Undue reverence for company founders harms Indian firms

The wider economy suffers, too

THE chairman of Microsoft, John Thompson, occasionally reminds one of its directors, a fellow by the name of Bill Gates, that his vote in board meetings is no more or less important than that of other members. Contrast that with Infosys, an Indian technology firm, whose own retired founder succeeded in getting its boss to quit on August 18th, after a months-long whispering campaign (see article). The board was dismayed, but the outcome was all too predictable, given India’s penchant for treating corporate founders as latter-day maharajahs.

Indian companies come in all shapes and sizes, from clannish outfits whose tycoon bosses routinely stiff minority investors, to giants like Infosys whose corporate governance (usually) matches Western norms. What unites them is that they accord undue deference to “promoters”, as India dubs a firm’s founding shareholders. The exalted status bestowed on promoters is a pervasive feature of the Indian corporate landscape. Of the 500 largest listed Indian firms, according to IiAS, an advisory firm, 344 are controlled in practice not by boards answerable to all shareholders, but directly by promoters.

Founders can exert unhealthy influence over Western firms, too, but they typically do so using their shareholdings. The sway exercised by Indian founders has its roots in a unique mix of moral suasion, regulatory advantage and the trickiness of doing business in India. In many industries, the promoter has relationships with people who matter. Only he knows which palms need to be greased to keep a power plant open, or which union boss has to be co-opted to avoid strikes. This knowledge makes the promoter central to the running of the firm, even if it belongs mostly to other shareholders.

Sometimes that leads to dominant promoters bilking the firms they run. They give family members juicy contracts, pay themselves excessively and get the firm to provide private yachts, London flats and much else besides. United Spirits, a booze firm promoted by Vijay Mallya but owned mainly by outsiders, used to pay for 13 properties for him and his family (he is now in Britain, trying to avoid extradition to India).

The promoter’s perch is bad for the companies themselves, and not just their shareholders. It is harder to recruit good managers when power lies elsewhere. Balance-sheets get stretched as investment is funded more by debt than equity—because debt is cheaper and promoters can thereby avoid being diluted to the point of losing certain privileges.

Promoter power is also bad for the economy. Inefficient firms that should be taken over by a rival stumble on, as promoters seek to preserve their perks. The promoter culture is partly to blame for the nearly one-fifth of all loans made by Indian banks thought unlikely to be repaid. When promoter-led firms cannot service their debts, dominant owner-bosses tend to skip repayments. They understand that banks cannot easily foreclose on them and later hope to sell the firm on, because any new owner would lack a promoter’s hold over the business. This has harmed the Indian banks and, in turn, the finances of the government that owns many of them.

Demotion guide

Promoters will not willingly give up their power. But others can help limit it. The original owners of companies will soon account for less than half of the shareholdings of India’s largest listed firms, down from 59% around a decade ago, according to IiAS. Much of the rest has been picked up by domestic institutional investors such as insurance companies and mutual funds . These investors have a duty to stand up to promoters, no matter how rich or politically connected they may be. Institutions should act as owners continuously, not just during a crisis. They should recognise the pre-eminence of boards of directors that represent all shareholders. And they should demand higher returns from promoter-dominated firms, in recognition of the higher risks.

The tide has begun to turn against promoters. Newish rules force them to secure a majority of minority shareholders’ approvals in some instances. Authorities are leaning on banks to restructure defaulting firms’ debt, or push them into insolvency. Some tycoons have had to sell prized assets to keep afloat, a once unthinkable affront. Founding shareholders can be a resource for a company, but only if they know their place—in the boardroom, perhaps, but not on a pedestal.

Making money in the subcontinent

As it gets easier to do business, it will get harder to earn huge profits

 

IF YOU run a big firm in India you must straddle different worlds. The country’s leading bosses can wax lyrical about artificial intelligence and debate returns on capital with foreign fund managers. But they have also mastered India’s poor infrastructure and huge informal economy. Shiny campuses sit beside open sewers. Millions of customers can be reached only by dirt tracks. Suppliers and distributors often operate in the shadows. In a typical month an Indian boss might have wheatgrass shots in Silicon Valley, slug bootlegged single malt with a local politician and sip masala chai from clay cups with villagers.

India’s gross domestic product (GDP) is the world’s seventh-largest and its stockmarket the ninth-biggest, but the country is like no other major economy. The informal sector accounts for about 50% of output, 80-90% of jobs and at least 90% of firms. Red tape and bad roads mean the country comes 130th in the World Bank’s ease-of-doing-business rankings.

However, firms that overcome these challenges are exceptionally profitable. Since 2001 the return on equity (ROE) of listed Indian firms has averaged 19%, eight percentage points above the figure for companies in rich markets and five percentage points above those in emerging ones.

India is a terrible and brilliant place to do business. Just as investors talk about a “Korea discount”, to describe chaebols’ lousy profits, so there is an “India premium”. The leading private lender, HDFC Bank, has an 18% ROE, ranking tenth among the top 100 global lenders. Hindustan Unilever, a consumer-goods firm, has a 77% ROE, over twice that of its parent, Unilever. Even in basic industries, such as cement, returns have been relatively high.

This record reflects good management: most firms know how to allocate capital well, unlike their profligate Chinese peers. But India’s informality and bad infrastructure also create obstacles for new entrants. Inputs such as capital, land and energy can be nightmarishly hard to secure. It takes 10-20 years to build dense national supply chains and distribution networks. For example, Maruti-Suzuki, the biggest car firm (with a 22% ROE), has over three times more dealerships than its nearest competitor.

Now, a quarter of a century after India first liberalised, the pace of formalisation is picking up. A breakthrough came in 2012, when the courts began to crack down on crony capitalists, especially firms that used graft to get access to natural resources and land. Now a new stage is in full swing, says Sanjeev Prasad of Kotak, a bank (14% ROE). A new value-added tax, known as the GST, requires firms to reconcile their tax returns with those of their suppliers and customers, forcing millions of companies into the tax net. The GST is complex but replaces a patchwork of local taxes, helping to create a single national market. A government decision to retire old bank notes at the end of 2016 has made it riskier to hoard illicit cash. E-commerce accounts for only 3% of retail sales but provides a new way to distribute products. New digital identities for all Indians mean that more can open bank accounts.

Measuring the share of economic activity that is informal is tricky. Still, the signs are encouraging. In the past year there has been a 13% increase in formal savings such as bank deposits, life-insurance policies and mutual funds. Cash in circulation has fallen from 12% of GDP to 10%. The value of digital payments have risen by over 40% and the number of taxpayers has almost doubled.

Make no mistake: parts of India are in a time warp. The north and east of the country lag behind. Courts have a backlog of 30m cases. Nonetheless, formalisation is happening. Firms of all sizes are responding to the GST: one fund manager recalls meeting a huge poultry business hidden away in Chhattisgarh, a remote state, which is planning to come into the tax net.

For tens of millions of informal firms—shoe factories, plywood manufacturers, drinks wholesalers supplying roadside stalls—tough times are ahead. If they stay in the shadows they will be cut out of formal firms’ supply chains. If they enter the formal economy, their tax costs will climb. Some will fail, causing unemployment to rise. Others will consolidate. For example, the fragmented haulage industry could merge into a few big firms that take advantage of a single national market. They may also take out more formal loans to lease trucks.

For big companies, formalisation could boost profits in the short term. They may take business from smaller firms: at least 40% of India’s tea, 85% of its jewellery and 70% of its dairy products are sold in the grey economy. Tata Steel, a metals producer, has said it expects to gain market share from informal smelters.

However the risk is that the “India premium” eventually crumbles along with long-standing barriers to entry. The assault on crony capitalism, along with lower commodity prices, has already reduced the ROE of listed Indian firms from 26% in 2006 to 13% (this is still well above the 11% global average). At least half of this fall is due to a slump at firms with reputations for graft, which often operate in the basic-materials, infrastructure, property and energy sectors—and the state-owned banks that financed them.

An uncomfortable seat in the premium economy

In most consumer-facing industries, returns remain high. But in the long run big Indian firms may be hurt by better-functioning markets for capital, land and natural resources, as well as more efficient supply and distribution chains. The advantages that they have assembled over years could be eroded. To maintain high profits, they may have to spend more on innovation.

Investors don’t seem to be thinking about this much. India’s stockmarket is valued at three times book value. That makes it the dearest big market in the world and implies, roughly, that long-term ROEs will be 17-20%. India’s consumer-facing firms trade on higher multiples of their profits than Facebook or Alibaba, and its best banks are not far behind. Formalisation is a giant step forward for India’s economy, but investors could be in for a shock.

This South American “Oil Fire Sale” Will Play Right Into China’s Hand

As a leading consultant on the global energy markets for over 40 years, Dr. Kent Moors knows what the industry’s biggest players are really doing. His clients include the world’s top oil companies and 20 world governments. Today, Kent’s bringing you expert analysis on the situation that’s unfolding in Venezuela right now… and how this could present an excellent financial opportunity for you.

Venezuela is now on the brink of total collapse. As you’ve seen before, national oil company PDVSA looms large in this unfolding crisis.

The focus is the company’s ability to pay bond interest due in two months. Doing so is crucial. But, that prospect is dwindling.

Along with it goes the ability of the central government to administer an entire population and avoid the country descending into outright civil war.

And PDVSA is at the center of it all.

Now, there’s talk of U.S. sanctions on PDVSA in particular.

Here’s how that may play right into Russia’s and China’s hands…

This is Venezuela’s Oil Supermarket

PDVSA is the vehicle for about 90% of Venezuela’s trade revenue and has served as a primary outside purchaser of all manner of staple commodities essential for the literal survival of a domestic economy rapidly sliding into oblivion.

While charismatic Hugo Chávez was in power, PDVSA was required to spend foreign hard currency export proceeds held outside the country to acquire food for import into Venezuela.

It prompted a colleague of mine at PDVSA to lament: “I thought we were an oil company, not a supermarket.”

Paying for the purchases abroad was supposed to minimize the adverse impact of exchanging currency under oppressive domestic inflationary pressures and a fractured infrastructure.

What it actually did was undermine any ability to use PDVSA’s revenues to buttress an increasingly insolvent central budget.

It also wasted money, as food was purchased and then transported through intermediaries at exorbitant prices. PDVSA, after all, operates oil tankers, not cargo vessels.

Nicolás Maduro, Chávez’s successor, complicated the matter even further by regularly raiding PDVSA coffers to pay for a wider range of imports, tied fundamentally unstable sovereign debt issuances to PDVSA bond futures, and relied on accelerating heavy-handed responses to local unrest.

As the crisis worsened, life in the streets became unbearable.

Contacts tell me that the few retail establishments in Caracas that managed to remain open often wouldn’t decide on the actual price of goods and services until you reached the counter.

Inflation was just that high, and the effective market value of the bolivar, the local currency, moved that quickly.

It reminded me of when I was living through Russia’s currency devaluations. A dollar went a long way in Moscow then, and in Caracas now.

As Maduro’s repression increased, America launched some initial sanctions. Another, more concerted round came in response to Maduro replacing the National Assembly (controlled by the opposition) with a new legislature more bound to his will.

Washington is now eyeing PDVSA specifically for sanctions, threatening, among others, to restrict or eliminate U.S. exports of lighter oil to PDVSA.

These exports are required to allow the processing of the much heavier oil from Venezuela’s Orinoco oil basin.

This area on either side of the Orinoco River may hold the largest oil reserves in the world.

But this is very heavy oil. I can personally attest to this. Years ago, I put some of this in the palm of my hand, turned the hand over, and it just sat there.

This oil makes molasses set speed records. It’s much more expensive to extract and process, requiring expertise and technology generally available only in the West.

If Venezuela were to lose the ability to process its oil products, the country’s domestic markets for gasoline, diesel, and other distillates would collapse. The resulting knock-on effect is certain to escalate inflation and make basic life intolerable.

And that’s not the only way in which PDVSA is under increasing pressure…

Russia is Silently Taking Over

The company has been delaying payment of vendors and in some cases even wages.

It’s also been unable to meet contract obligations at terminals in the Caribbean, forcing the introduction of storage and transit agreements that further increase costs and reduce revenues.

That has set the stage for one heck of a fire sale.

Russian companies have been moving in to cherry pick PDVSA assets. So far, the biggest prize – the large refinery complex on the island of Curaҫao – remains in PDVSA hands.

But it’s unknown for how long the company will be able to maintain an increasingly onerous working capital requirement.

Meanwhile, Rosneft, Russia’s largest and state-controlled oil producer, has been acquiring upstream and midstream assets inside Venezuela in return for a combination of straight payment and/or assumption of debt.

PDVSA desperately needs the funds, but Rosneft’s largess is not inexhaustible. And all of this still requires the expensive development of the Orinoco and its heavy oil.

Neither PDVSA nor Rosneft can shoulder this burden for long, especially at today’s global oil prices.

Nonetheless, control of upstream operations in Venezuela can provide Rosneft with contract swaps and targeted market penetration.

Years ago, five Russian oil majors set up their own joint venture to participate in the Orinoco along with PDVSA. There was also a joint investment bank established in Caracas for the same purpose.

The venture collapsed and the bank languished. But they remain and can be resurrected on short notice.

The other likely outside beneficiary of this fire sale is China.

U.S. Sanctions May Play Into Russia’s and China’s Hands

Chinese companies have moved into Venezuelan upstream activities as well. However, here the primary play has been to control oil export revenues.

Beijing does this through repayment of large loans provided both PDVSA and the Venezuelan government. In an approach already used in Brazil and especially in Ecuador (the smallest OPEC member, where the Chinese now control oil payments), exports no longer return to the Chinese mainland.

Rather, they move anywhere national oil company Petroecuador (in the case of Ecuador) can attract the best price. But most of the sale proceeds are transferred into accounts under Chinese control.

Here as well the Chinese may make use of the oil investment bank in Caracas. Both China and Iran were parties in the bank’s creation, although aside from some Chinese correspondent accounts, foreign use of the bank has largely been Russian.

Washington needs to keep this in mind when determining the next sanctions. Coming down on both Maduro and PDVSA by assaulting oil may simply further Russian and Chinese plans already underway, pushing Venezuela further into their arms.

Swedroe: Grading The Forecasters ( Badly needed for Indian business news channels)

The financial media tends to focus much of its attention on stock market forecasts by so-called gurus. They do so because they know that it gets the investing public’s attention. Investors must believe such forecasts have value or they wouldn’t tune in. Nor would they subscribe to various investment newsletters or publications that, like some, claim to provide you with “news before the markets know.”

Unfortunately for investors, there’s a whole body of evidence demonstrating that market forecasts have no value (though they supply plenty of fodder for my blog)—their accuracy is no better than one would randomly expect.

For investors who haven’t learned that forecasts should only be considered entertainment (or that they may fall into the more nefarious category of what Jane Bryant Quinn called “investment porn”), they actually have negative value because forecasts can cause such investors to stray from well-developed plans.

Empirical Data On Forecasting

A new contribution to the evidence on the inability to forecast accurately comes from David Bailey, Jonathan Borwein, Amir Salehipour and Marcos Lopez de Prado, authors of the March 2017 study “Evaluation and Ranking of Market Forecasters.”

Their study covered 6,627 market forecasts (specifically for the S&P 500 Index) made by 68 forecasters who employed technical, fundamental and sentiment indicators. The sample period is 1998 through 2012.

Their methodology was to compare forecasts for the U.S. stock market to the return of the S&P 500 Index over the future interval(s) most relevant to the forecast horizon. The authors evaluated every stock market forecast against the S&P 500 Index’s actual return over four time periods—typically one month, three months, six months and 12 months.

They then determined the correctness of the forecast (i.e., whether the forecaster has made a true or false forecast) in accordance with the time frame for which the forecast was made. Because of the more random nature of short-term returns, they weighted the forecasts as follows:

• Up to one month: 0.25
• Up to three months: 0.50
• Up to nine months: 0.75
• Beyond nine months (up to two to three years): 1.00
• If the forecast does not include a time frame, or unless there is an impression stating otherwise: 0.25

Following is a summary of the authors’ findings:

• Across all forecasts, accuracy was 48%—worse than the proverbial flip of a coin.
• Two-thirds of forecasters had accuracy scores below 50%.
• About 40% of forecasters had an accuracy score between 40% and 50%.
• About 3% of forecasters fell in the left tail, with accuracy scores below 20%.
• About 6% of forecasters fell in the far right tail, with accuracy scores between 70% and 79%.
• The highest accuracy score was 78% and the lowest was 17%.

The distribution of forecasting accuracy by the gurus examined in the study looks very much like the common bell curve—which is what you would expect from random outcomes. That makes it very difficult to tell if there is any skill present.

Famous Forecaster Scores

There were many well-known forecasters among the results. I’ve highlighted 10 of the more famous, most of whom I’m sure you’ll recognize, along with their forecasting score:

•  James Dines, founder of The Dines Letter. According to his website, he is “truly a living legend … one of the most accurate and highly regarded investment analysts today.” His forecasting accuracy score was 50%. Not quite the stuff of which legends are made.
• Ben Zacks, a co-founder of well-known Zacks Investment Research and senior portfolio manager at Zacks Investment Management. His score was 55%.
• Bob Brinker, host of the widely syndicated MoneyTalk radio program and publisher of the Marketimer newsletter. His score was 46%.
• Jeremy Grantham, co-founder and chief investment strategist of GMO, a global investment management firm. His score was 42%.
• Dr. Marc Faber, publisher of the Gloom, Boom & Doom Report. His score was 39%.
• Jim Cramer, host of CNBC’s Mad Money. His score was 37%, finishing in 50th place.
• John Mauldin, well-known author. According to his website, “his individual investor-readers desperately need to know what his institutional money-manager clients and friends know about the specific investments available to help them succeed in challenging markets.” His score was just 36%.
• Gary Shilling, Forbes columnist and president of A. Gary Shilling & Co. His score was just 34%.
• Abby Joseph Cohen, recently retired from her position as president of Goldman Sachs’ Global Market Institute. Her score was just 34%.
• Robert Prechter, president of Elliott Wave International, publisher of the Elliott Wave Theorist and the author of multiple books. He brought up the rear, with a score of just 17%.

Of course, there were a few forecasters with fairly good records. But only four of the 68 gurus posted scores at or above 70% (among them was David Dreman), and just 11 in total had scores above 60%.

Yet 18 forecasters had scores below 40% (versus just the 11 with scores above the 60% mark), and five had scores below 30% (compared with just four with scores above 70%). It’s also important to keep in mind that strategies based on forecasts have no costs, but implementing them does.

Hindsight Is 20/20

As the authors noted, while some forecasts turn out to be uncannily accurate, others lead to significant losses. Unfortunately, it’s extremely difficult to determine ahead of time which will prove accurate. And if you pay attention, even those who provide the forecasts have admitted the difficulty (though they get paid a lot of money to ignore the evidence).

Here’s what Barton Biggs, who at the time was the director of global strategy at Morgan Stanley, had to say: “God made global strategists so that weathermen would look good.” Keep this in mind the next time you find yourself paying attention to some guru’s latest forecast. You’ll be best served by ignoring it.

As I point out in my book, “Think, Act, and Invest Like Warren Buffett,” that’s exactly what Buffett himself does, and what he advises you to do—ignore all forecasts because they tell you nothing about the direction of the market, but a whole lot about the person doing the predicting.

Patanjali’s retailing empire now has competition from another spiritual guru

Patanjali’s retailing empire now has competition from another spiritual guru. Sri Sri Ravi Shankar, founder of the Art of Living Foundation, will open about 1,000 retail stores to sell ayurvedic toothpastes and soaps, reflecting the increasing demand for herbal products across India. 

Sri Sri, who has been honoured with the country’s second-highest civilian award, will also launch clinics and treatment centres in a striking resemblance to the retailing strategy of Baba Ramdev-led Patanjali, the surprise and successful challenger of hitherto MNC (multinational corporation) dominance in India’s consumer industry. 

The debut list of products will include toothpastes, detergents, ghee and cookies. “People have now accepted ayurvedic products in their daily lives, and we believe our brand offerings are different compared to those of existing players,” said Tej Katpitia, chief executive of Sri Sri Ayurveda (SSA) Trust, the FMCG (fast-moving consumer goods) establishment that will open ‘Sri Sri Tattva’ branded stores. 

The company has already been selling health drinks, soaps, fragrances and spices since 2003 through modern retail stores and online, but will now enter several food and home categories expanding its portfolio to over 300 products. The company makes these products in-house at three manufacturing units in India. 

 

“Through clinics, we can carry the entire expertise of the brand in traditional ayurveda diagnosis. We don’t intend to compete with any player and instead grow the ayurveda market,” added Katpitia. 

RIVALS UNITED 

Similar to the cluster strategy at malls that club together the same category of stores, the majority of Sri Sri Tattva stores could be near Patanjali’s outlets, although with relatively premium positioning and formats. 

“The first store will be launched next month with plans to open 50 doors by November. The aim is to have a billion dollar business in the next few years,” said Gaurav Marya, chairman of Franchise India Holdings, a retail solutions provider that is helping the company get franchise partners. 

Patanjali’s rise to a Rs 10,000-crore company in less than a decade has made most MNC rivals shift their focus to the herbal sector. 

Hindustan Unilever has relaunched Ayush brand of ayurvedic personal care products, acquired Indulekha hair care brand and launched Citra skincare brand. Similarly, L’Oreal launched a hair-care range under the Garnier Ultra Blends made with natural ingredients. 

Dabur launched India’s first ayurvedic gel toothpaste under the Dabur Red franchise to contemporarise ayurveda for the younger generation. Indigenous manufacturers are driving the natural personal-care market, which is fast-expanding. 

ADVANTAGE INDIA 

“Consumers are drawn to Indian brands when it comes to naturals, under the assumption that manufacturers of these brands use ‘common kitchen ingredients’, making it safe for consumption and less likely to result in side effects or allergies,” said a recent Nielsen study. 

Homegrown companies account for about 79% of India’s natural personalcare market. Brands using natural ingredients now make up more than a fifth of the country’s oral-care market. 

A 2016 report by brokerage house Edelweiss said SSA is riding on the brand equity of its founder and has a huge captive base — 370 million followers across the world. But the company’s muted success to date is due to limited distribution and brand visibility. SSA is beginning to use mass media, point of sale advertising and decent digital presence, including Amazon, Big Basket and its own website. 

Unlike Baba Ramdev, who is personally involved in marketing the products, Sri Sri will not be the face or brand ambassador, the company said. “Brand quality and product benefits will drive sales,” said Katpitia.

The Greatest Ever Global Equity Bull Run is Finally Over?

Our World of Spirituality  

 

In accordance with the wishes of our readers we would want to talk about "hope" today.  

 

Hope and positivity is a state of mind that we consider central to the concept of human and spiritual life, the way we see it. However, depending on where we are in our spiritual journey, "hope" may have many different connotations and implications. If hope to us is not about a certain defined outcome or a possibility; rather, it is about life in general and our continued state of happiness, and of those around us, we are truly evolved beings. For such blessed individuals, hope may not have any genesis or any logic or basis. Hope for them is not a means to an end, not even a good omen. It is almost an end in itself. To them it is a barometer of their spiritual health and they feel blessed and privileged just to be able to live their hope. 

 

On the other hand, if we are sitting at the top of Maslow's need hierarchy, and we have access to practically all of the world's material pleasures, and yet, our hope remains tied to a defined outcome or a certain event, we certainly need spiritual help; we need to seek knowledge, health and consciousness and find true happiness which clearly, and almost by definition, eludes us.  

 

For all of us teeming millions and billions who are still in the midst of their journey up the needs' hierarchy, it is perfectly healthy, and even spiritual, to have our hope tethered to a certain expectation or a certain outcome. We believe that experiencing "ample" amount of worldly and material pleasures is a precondition for most of us to rise above these worldly pleasures and to become truly eligible to seek true happiness and bliss (only super humans like Mother Teresa are  exceptions to this). We, as a humble representative of these billions, seek the following blessings from our readers: 

 

Bless us that, "In the face of an overwhelming defeat (or even death) we should not lose our hope; and in the face of a resounding victory, we should not lose our humility". 

 

While we make the journey up the needs' hierarchy, we would continue to be, at the very least, mindful of our consciousness and our spirituality. This will greatly empower us on our way up and also provide the necessary cushion and strength, as and when we stumble at times, and as we inevitably lose some of our life's battles on the way.     

 

And now back to the markets! 

 

It is not just the end of a bull phase that we ponder about. This is the end of an era in world history and will result in paradigm shifts not just in the financial markets but in just about everything else. We believe that it is not just the US Bull Run since Trump election or the EM Bull Run since January 2017 that has peaked out. It is also the great Bull Run since March 2009 that has come to an end. It is also the even bigger global equity Bull Run since 1984 that is now over. We believe that the Super cycle since 1932 is over too. Even the Grand Super cycle since the South Sea crisis of 1720s has come to an end. In fact, we have come to believe that the Grandest Super cycle Bull Run, that has been on since the dawn of Capitalism/ Mercantilism in the 16th century, is beginning to turn its back on us.  

 

The rise in equities has been so relentless and so overwhelming that we now consider it nothing short of our birthright to be in good times for our entire lifetime. The Great Depression of the 1930s sounds so primitive and so pre-historic; and the current times so sophisticated and so nuanced that an economic depression in the current context seem to be nothing more than a hallucination of the mental wrecks. The Great Recession of 2008-09, which in economic and historic terms was a “blink and you will miss it” type of phenomenon, only strengthened the belief that we are now complete masters of our economic destiny. We have come to believe (history will obviously prove 

August 8, 2017 

 

 

us wrong) that we can now prevent “primitive” phenomena like economic depression from happening through clever and deft maneuvering of our economics and politics (read: Greenspan put, Bernanke put and now the Yellen put).  

 

What we have seen in the last few weeks and alsothe last few months is nothing but a grand finale to this long era of relentless economic boom. And what a spectacle it was! The CBOE VIX has been below 10, no less than 36 times in 2017. To put things in a perspective, VIX has been below 10 a total of 18 times in 23 years from 1993 to2016. This is just one data point which goes to prove how stubborn and complacent this Bull Run has been, particularly so in 2017. There are countless such indicators that we see in the financial markets and we would be happy to share those with you in a separate newsletter.  

 

We believe that the peaks made in recent days by a vast majority of global indices will not be violated in a long long time. These peak levels and the associated dates would probably go down in history as the symbol of an era gone by. For your ready reference, we present a table below, with these levels and the dates. We expect at least 80% of these indices to not violate these levels for years, if not for ever (some may go a shade higher in next few days though). 

 

Index High Date High Level Russia 02-May-17 4472 Bovespa 23-Feb-17 69487 DJT 14-Jul-17 9763 Russel 2000 08-Aug-17 1521 Turkey 08-Aug-17 110322 Pakistan 25-May-17 53127 HSCI 02-Aug-17 11147 Dow Jones 08-Aug-17 22179 S&P 500 08-Aug-17 2488 Nasdaq Com 27-Jul-17 6460 South Africa 04-Aug-17 5577 DAX 20-Jun-17 12951 FTSE 02-Jun-17 7598 CAC 09-May-17 5442 Hangseng 08-Aug-17 27799 Kospi 24-Jul-17 2451 Sri Lanka 14-Jul-17 6769 Singapore 27-Jul-17 3354 Shanghai 02-Aug-17 3305 Shenzen 02-Aug-17 3784 Taiwan 08-Aug-17 10619 Philippines 27-Jul-17 8106 Nifty 02-Aug-17 10137 S&P BSE Small Cap 26-Jul-17 16186 S&P BSE Mid Cap 08-Aug-17 15642 Jakarta 22-May-17 5910 Australia 12-Apr-17 5947 Canada 30-May-17 15792 

 

 

 

We also believe that the global financial markets are now starting a phase which will mark the beginning of the end of the great Bull Run. We expect to see a 15-20% kind of correction across equity indices within the next 10 weeks. Of this, the next 6 weeks are the ones to really watch out for. 

 

EM carry trade to end in tears, yet again 

 

The EM carry trade has, eventually, always ended in tears over the last 3 decades. The fate will probably be the same this time around. In fact, the sheer conviction and the air of infallibility about the EM carry trade participants this time, is something like we have never seen before. We kind of agree with them when they say that it’s going to be different this time. That difference however, is not that the carry trade this time will go on for ever (something that they totally believe in). The difference is that this time, it will not end in tears of water, but of blood! The time to exit is NOW! 

 

We expect EM currencies to lose about 10-15% against USD over the next 3 months. EM currencies of countries like India, South Africa, Mexico, Brazil, Indonesia, Philippines and South Korea may be among the worst affected. 

 

We also expect a selloff in the bond markets of all EM countries. The sell off could be particularly intense in countries where the 10 year government bond yields are in excess of 5%. The usual suspects include India, Indonesia, Brazil, Turkey, South Africa, Mexico, Russia and Colombia. 

 

The Dollar is not toilet paper; not yet!   

 

US dollar has become a very convenient and potent weapon, of late, for the rampaging “risk on” bulls. Every major fall in dollar is cheered by the US equity markets, because the earnings of American companies get a boost by a cheaper dollar. And guess what; it works well for other geographies too. This is because with their rising currencies, even more money gushes into their financial markets from overseas, and creates an even bigger bubble in their already inflated equity and debt markets. Never before in the history of financial markets has such a conveniently synergistic, opportunistic and self fulfilling prophecy been taken to such insane extremes as it’s been done this time around. The consequent outsized gains across geographies are being relished by traders the world over. “Free Lunches”, it seems, are not a taboo any more in the financial markets! 

 

The bills for those lavish “Free Lunches” will finally be presented, after all. That time, in our opinion, has arrived. This would come in the form of a sharp rise in the dollar index, which will inevitably accompany the ensuing wave of global “risk off”. When the global “risk off" wave reaches its crescendo, the currency markets would hear the threatening roar of the lion (read: US dollar) in a jungle; or experience the havoc wreaked by an elephant in a china shop.  

 

We expect the dollar index to climb back to 98-99 levels from the current 93 levels. The worst affected currencies will be Euro, AUD, CAD and almost all EM currencies. This flow of money back to the US will accentuate the negative feedback loop between the world’s currency and equity markets and roil both the equity and the debt markets the world over.    

 

Crypto currencies: End of the Road 

 

Crypto currencies, particularly the Bitcoin, started off as virtual alternatives to fiat currencies, many of which, in 2009, looked doomed because of zero interest rates and the relentless quantitative easing. However, of late, many of these virtual currencies have evolved into being safe havens for the unobtrusive denizens of the dark web. Their rampant misuse as mediums of exchange for the nefarious activities of extortionists and criminal hackers is surely going to attract regulatory attention.  With the rising dollar index and the imminent fears of a multilateral regulatory crackdown, we expect crypto currencies to get the rough end of the stick over the next one year. A 90% fall will certainly not be out of line. 

 

 

 

 

EM Equities: Massive underperformance ahead   

 

EM equities have had a dream run in the last seven months. This trend however, seems to have come to an end last week and we do not see most of the EMs making higher highs in the coming days. Over the next 6 weeks, the fall in EM equities could be much more compelling and stark than their Developed world counterparts. While some may get away with a mere 10-15% fall, many others may have to brace themselves for a 20% or even 25% fall. 

 

VIX has bottomed out forever! 

 

We waited a quarter of a century (since 1993) for VIX to come below 9. It did that about 10 days back for the first time after December of 1993. We believe that we may have to wait for at least a 100 years, if not for ever, for the VIX to come below 9 ever again.   

 

Industrial Commodities: Sharp falls ahead 

 

We are getting extremely bearish on Industrial commodities because of multiple factors. Over the last few months, they have had multiple home runs thanks to the falling Dollar index, the great “risk on” rally the world over and great data from China and pretty much everywhere else. The Bull Run in industrial commodities seems to have completely run its course by now. As each of the above positive factors reverse, industrial commodities are slated to begin their most severe bearish phase post January 2016. We see declines of 15-25% over the next 3 months. 

 

The Probability Distribution: 

 

We would assign a probability of 90% to a massive “risk off” phase happening over the next 6 weeks. The probability that a mere correction will happen instead of a full blown reversal is about 9%; the balance 1% being the chances of markets going yet higher over this period. 

 

Bears: Lonely at the bottom   

 

Bears have been so completely massacred this time around that when a bear is unable to camouflage his real identity (believe us when we tell you that they just have to these days) any more, his business associates start worrying about his solvency! It has become hard to even imagine a bear who is not bankrupt or is, at the very least, not in serious financial difficulties. We cannot think of any parallel to this phenomenon in the history of global financial markets. Most of the bears have happily converted into bulls over the last few months and seem to be now basking in the glory of their new found wisdom (and success).  

 

The very few surviving bears are absolute diehards and will probably end up multiplying their capital, or what is left of it, at least a 100 times over the next few years. Yes, you figured it out. Somebody would need to put in a paltry sum of US$ 10 Billion to be the only Trillionaire ever to walk this planet! 

 

We believe that the bulls are nowhere near as much of a genius, as invincible or as infallible as they seem to be after these eight and a half years of scorching Bull Run; nor are the remaining bears as foolish or as dumb witted or as hapless as seem to be, at this point. In fact, we believe that the biggest mean reversion in the history of financial markets is not going to happen on the global equity indices; rather it is going to happen in the general assessment of the capability quotient of bulls/bears! 

 

On the sidelines - Is China going to be the next global super power??? 

 

With the American influence in global politics clearly on the wane under Trump, there have been many suggestions that China may gradually ease into the position that US seems to be vacating. We find the suggestion quite laughable.  

 

 

 

First things first; nobody can take away from the fact that, considering its size and population, China's economic rise of last four decades is absolutely unprecedented in world history. However, it would be pertinent to point out that no country in history has ever become a global superpower without being at the cutting edge of innovation, technology and enterprise. This was true of the Greeks, the Romans, the Arabs, the Dutch, the English and finally the Americans. When we checked last, China was not yet at the cutting edge of innovation and technology, except may be when they are designing the cheapest copycat version of a recent American invention! When we checked last, China also didn’t seem to be at the cutting edge of enterprise, except, may be, when they are playing at the Macau casinos! Probability of China becoming a global superpower anytime over the next 500 years is about as high as that of US becoming a banana republic! We may wish to believe it, but it’s not gonna happen; with or without Trump. In the meanwhile, the kids from the most influential American families will continue to learn Mandarin. And, if they are lucky enough to have a grandfather named Trump, they may even get to recite poems in Mandarin to the visiting Chinese President! 

 

On the sidelines - End of the road for the Republican Party?? 

 

The Trump presidency will cost the Republican Party very dearly. The fact that under their watch, a complete ass of a man got elected to the White House and the fact that he is allowed to disgrace the entire American civilization with such callous impunity will reverberate through the country’s politics and society for a long long time. Many of the Congressional Republicans have started to shun him and his shenanigans, as is evident from the recent Russian sanctions bill, and also from the proposed bill that would make it practically impossible for Trump to fire Mueller. Most others are still choosing to stand behind Trump only because the Trump’s voter base, even though on the downhill, is still more or less intact. The ensuing markets’ fall, among a million other factors, will further erode this already eroding base and that is when crap is really going to hit the fan for Republicans. We expect more and more Republicans to turn against Trump with every passing week, worsening the existing political logjam many times over. To put things in a perspective, Republican Party had enough problems of their own even before Trump happened, especially with their deep divisions between the Moderates, the Conservatives and the Tea party. We believe that the after effects of Trump presidency will be the last nail in their collective coffin.  

 

We were initially toying with the idea of a split in the Republican Party, but a deeper dive into the US and the world history tells us that Republicans need not bother with this idea at all. Instead, the party will very soon begin a multidecade decline and will eventually drive itself into an oblivion of irrelevance. In fact it is the Democrats, who will eventually have to split into two different parties. This is because the American political system needs at least two mainstream parties, and the Republican Party may be anything but a mainstream party after a few decades. By that time, we believe that the western world would have decidedly turned leftist in any case. Hence, we expect the Democratic party to eventually split into two; a relatively moderate left version; and a relatively extreme left version. Expect these trends to play out over the next few decades! 

(From the Desk of Amit Goel )

Turkey Greater Risk than North Korea-Todd Mariano

With geopolitical uncertainties injecting more volatility into the markets, Financial Sense Newshour sat down with Todd Mariano at Renaissance Macro to get his thoughts on North Korea and other hot spots around the globe, including Turkey, which, he said, is one of the greatest and overlooked concerns right now.

Is Nuclear War Imminent?

The short answer is that no, it isn’t, believes Mariano.

What we’re observing is that markets are reacting to uncertainty, specifically due to the shifting approach Washington is using to engage with North Korea, he noted. However, the situation really hasn’t changed all that much from a policy perspective, even under the new administration in Washington.

“What markets are really reacting to amounts to headline risk because of the comments that the president made,” he said. “The way I think this goes is certainly not a preemptive strike by North Korea. No one understands better than the North Korean military and Kim Jong Un that a preemptive strike coming from them would spell the end of the regime.”

It’s important to remember that Kim Jong Un’s regime is most concerned with its own survival. This is why Kim Jong Un has so doggedly pursued a nuclear program.

If that assessment is accurate, while his behavior may seem irrational to us, in the context of preserving the regime, it’s actually quite rational in terms of having a standoff weapon that would preclude regime change.

Venezuela’s Growing Dictatorship

Another area that's been getting heightened attention is Venezuela, especially in terms of its potential impacts on the oil market.

We’ve seen the Maduro government in Venezuela become increasingly authoritarian, and this may have direct effects on oil, especially within the United States, given that we are the top buyer of Venezuelan crude oil. Many Gulf Coast refiners are set up to process heavier, medium grade crude from Venezuela, and have missed out on the shale revolution at home as a result.

Tensions have increased recently with the vote held in Venezuela to set up a constituent assembly, which amounts to a subversion of democracy, Mariano noted.

“The constituency assembly is certainly a new low for Venezuela,” he said. “What we’ve seen there is a slow-motion formation of a civil war. I wouldn’t yet call it a civil war, mainly because it’s more political opposition at this point.”  

This certainly amounts to a push toward a dictatorship in Venezuela, though, he noted. We just haven’t seen armed opposition contesting territory there yet.

“The government retains a monopoly on the means of violence now, which in political science is generally the hallmark of a state,” he said. “The opposition is mainly a popular uprising. … (Civil conflict) could be simply in formation, and we’re waiting for it to be categorized as a hurricane … but I don’t think that we’re there yet.”

Turkey Moving to Theocracy, ISIS Winning Hearts and Minds

Turkey is one of the greatest geopolitical concerns right now, but this hasn’t been mirrored in markets yet. Erdogan’s Turkey has moved more towards a theocracy and an authoritarian system, Mariano noted.

“In the Middle East, Turkey will always have a prominent and weighty role to play,” he said. “Syria is a multifaceted conflict, but in a few of those facets, Turkey is an important player at the table, and that won’t change in the near future.”

For the West to be in conflict with Erdogan is a distressing geopolitical signal. How exactly this will affect financial markets is unclear. But the issue looms over Western policy as we begin to envision what the future of the Middle East will be going forward.

In Syria and other parts of the Middle East, though it appears ISIS is losing ground and may not control any territory much longer, the real threat of that group lies in its ability to radicalize others already in the West.

“The fact that we’ve seen ordinary citizens in (the West) radicalized from afar does not represent a strategic threat to the United States,” Mariano said. “But it’s certainly a worrying signal, one that’s far harder to combat than the folks on the ground in the Middle East.”