ValuePickr Forum

2017 Global Multi-Year Trend Reversals: Implications for Indian Markets

Ruchir Sharma - Top 10 2017 trends on NDTV with Prannoy Roy

The extent to which we agree or disagree with some of these may vary, but there is that sense of disquiet in the way the global economy changes are coming through. The direction is unmistakable, and as Ruchir says, some of these are deep-rooted changes - they wont go away easily!

So how should we as responsible investors in Indian markets think abut these in specifics and the fragile world economy in general?

Implications??
Strategies??
Tactical Responses??

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This has to sink in for a natural optimist like me :wink:

But one of the first things that struck me, even before watching these (came up in discussions with our venerable @hitesh2710 Hitesh Patel), we gotta increase reliance on Indian-opportunity focused players much more than before, now more so in our Portfolios.

In the last 4-5 years, having an export bias in the portfolio had helped much. Time now to have an inward-looking Indian Opportunity bias in the portfolio??

Tactical response :slight_smile:
Temporarily affected Consumer focused businesses that might have faced/might face for another couple of quarters the crunch - actually might see all that pent-up (deferred) demand returning eventually with a bang?

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The challenge with macro forecasting is that it is fraught with too many unknowns. Also, even if you get the forecast right, it is another matter to get the market view and the stock view right as well. A recent example is a very beautiful illustration of what I am saying.
The US markets rallied for 5 days consecutively after the presidential election. First 2 days, US markets were rising because all the polls suggested Hillary Clinton to win by a large margin. When the results came out, everybody braced for a market fall, but surprisingly markets went up straight for the next 3 days, after which I lost interest in this intriguing phenomenon and stopped tracking.

If you look at what is happening in India, with interest rates going down, it should ideally be good for equities in general and leveraged businesses in particular. Similarly, with increasing interest rates in US, implying business cycle improvement, may actually bring in good news for the export sector as well.

Personally, I think as investors, we need to wait and watch to see how things are unfolding in US and the major economies in Europe. Somehow, the portfolio investments in India from FIIs is miniscule when compared to their overall size and I don’t know how much will really get impacted or flow out.

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Actually, the good part here is that there is no forecasting by Ruchir Sharma :wink:
He has compiled and brought to the fore indisputable reversal in multi-year trends like de-globalisation, rise of authoritarian/protectionism sentiments, slowing of global capital availability, and so on including the China Ticking bomb of $4.5 in debt requirement to fuel $1 of GDP growth. (US situation pre-lehman was $3debt to fuel $1GDP growth)

It is unfair to compare major trend-reversal in global macro-economic situation to weekly or monthly market directions.

Although we have always focused on bottoms-up stock-picking it is advisable for us to become more aware/keep in our radar major macro trend reversals, and continuously ask folks much more experienced than us in the Industry - that have witnessed 3-4 market cycles - how do they read into the same indisputable trends - what are their reactions, strategies, responses??

Some of the things happen so slowly and spread over 6-9 months to a year, that this let’s watch and we will figure out strategy usually never works. It keeps getting incrementally worse …remember our reactions post Lehman collapse in 2007 and how long it took for our markets! And the continuous downslides.

I am a born optimist, the most sanguine of folks that can be (jo ho raha hai accha ho raha hai types) but personally I cant ignore the implications of a very fragile global economy around us…am quite scared, actually.

So let’s be more open to allow…for want of a better word …scenario painting/understanding implications…and then strategising, if that’s at all possible :slight_smile: Why not??

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I am not a big fan of macro forecasting because of so many variables involved in it.

But in my talk with Donald I had highlighted the probability that with the imminent impact of demonetisation, the consumer companies are likely to face some headwinds although it will be for a few months. It can range from 3-12 months according to the varying viewpoints put forward by different people. But at the end of this period, there is likely to be a huge demand for consumer items. This will be a combination of the demand which was postponed due to impact of DM and the existing demand at that point of time.

But in the immediate future which is usually where markets typically focus during weak markets, these companies are likely to post weak results which could make them undergo time/price correction or a combination of both type of corrections. And that is where I feel no brainers will emerge provided one has done some basic diligence about the companies he is interested in it and provided he has got enough cash at that point of time.

In the immediate future I think money is likely to flow to sectors and stocks less impacted by DM. Sectors that immediately come to mind for these are IT, pharma, some B2B and other companies where major chunk of revenues are from exports. But as we have seen recently IT and pharma have their own set of problems and one needs to be careful about picking stocks from these sectors as well.

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While we should lap up the generous hints, just so folks don’t get it wrong, this thread is NOT about the immediate future forecasts and our tactical responses in the near term …which can be the subject for another interesting thread…not this one :wink:

this thread is about 2017 Global Multi-Year Trend Reversals: Implications for Indian Markets (slightly edited the title for clarity)

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What I am trying to think through is whether there is any long term trend reversal at all. To answer that we need to answer what “long term” means and what “trend” we are talking about.

As for Ruchir Sharma’s thesis, there are multiple points for a contrary opinion. He talks about the 4Ds – De-population, De-globalization, De-leveraging and De-democratization. In this he talks about globalization as a 20th century trade phenomenon. In my opinion, that is an oversimplification. Globalization is an extension of the global trade that happened and finance started formally in the 15th century (courtesy the Medicis et al) in Florence and other areas. It moved from city-states to empire building and then on to nation states. Movement of capital and people has always happened in the recorded history of the world, and I don’t think a mere Trump has the power to reverse it.

So, long term of 30-50 year tranches, the thinking has to be different when compared to a long term of say 10 years.

I am not competent nor qualified enough to talk about either of the long term brackets :wink:

The simple point I was trying to make is that investment sometimes go contrary to economic perceptions (again as an example, NIKKEI has given more than double the returns than DJIA in the last 5 years and Japan is supposed to be an ageing economy with no global business leaders any more).

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On the other hand, the next few years, India seems to be on a good wicket from an economic perspective. Low(er) interest rates, large labour pool (could go both ways if we are unable to produce quality jobs), productivity improvement in agriculture and industry, better formal financial saving, large captive market.

The risks are overvaluation in certain themes which have the potential for imploding (internet startups), policy uncertainty, law and order and terrorism.

The population benefit of having a large talent pool both in India and as an “export product” is a definite trend which I don’t see easily reversible. short term xenophobia may be a cause of concern, but end of day, ageing economies would need younger people to run their industries & services. In this Japan would be an interesting case study to keep tabs on as they are a non-immigration allowing country.

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I read Ruchir Sharma’s book “The Rise and Fall of Nations” (as a light read). I continue to remain bottoms up stock picker. One of the main criteria for stock picking is that a country should have good economic fundamentals with stability in business climate, currency, policy, debt etc. Only in this background, I think stock picking can work (try picking stocks in Greece or Russia!). With this context, following are some things I found interesting -

Commodity Prices
The historical pattern for commodity prices is as follows - there tend to be a boom for a decade, then fall for next two decades. Are we looking at low commodity prices for a long time?

Working Age Population
There seems to be very strong correlation between rate of growth/decline of working age population and economic growth. A 1 percentage point decline in growth of labor force will shave about 1 percentage point off economic growth. The two contrasting cases in point are China and Japan. One of the reasons China grew so fast over so many years was increase in its working labor force (15-65 years) and decent woman participation. The one child policy now has caused this rate of rise of working population to decline and this might hit China’s growth rate. Japan’s growth slowed down considerably after its labor force growth became stagnant or declining. Many countries attracted woman to workforce, increased retirement age and have managed to improve the growth rate. India also shall do well for coming years (but will there be jobs?)

Bad Times, Good Leader
Bad times make people turn to good, reformist leader. Once this leader reforms and results start showing up, bad policy decisions start creeping in i.e. when times are good, countries turn to left and when times are bad, they turn to the right.
Ruchir’s statistics show that, when a reformist leader takes over, the country’s stock market tend to beat the emerging world average by about 30% in first three and half years. Then markets start moving sideways. As leaders get into second term, results turn out to be average.

Good Billionaires, Bad Billionaires
It is natural & healthy for a growing economy to generate wealth and to have emergence of billionaires along with it. It is important that more billionaires are emerging into innovative and productive industries (IT, Automotive, Pharma, electronics manufacturing etc.) than those in the rent seeking industries (Real estate, oil, gas etc.) which are dependent on family ties and political connections.
Creative destruction drives strong growth in capitalist society and bad billionaires have everything to gain from status quo.
Following table is an interesting one ->

Rate of Investment
The statistics tell that for fifty-six highly successful postwar economies in which growth exceeded 6 percent for a decade or more, average rate of investment was about 25% of GDP during the boom period. Anything less than 20% and more than 35% are a bad sign. When investment usually goes above 25%, money flows into unproductive industries like real estate, state sponsored companies etc. It is also important to look at the quality of investment spending i.e. whether the money is going into roads, ports, factories or whether it is going into subsidies etc.

Inflation, Deflation and Why CPI is not the Whole Story
Many emerging economies face inflation due to supply side limitation and many times this hyperinflation leads to change in governments, riots, unrest etc. Low inflation is usually good sign as it signal strengthening of supply side infrastructure. Deflation is not so straight forward as it can be due to productivity improvement (good) or due to decrease in demand (bad).
But CPI is not the whole story, it is important to track asset prices (stocks, housing) as well. Every major economic shock in recent decades has been preceded by an asset bubble e.g. Japan 1999 (Stock & Housing bubble), US 2001 (Tech stock boom), US 2008 (Housing bubble). Generally, bigger & faster the run up in asset prices, more the likelihood of the crash.

The Kiss of Debt
Just for this chapter, I would say that this book has been worth a read. The name was invented by Robert Zielinski, a bank analyst who had seen the impending Asian financial crisis. He wrote a brief paper that stated that many financial crises in the emerging world had been preceded by five consecutive years of debt growing at 20%+. Instead of writing it as a report, he wrote a play named “The Kiss of Debt”.

If the five year increase in private credit share of GDP is more 40%+, the economy is likely to face a slowdown/crisis. Conversely, if the private credit grows much slower than GDP for five years running, it creates conditions for economy to recover strongly as banks would have rebuilt stores of deposits and will be comfortable lending again.

According to McKinsey report, out of $75 trillion increase in debt since 2007, $21 trillion+ has been racked up by China. China remains a ticking debt bomb and very likely next crisis is likely to originate out of China. In 2013, the five year increase in private debt reached a record 80 percentage point of GDP.

In recent decades, recessions can arise out of debt fueled property booms just because of explosion mortgage finance business. In 140 year period in 17 advanced economies, mortgage lending has increased by factor of 8 while bank lending for other purposes has increased by factor of 3. (Affordable Housing will end in bubble?)

Another important learning is perils of “collateralized lending” compared to “cash flow based”/“repaying ability” based lending. The former lending works as long as borrowers short on income can keep getting new loans to cover their old loans - based on rising price of property or other assets.

Typically, when a bank is disbursing more money in loans than it holds in deposits and relying on outside funding to fill the gap, it signals a trouble.

Regards,
Rupesh

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Although it is a distinct possibility, just the fact that China has a near fixed currency and a command-control structure of economy, makes it all the more possible to avoid a catastrophe :slight_smile: Most of the “armchair” pundits [including me - armchair variety, I mean, not pundit :wink: ] have been wrong on China for a very long time and in my opinion would continue to be wrong!

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