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April 2017

India growing nicely: 1st Quarter 2017 newsletter

Key issue: there is increasing understanding that emerging markets should not be

categorised as one simple asset class. Different nations will represent vastly varying societal

communities and corresponding investment outcomes.

Key recommendation: democracy and an English legal system combined with strong

demographics sets India apart from most EM. Robust economic growth is likely to continue

to lead to superior returns.

‘The underlying analysis of the Indian economy being that matters are fundamentally

correct.’ Tim Worstall Forbes contributor Jan 2017 (source: Forbes.com 18/1/17)

The ending of the colonial system precipitated civil war, and a break-up of India into three

constituent parts. The Nehru regime followed this with a retreat from the global economy,

miring into Statism and virtual autarky. Introspection and extreme poverty dominated

politics. However, through this long period of stagnation, democracy had taken root allowing

the prospect for future peaceful change. As the nation observed incredible economic

development in other Asian countries the moment for change was finally reached.

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Manmohan Singh's 1991 Budget: the

day that changed India forever Headline in ‘the Hindu’ (on the 25th anniversary of this momentous event 24/7/16.)

Forced by a balance of payments crisis, and a sense of hopelessness with the prevailing

economic policy, finance Minister Manmohan Singh brought about a range of much needed

policy changes. These were;

Floating and devaluing the Rupee

Reducing the fiscal deficit, cutting subsidies and export restrictions

Effectively ending the Licence Raj that had stifled competition and fostered oligopoly

Opening up the economy to foreign portfolio and direct investment

Tax simplification and amnesty

Privatisation of many industrial assets

‘Let the whole world hear it loud and clear, India is now wide-awake’ Manmohan Singh

(source: The Economist 21/7/11.)




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25 years since opening up of the economy in 1991

India has not been alone in benefiting from this period of liberalism and free markets. As

these successful changes spread throughout society, a political consensus has also formed to

cement these reforms into a genuine mixed economy.

Now in the fast lane

Democracy

When the British faced the reality of the end of Empire, both in India and elsewhere, there

was a general loose desire to leave a legacy of democratic institutions. In most post-colonial

governments this did not last. With the exception of the Dominions of Australia, New Zealand

and Canada, dictatorships and command economies rapidly became the norm. From Nigeria

to Pakistan the ballot box was quickly replaced by the gun.




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Many different rulers of India: all emerged peacefully

The precise cocktail of factors that has ensured India’s successful emergence as the world’s

largest democracy is not precise. Credit should definitely start with the founding Nehru

dynasty, also unlike Pakistan, the establishment of a truly secular state. The size of the

country also benefited, with a strong federal state system that allowed local identities to be

cherished.

Ultimately the populace must take the greatest credit. Despite being in many ways one of the

poorest and least literate on earth, Indians had a clear sense of national engagement. Abuses

of power, and episodes such as the state of emergency during 1975-77 and the assassination

of Indira Gandhi, represent moments when the system could not entirely cope with pressures

within society. However, the ability of a fresh government to be made via the ballot box as

represented by example of the election of Narenda Modi, demonstrate a really flexible

working system of change.

Demography

‘To a large extent, the realities of population size and growth, and of population characteristics and distribution, govern, or at least set some broad outer limits upon, what is possible for the economy and for governments and the corporate world within the economy.’ Thomas Symons, Chair, British-North American Committee Working Group on Demographics




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Too few or too many is a problem, what is needed is a ready supply of labour/tax payers to

support the non-productive young/old parts of the economy. The world’s rapidly emerging

demographic crisis is no longer confined to a few highly developed economies. Everywhere

from Poland to China, the prospects look alarming for societies to support ageing populations.

India is different. While memories of famine and scarcity still scar parts of the poorest

communities, cultural factors make larger families the norm. Economic optimism has also

bolstered the middle-classes, children cement that process.

While the government has enabled contraception to become available, caution has governed

too active an involvement in trying to restrain population growth.

Diaspora

The benefits of being part of the world’s largest empire may still provoke mixed feelings

amongst modern Indians, but the building of communities throughout some of its farthest

reaches now gives a powerful diaspora.




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Karan Bilimoria: playing both ends well.

Modern business has picked up the opportunity to sell goods and services to this ready

market, and then use that foothold to engage with other export opportunities. Whether this

is spices, Indian beer or software and garments, Indian know-how has used this ready market

effectively. This process works both ways, with businessmen not only selling to, but also

buying in Indian talent. Learning how to run multi-national businesses has also fostered new

entities such as Tata.

Amongst educated, middle class Indians a stint at a western business school or other similar

establishment is made easier to succeed at with often local family networks.

Only the Chinese can rival this global reach.




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A connected populace

On-going Reform: De-monetisation and others

Part of the transformation from the sclerotic, slow growth old India to today’s 7%+ PA growth

has come from genuine economic reform.

In his home state of Gujarat, the now Prime Minister Modi was quick to showcase a new way

of doing business. New roads and an emphasis on infrastructure, were all used to transform

this once sleepy backwater.

However Walmart’s experience in India demonstrates how many difficulties still lie for new

investors both foreign and domestic. A partnership between America’s largest retailer and

Bharti Enterprises founded in 2007, was dissolved in 2013 with only 20 superstores being

opened. The difficulty in living with local supplier content rules, made the role out of the big

box concept barely viable. Both foreign and local retailers have suffered as the politic muscle

of small scale shopkeepers, has made governments reluctant to open up this segment of the

market.




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Recent regional electoral success in Uttar Pradesh, and the apparent resilience of the

economy to the demonistisation , should give confidence that the next phase of reforms is

firmly on track. While the consituition still provides checks and balances to the governing

party, momentum is now with the Prime Minister and his plans.

Reforms in the pipeline;

Deregulation of gasoline/kerosene/diesel

Remove agricultural price minimums, and other subsidies

Open up service sector, legal profession etc

Unify national tax system

Speed up business formation, and other corporate bureaucracy

Fully open up Indian business to foreign shareholding

Infrastructure push

Broaden trade deals with key export/importers

Upgrade and expand power station capacity/efficiency

Greater internet/broadband/mobile penetration




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Brave experiment—should yield long-term efficiencies

Emerging market conundrum: volatility to be expected.

All investments are subject to market cycles, and trying to judge these turning points is not

easy. The financial services industry is notorious for building up hyped new investment fads,

and the very advent of ‘emerging markets’ has been one of the more successful odysseys.

For more sober players, stock exchanges with little history and fewer local investors’ will

demonstrate greater volatility. This should be acknowledged as inevitable. However, we

should not shy away from risk taking, but also try and judge where in these brutal cycle Indian

assets stand. Valuation and sentiment are parts of the picture.




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Drawdowns: part of the picture

Indian Equities

Exports are a smaller part of the overall economy than most emerging markets, the domestic

component is around 80% and hence resilient to possible Trump related trade issues. Hence

demand is likely to be less correlated to the world business cycle.

Overall market cap is around 70% of GDP, the economy has grown while stocks have not

caught up since the financial crisis.

Growing middle class will spur new investors into the stock market, and hence stretch

valuations.

Oldest stock exchange in Asia founded in 1875, third largest global daily volume, deeper

trading possible than many comparable markets.




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One source of new buyers

This market is not cheap: but

Now that we are fully eight years into a developed market bull market, and US indices are by

many measures close to all-time highs either versus forward P/E ratios or CAPE, there are

not many cheap securities to buy where ever you look. Investors face difficult choices in

allocating capital to what could look like expensive levels.

OTHER INDEXES

Friday, March 24, 2017

P/E RATIO DIV YIELD

3/24/2017† Year ago† Estimate^ 3/24/2017† Year ago†

Russell 2000 138.40 nil 19.05 1.46 1.67

Nasdaq 100 25.97 21.55 20.34 1.12 1.27

S&P 500 24.52 23.53 18.27 1.97 2.23

† Trailing 12 months ^ Forward 12 months from Birinyi Associates; updated weekly on Friday. P/E data based on as-reported earnings; estimate data based on operating earnings.




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For corporate America there is another sobering truth, that earnings per share has been

mired since 2014. While markets have indeed continued to ascend, it has been driven by

share buy backs and expansion of multiples. While economic conditions in Europe have

improved, profitability has barely budged.

Earnings growing well, and steadily

It’s obviously easier to generate real earnings growth in an economy that is expanding and a

population that is increasing.




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Fair value: unlike some

Seeking Alpha and Beta

The cult of passive investing goes from strength to strength, and even Indian equities are not

immune. However, as indicated with more dramatic swings in markets there are

opportunities to change asset allocation profitably.

Buy and hold is not the best strategy as significant blow offs, both to the downside and upside

are inevitable. While long term engagement is advantageous additional returns can be

garnered with some risk management.

With over 7,000 listed stocks there are plenty of opportunities to find value. Trading volumes

are generally above $3bn giving decent liquidity and low dealing costs. Industry concentration

is more diverse than many emerging markets that have tended to be over reliant on a few

large cap Banks or energy companies. Listed Indian stocks are widely spread in heavy

industry, power generation, software and others. Opportunities to deliver real stock picking

abound.




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A lot of stocks to pick from

Conclusion: India a story for the 21st century

Ultra-low interest rates (or negative), and QE have depressed returns and created arguably

bubble conditions for many traditional assets. Careful consideration needs to be made as to

where genuine corporate, as opposed to leveraged or fabricated, earnings can be found.

India’s macro story is sound, with limited political risk unlike many other emerging societies

where unexpected developments—pace Turkey or Brazil---can upend what seemed like solid

foundations.

Companies are growing, using the vast network of educated Indians that span the globe.

A sensible allocation to this market will provide diversification, and good prospects for

success.




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As good a future as we can see




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