scheme for the Textile industry, targeting value-added products such as MMF (man-made fiber) and technical textiles. Although the size of the scheme (US$1.5bn) is somewhat disappointing, we hope this is just the beginning and not the end. Large textile manufactures servicing the domestic or exporters will both benefit. However, given the strong returns already, we have been forced to be somewhat selective, reflecting in the only 20% weight to manufacturers/ exporters in our portfolio. Further, manufacturers/ exporters find it hard to deliver high ROEs given the moat is not as high as brands.

References (writeups in the series) :
https://determinedinvest.wordpress.com/2021/09/19/determined-apparel-opportunities-portfolio-p3/
https://determinedinvest.wordpress.com/2021/09/05/determined-apparel-opportunities-portfolio-p2/
https://determinedinvest.wordpress.com/2021/08/29/determined-apparel-opportunities-portfolio-p1/
https://determinedinvest.wordpress.com/2019/10/21/macro-window-india-today/

Disclaimer – Equity/ share market investing involves risks – notably the loss of principal/ capital. The discussion on any individual stock below is not a recommendation to buy/ sell the same. Any discussion on individual stocks below do not imply their inclusion/ exclusion in the portfolio (dubbed Determined Apparel+ Opportunities).

• Listed India Apparel+ exporters are on fire – led by US/ EU markets. Figure 1 presents the performance of the top listed India Textile exporters – they have been on fire, to put it mildly. Forget pre-Covid, they are hitting new highs 50-100pc above previous highs. What is driving this extraordinary performance. US/ EU Apparel+ demand growth has traditionally been around 2-3% CAGR (in US$ terms) and imports around 3-4% CAGR. Yet recall what we have continually highlighted in our inflation notes wrt these countries – large fiscal support to their consumers in the form of income support during Covid lockdowns. As Covid recedes, these excess savings are turning over to strong consumption trends. US data shows Apparel+ demand is currently running 15-18% ahead of 2019 levels (translating into 7-9% CAGR in US$ terms, which is extraordinary for a mature market). And by all expert accounts, these trends are also sustainable in the near term (long term ?). But make hay while the sun shines – and the sun shining brightly on India Apparel+ exporters for the time being.

• ‘China+1’ adds legs to what would have been a one-off. China is the dominant player in the global Apparel+ exports market with >1/3rd share. Yet China has been slowly but steadily losing ground due to multiple reasons. (1) Cost advantage is eroding as China worker wages and per-capita income has risen considerably. (2) China itself is willing to cede ground in low-value-add industries and transition to high-value-add industries (making a big push towards self-sufficiency in Semiconductor manufacturing, for example). (3) Climate reasons – Textiles and associated Chemicals industries are highly pollutive and China has aligning its Climatic goals with the world for domestic as well as export sustainability. US/ EU vendors have also realized their China dependence and have been exploring alternate sourcing geographies (broadly dubbed the ‘China+1’ strategy). Yet India has not been a natural beneficiary and has been a laggard – ASEAN nations (Vietnam, Indonesia) and Bangladesh have gained (Figure 4 likely overstates the quantum but the direction is just about right). So what has changed? Recently, US has decided to ban the use/ imports of China cotton from the Xinjiang region. India already has a very strong position in the global cotton supply chain and stands to benefit. Given the ‘China+1’ wave, experts believe (we concur) the benefit may extend beyond just fiber/ yarn and extend to value-added products (fabric/ garments).

• Textile PLI scheme to expand the base of operations. Whereas India dominates the global cotton supply chain, China has maintained such a high market share in the global Apparel+ market on the back of its strength in MMF (man-made fiber). The share of cotton in the global Apparel+ market has been coming down (also due supply/ availability challenges) in favor of MMF. The Govt of India has been launching PLI (Production Linked Incentives) schemes across industry segments and recently one has been launched for Textiles industry also. Relative to other industry PLI schemes, the size of the export opportunity and the size of the domestic industry itself, the US$1.5 Textile PLI launched disappoints. Nonetheless, one can always hope it is a beginning rather than the end. The interesting bit is the Govt has given a wide berth to the cotton value chain and instead focus on MMF and technical textiles. This opens up new vistas for the Indian Apparel+ manufacturing/ exports, and large Textile manufacturers servicing the domestic market or exporters are both widely expected to benefit. The incentive structures (7-11%) are really strong given the low profitability of the segment, but the bar of incremental sales is also high (that too in relatively new segments). We hope the Govt of India gives some thought to the blended (Cotton+MMF) value chain. Details below…

https://www.financialexpress.com/economy/pli-for-textile-govt-targets-50-laggard-high-potential-products/2215621/

• Stock selection – Home Textile vs Apparel, Domestic vs Exports. India may have a very small share in the global Apparel+ exports market (4-5%), but one segment that India dominates is Home Textiles (in US, strong #3/4 player in EU but the reason for lessor market share here is taxation). In fact, the two players mentioned in Figure 1 (Welspun India, Trident Ltd) are the leading Home Textile players out of India. And although ‘China+1’ is a great opportunity, US/ EU demand/ growth to remain strong in the near term, it may flag in the long run. At any rate, these stocks have been re-rated already. Home Textile have benefited from Home becoming the center of consumer’s attention during Covid. However with Covid receding to the background, core Apparel (Out-of-Home) demand/ growth has started picking up and is likely to strengthen further. This is true for the export market (leading variable) as well as domestic consumption (lagging variable). Our stock selection has taken these factors in account, given we are positioning this as a reopening portfolio. We have been somewhat selective with only 20% weight to manufactures/ exporters. Another reason is because they find it hard to deliver high ROEs given the moat is not as high as brands.