This week, we explain why the Indian bond markets may be at an inflection point, summarize highlights of some great reads of the week, share insights from Uday Kotak and more. If you like it, please consider sharing and if you haven’t subscribed, you can do here to get this weekly mail directly in your mailbox. Let’s get started!
Outline
1. Market snapshot – Signs of shift to capex heavy
The week that was: While pharma remains subdued, all other indices saw gains last week with Energy (up 5.0%) and Telecom (up 4.4%) being the best performers. Power, Telecom and Energy have been top performers last month – indicating focus on capex heavy segments.
Last 6 months: Top performing sectors for the last 6 months are IT, Commodities/ Materials and Power Utilities.
2. Indian Bond markets at an inflection point – highlights from Morgan Stanley’s report
Indian bond markets lack the depth of other key economies, but that’s set to change. As per Morgan Stanley, the global bond indices are set to include India in early 2022, thus triggering significant index-related inflows.
How much inflows?
The inclusion of Indian Government Bonds (IGB) in global indices can be a game-changer and can bring in total inflows of US$ 170/250 B in this decade ($40B in 2022 and $18.5B each year) compared to $36.4B in the last decade. This would increase foreign ownership of IGBs to 9% by 2031 from 1.9%.
But what has changed now?
India has always been concerned about its macro stability and the volatility in currency due to flows in bond markets. Thus there were many limitations imposed on foreign funds. That changed in 2020 when the Budget established a program that allowed foreign investors to buy an unlimited amount of Indian sovereign bonds via the Fully Accessible Route (FAR). But what caused the change in stance?
External stability and focus on capex-driven growth
Contrary to common perception, the external position of India is stronger than reported in media. The push for capex-driven growth alongside an improvement in macro stability has set the stage for a calibrated opening up of India’s government debt market:
1. External stability: While there are challenges on growth front, the current account deficit (CAD) has has been below 2% of GDP over last 8 years, indicating lower risks from external funding. FX reserves are at all-time high (US$ 621 BN), with a comfortable import cover of 15.7 months. One interesting observation from the detailed report is that external debt in India is ~3% of total debt versus 47% for BBB rated peers.
2. The government wants to push for capex-driven growth and tapping into alternate sources of foreign saving is expected to push public capex higher in coming years.
Implication for economy
The opening of India’s sovereign bond market is expected to see strong interest by foreign investors. These bond inflows will help India’s balance of payments towards attaining surplus and might drive the INR to appreciate, if inflation comes down to normal levels.
Implications for investors
The MS report calls it “collateral gains for equities” and has identified key pockets that stand to benefit.
1. Indians banks: These inflows would flow into Indian Banks and over time, add to growth capital for Banks, help to manage interest rates by lowering SLR requirements and thus improve profitability for large private banks. MS also expects higher Treasury gains as bond yields move lower.
2. Wholesale-funded and corporate-backed NBCFs and HFCs: NBFC credit growth has been subdued after the DHFL and IL&FS default in 2018 due to lower risk appetite of debt investors. Albeit, NBFCs are a key pillar of rural growth and account for 25% of domestic credit. The opening up of the sovereign bond market can revive access to Debt capital and lower cost of borrowing. Given that NBFCs and HFCs have stronger balance sheets versus history in terms of leverage, loan loss provisioning coverage and liquidity, MS expects them to be bigger beneficiaries compared to Banks. Key beneficiaries: HDFC Ltd, Bajaj Finance, SBI Cards, Mahindra Finance and Cholamandalam Finance.
What is your view on this development? Is this really significant or another flash in the pan?
3. Visual weekly – Some interesting charts
3.1 Equity inflows in 2021 has surpassed the total inflows of last two decades
- Global equity inflows in 2021 YTD: $676 BN
- Net global equity inflows in 1996 to 2020: $179 BN
That’s bonkers. A large part of the flows have come in US technology stocks whereas the small caps are seeing fund outflows.
3.2 I came, I saw, I conquered ~ ft. UPI
3.3 Outlook is strong for structural steel tubes (APL Apollo and Surya Roshni)
Total demand for structural steel pipes is expected to grow from 4 MN tonnes in 2020 to 13 MN in 2025 and 25 MN in 2030. Source: IDBI Capital’s IC report on Surya Roshi which is a second largest player in steel pipes (after APL Apollo) and in LED lighting
3.4 Sector-wise EPS growth outlook: Advantage Auto, Capital Goods, Metals and BFSI
3.5 All the unicorns in the world are worth one Apple
4. Good reads of the week
4.1 An Essay on Investing in Small Stocks – Ian Cassel
This a nice write-up and I strongly recommend you to read it.
Quoting my favorite bits:
My investment philosophy is quite simple. I study great stocks, great businesses, and great leaders – hundreds of them. I put in the reps to develop pattern recognition and then go find them when they are small. I want to invest in undervalued companies that will get overvalued.
Combining tailwinds (top-down) and scarcity (bottom-up) become powerful drivers of returns. A tailwind is a wind that blows in the direction you are going – from horses to horse drawn carriages, to cars, to electric cars, and soon to be autonomous cars. From mainframe computers, to personal computers, to laptop computers, to computers you hold in your hand, on your wrist, and perhaps in the future linked to your brain.
Scarcity is when demand outstrips supply and prices go up and up and up.
If you ask management about 1-year goals, you get guidance. If you ask management about 3-year goals, you get strategy. You’ll be one step ahead of most investors if you can simply look beyond the next quarter.
All my winners had one thing in common, I was always averaging up. Most of my losers had one thing in common, I was always averaging down. Holding losers is easier than holding winners. Why? Because losers always look cheap. Holding winners is not easy. You will have to hold while the stock doubles in a year. You will have to hold as the stock pulls back 50% from its highs.
4.2 Is Warren Buffet truly a value investor?
Popular media portrays Warren Buffet as purely a “Value Investor” who just invests & holds businesses which have a great potential and are available at great value. This interesting article ‘ The many myths of Warren Buffett’ digs deeper and explains how Berkshire has functioned more like a hedge fund manager – Derivative trades to take advantage of the short term opportunities, distressed investing and more.
4.3 Are your really sorted out by Anand Sridharan.
If you love both cricket and investing you must read this. Investing has a broken scorecard – the link between process & outcome might deviate in short run, but you gotta stick to it. Extract:
5. Video of the week
Highlights from Udayan Mukherjee’s interview with Uday Kotak
Udayan Mukherjee is back (with Business Today) and I couldn’t help notice the glee on the face of the many popular guests he interviewed last week – Uday Kotak, Shankar Sharma, Samit Arora and Byju Raveendran. Some notes on the talk with Uday Kotak
- Can’t classify companies as over/under valued based on the noise in the market. Facebook saw skepticism when it listed at 20 Bn$ but now it is a trillion $ company. Only a limited number of companies will be able to sustain.
- Geographical barriers are now history and India needs to focus on education so that it can benefit from the technological era.
- Covid has bifurcated fundamentally strong financial institutions that have easy access to capital from weaker institutions for which availability of capital has become difficult. Here is how the Banks compare – Kotak has a clear edge.
- Believes in the potential of cryptocurrencies: Crypto is like the digital gold mainly based on perspective & trust, it can evolve as a relevant asset class in our country if controlled well by regulatory bodies.
- Discount brokerages have done well by attracting a lot of new investors but emphasis should be more on nurturing the existing customers (so that they don’t exit the market after experiencing a downturn) rather than only focusing on capturing new customers.
6. Tweets of the week
Happy weekend!