Hope and a Kiss

Oil prices had demonstrated tremendous strength despite the global slowdown maintaining $100 and above. This happened principally due to China’s energy intensive growth and global monetary expansion. However, oil prices have been on a downward tear for the last few weeks crashing new technical levels. OPEC countries, Russians and Venezualans (and some large banks) are sweating how this massive downward revision will impact their economic stability and the geopolitics they practice.

But first how it came to this. North America has witnessed a massive revolution in energy driven by shale and oil sands. US today has begun to produce almost twice the volume oil it produced in 2005 (5 million barrels per day) and Canada has added almost 1mbpd.  This US production is poised to expand with some estimates of shale standalone being 12mbpd. In addition Canada oil sands could add another 2mbpd over the next 4-5 years. This is in the context of US consumption being ~19mbpd. EU and Japanese demand has declined by 1mbpd each in the last 5 years and US automotive efficiency has increased by 25% since 2008 keeping global demand fairly static at 90mbpd. This decline will surely make shale gas finds unviable and impact future investments in the sector. But what it importantly does is put a cap to prices in the sector. "We think the world has plenty of oil at $90 going forward," Morse (Citibank) writes, "but supply may be less adequate on a sustainable basis at prices much below $70...even though on a shorter-term basis, US shale production can continue to grow robustly even at lower prices."

As I have written previously, Saudi is the lowest cost producer and is able to balance its budget at $85 at current production levels (they have a swing capacity of around 1mbpd). Anything below puts a significant stress on OPEC and Russians. Russians will surely remember the economic crises leading to a break-up that low oil prices brought in the 1980s while Iranians apparently have already cut their budget to Hamas by a third.

This fall in prices if it lasts in excess of 6 months and begins to seem more enduring will begin to change geopolitical behavior globally. Americans already are moving towards reconciliation with Iran, despite Saudi reservations, changing the contours of the middle-east and higher oil production will begin to reduce cost of production in the US reviving manufacturing impacting exporting nations like China and Germany.  Saudi and the Iranians will have to turn their focus on internal stability and have lesser economic ability to fuel the various clandestine programs. Russians typically always prioritize politics to economics but theirs is now an economy more integrated than any time before in history, it will be interesting to see their moves in Ukraine. “Oil creates the illusion of a completely changed life, life without work, life for free. Oil is a resource that anaesthetises thought, blurs vision, corrupts.” ― Ryszard Kapuściński, Shah of Shahs

The deflationary push of oil prices and commodities ranging from iron, cotton and sugar is likely to lead to rate reduction to stimulus measures in EU, Japan, China, Australia and Brazil. Japan has already added to its QE program and China has reduced interest rates (driven more by a massively slowing economy though). Oil prices will provide an added push to the USD leading to further depreciation in commodity prices and creating pressure on global liquidity, consequently emerging market financial assets.

By the turn of the 20^th century, oil has been a key determinant of a nations’ prosperity and even its survival. And, as the tide turns, its impact will play out.

“Never let a fool kiss you or a kiss fool you”

Building an Alternate Vision of India

"The empires of the future are empires of the mind." - Winston Churchill

"Determine that the thing can and shall be done and then we shall find the way." - Abraham Lincoln

The Nehruvian consensus that built India over the last 6 decades has been given a pause if not a full-stop. This was defined principally by socialism, controlling the commanding heights of the economy and non-alignment. Each of these elements spawned their own direct and side effects. Socialism morphed by 2004 to massive distributive agenda by the UPA that nearly bankrupted the fiscal, ‘controlling the commanding heights’ into a halfway free economy with crony capitalism and non-alignment to giving up India’s strategic interests and defense preparedness. In essence it evolved into a state under UPA to where managing the environment to prolong the existence while the state satraps extracted their pound of flesh in exchange. Regionalism has always been strong since the early ages and India has been for most of its history been ruled by multiple kingdoms which have in the new age arrived in the form of regional parties that espouse their identities and interests.

With the recent elections, environment and ideology has turned favorable to building a stronger India. The national elections have for the first time since independence resulted in a majority to an alternate ideology and to man who that has no baggage of the freedom struggle or Nehruvian thought. With the BJP ruling not only the center but substantial parts of the country, Modi has the power to enforce his will. It will face resistance not only from the entrenched people in bureaucracy, government controlled corporates, media among other organizations. Political resistance will also be stiff as the hitherto the regional satraps which had considerable power and say and now they have nothing for the next five years except the fear that they may lose the states they govern as well.

Since coming to power it has begun to curtail the various distributive programs by UPA (MNAREGA and energy sector subsidies) with next attempt to push ahead basic infrastructure (i.e. coal, GST, roads). The decline in Chinese consumption has already led to a massive decline in commodities. These will help significantly in reducing our cost of infrastructure. The critical thing would be to institutionalize the decision-making in key sectors through setting up regulators backed by laws. This would in essence ensure transparency and continuity of thought making political interference much less easier. Whether the BJP and Modi have the courage to give up the powers they gained will define their legacy?

The commanding heights or the public sector behemoths like Air India or BSNL need to be privatized. These are the hotbeds of significant corruption and drag economic growth by under-utilizing assets.  Government as we all know needs no presence in the sector airlines or telecom especially when it will be a dead brand within the decade. Entrenched interests and labor unions will undoubtedly resist.

The most important function of the state is to guard its borders and in that context it is the key role the leader plays. The Indian elite have been fed with a massive dose of ‘pacifism’ and have understood India’s strategic dimension. Curzon (I think 1905) stated,” The central position of India, its magnificent resources, its teeming multitude of men, its great trading harbors,... all these assets are of precious value. On the West, India must exert a dominant influence over the destinies of Persia and Afghanistan; on the north it can veto any rival in Tibet; on the north-east it can exert pressure on China, and it is the guardians of the autonomous existence of Siam (Thailand).”  Nehru displayed his abysmal understanding in three key occasions – the referral of Kashmir to the Security Council, his lack of understanding of Chinese strategic thought and when USSR asked Nehru regarding India’s membership to the Security Council he basically preferred China not India! The Congress for the fear of the Bofors re-run has in the last decade given up on building the armed forces by delaying critical orders and never has in the past six decades has any government given a serious thought to building domestic manufacturing in this area. No eminent power can be at the mercy of international supplies in situation of crises (for those who know Nehru’s letter during Chinese war to Kennedy). As India stands today, it has a fairly difficult neighbor-hood:

• West Asia is facing the ‘double whammy’ of Islamic State and now a massively decline in oil prices which will create massive impact on the budgets of the Middle Eastern states. Saudi Arabia which is the cheapest producer in the Middle East has a budget breakeven at around $85;
• Afghanistan and Pakistan our most proximate and most critical border continuous under tremendous turmoil; and
• On the west, China while has built massive infrastructure and military capability is facing its own downward cycle economically and politically (i.e. HK protests) after 3 decades of incredible growth.

Modi has since election revived India’s interest and vice versa in states like Japan, US, Vietnam and Australia. It has changed India’s defence posture from ‘minimal deterrence’ to ‘adequate deterrence’ and is now focusing on building border infrastructure. While it has changed the terms of engagement with Pakistan, it is a neighbor and India’s as the dominant state in the neighbor-hood needs to acquire the capability to change its behavior. West Asia is where Modi seems to following the policy of staying away. But with our old relationship with Iran and our significant interest in Middle Eastern energy, no policy is a 'non-answer'.

I had written in October 2013,”In effect the 4 key tenets of the state – security, governance, economics and unity - have been undermined, corrupting the functioning of the state. The tryst of the Indian state with its destiny continues to yearn for fulfillment…even in 2010 the World Bank reported that 32.7% of the total Indian people fall below the international poverty line of US$1.25 per day (PPP) while 68.7% live on less than US$2 per day.” In essence a small beginning has been made but Modi needs to change the direction and character of the Indian state.

Deflation and Liquidity

"The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand - a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending - namely, recession, rising unemployment, and financial stress." – Ben Bernake, November 2002

As aggregate demand collapsed post the 2008 financial crises, the most significant response of the policy makers was to expand liquidity at an unprecedented pace. This addressed the immediate cliff the multiple markets and participants faced. But the expansion of liquidity never addressed the underlying issues that caused the crises. The underlying cause was that the world had just one principal consumer, the US, and rest of the countries (China, Japan, EU or the South-East Asian nations) were just net exporters into this vast market. Bernake knew that aggregate demand was the root cause but he sought to address this through asset inflation (higher asset prices expanding demand). But he did what he could; rest is in the realm of government policy action rather than with central banks.

This lack of demand has manifested in different ways:

• China has >250% debt to GDP and slowing domestic demand especially for materials is manifesting itself from Australia to Brazil and coal, iron-ore and oil have all faced significant declines;
• Europe is staring at down-right recession with massive youth unemployment in Southern European countries;
• Japan has struggled to grow despite a ~25% currency depreciation;
• US Fed has added international growth worries to its list of reasons why they might postpone increase in interest rates despite the earlier principal marker being domestic employment.

The incremental worry that the central bankers face with a declining commodity prices, especially energy, is it fuels the deflation scare. This leads to talk in the media and political circles to have more of the same medicine - further central bank action, the latest being the ECB - rather than improving productivity regulations (i.e. labour laws).

The other side of this coin of global slowdown and imbalances as I have pointed earlier is the Saving-Investment (S-I) mismatch. Globally, Savings has to be equal to Investments. But as country, if Savings is greater than Investments it manifests itself in the country having a current account surplus (exporting capital) and vice versa.

Country	Global Investment Share 1990	Global Investment Share 2013	Global Savings Share 1990	Global Savings Share 2013
US	24.1%	17.8%	22.6%	15.4%
Japan	19.0%	5.7%	21.1%	5.8%
China	2.6%	24.8%	3.1%	25.5%
Germany	7.5%	3.4%	7.9%	4.7%
India	1.6%	3.2%	1.5%	3.0%

US has consistently carried a current account deficit (demand surplus) while China, Japan and Germany a current account surplus (demand deficit). As Chinese investment demand declines on the back of credit issues, export slowdown and population decline, it will result in its current account surpluses expanding even further. While this expanded liquidity directed globally will keep cost of capital low, it will create issues of Chinese influence and ownership of assets, principally in the US as that is the economy with the potential to absorb this scale of savings. This potentially also explains the new trade deals the US is pursuing like TPP (with Pacific countries excluding China) and TTIP (with European Union) to correct this imbalance one way or another.

Consequently, the critical questions that will need to be answered for the global economy in the next few years - Will the US turn insular to retain more of its internal demand or will it force rest of the world multilaterally to address the massive imbalances which exist and, therefore, force them to create their own demand?

Global Disorder

At the core of the balance of power theory is the idea that national security is enhanced when military capabilities are distributed so that no one state is strong enough to dominate all others - Kegley & Wittkopf 2005

Global system witnessed a ‘balance of power’ between the World War II to the break-up of USSR in 1991. In essence USA and Russia restrained themselves and their alliance partners in substantially a geopolitical status quo system during the period. With the break-up of USSR and the Japanese economy going into a tailspin, the American’s emerged as the sole super power globally. What followed was an era of increasing number of countries being pulled into the capitalist system (Eastern Europe, South East Asia, even India initiated liberalization in 1991). US became the sole global policeman managing multiple theatres (Bosnia, Iraq) and ensuring sea lanes of communication with its blue water navy. With its economy powering ahead, it also became the central pole of the global economic system allowing it to outspend the next 10 countries on defence.

Following 9/11, it intervened in Afghanistan and more importantly Iraq, breaking the ‘distributed power’ that existed in the region. As Iraq disintegrated, Iran became free to exercise influence in Iraq and the Levant. While Russian defence spending collapsed post the disintegration of USSR it recovered and has been sustained between 4-5% GDP for the last 15 years (3^rd largest budget globally). In the same period, the Chinese economy powered ahead and its defence spending accelerated to ~US$150bn (11% of global spend as against 37% by US).

The Americans are able to address grand strategy of nations (e.g. USSR), empower nations given time geographically proximate to the relevant theatres to maintain stability (as long as they have basic institutions unlike Afghanistan) and exercise significant leverage through international institutional structures but the ability to address near term situations in distant areas like Ukraine or seek to address long-term changes in area-denial (South China Sea) capability of the Chinese are limited.

Let’s take each of the situations one at a time:

• Russia / Ukraine – When the USSR disintegrated, Ukraine, US, UK and Russia entered into a treaty in 1994 whereby Ukraine would give up the nuclear weapons in exchange for ‘independence and sovereignty of the borders’. But when the Crimean crises and its aftermath came there were no guarantors for the borders. Given Ukrainian importance to the Russians (Odessa is the largest warm water port, gas pipeline infrastructure, food security and geopolitical space) this situation were to come the moment West tried to wean Ukraine away from Russia. Russia would exert its full might to ensure Ukraine stayed. US and UK understand not only the importance of Ukraine but also their inability to exert meaningful pressure on the Russians, despite the economic sanctions. Therefore, the situation continues. It will take a while to resolve till Russian core interest are agreed to be protected. Not to say the current impact doesn’t impact the Russians, it does run against the clock they set for economic modernization before the adverse demographics takes over;
• Syria / Iraq – As Iraq disintegrated the Americans looked to stabilize it but they had destroyed whatever governance structure including the Army. This meant some regional influence had to move in (Old maxim ‘Power abhors a vacuum’). As Iranians moved in old rivalries, principally Sunni Saudi Arabia, came to fore. The Americans allowed the same to exit Iraq and that drew a blowback from the Sunnis. Syria anyway a multi-ethnic state (Kurds, Sunnis, Shias, Allawites and Christians) became a stage for the Iranians and Saudis primarily and then the rest including Russians and Americans joined the party. The blow-back of break-down of power structures is the ISIS which now the new ‘coalition of the willing’ resists;
• China and the South China Sea – China is a more long-range issue unless it faces a significant economic decline. Like the Mediterranean became central to Europe and Caribbean is the ‘American Mediterranean’ which American’s rule completely allowing it ability to throw spare power across the globe, the Chinese seek to rule the South China Sea. South China Sea not only is the heart of today’s global maritime economy where more than a third of global shipping transits, it has potentially large oil & gas reserves. This is the path way to China, South Korea and Japan in the North and surrounded by Malaysia, Vietnam Philippines and Cambodia and Indonesia. By 2050, East Africa through to Japan (via Indian Ocean and the South China Sea) will have more than 2/3^rd of humanity and all their commerce and defence will be played out in these crowded waters. As China ups the fight for these waters by improving defence capabilities and denying space to US Navy and other regional players, we will see significant pressures play out at the global stage.
• In addition to geopolitics, a universal issue of global climate change will create more pressure on under-developed and developing countries in terms of food, water and health issues resulting in greater social and consequently political issues.

These political pressures have emerged as economic issues brought out by the 2008 crises have refused to dissipate. Central question raised by the economic crises is the future of Europe as a union, which I have discussed in my previous articles, that still remains unanswered. This disorder is exaggerated by the massive pace of innovation especially in information technology. After two decades of relative calm, the change in power distribution has created disequilibrium. All this comes at a time mankind enjoys remarkable progress in health, technology, education…but so did Europe as against any time in history before the World Wars.  

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only. – Tale of Two Cities

Won’t pay, Can’t pay

Don Corleone: Why did you go to the police? Why didn't you come to me first?
Bonasera: What do you want of me? Tell me anything. But do what I beg you to do.
Don Corleone: What is that?
[Bonasera gets up from his seat and whispers into the Don's ear; for a long moment the Don is silent]
Don Corleone: That I cannot do.
Bonasera: I will give you anything you ask!

Look around and the world is completely distorted with variety many easing programs at work:

In Europe,

• A bankrupt Greece still able to borrow when it may go for more rounds of haircuts;
• Spain with world beating unemployment being able to borrow under US or UK rates;
• Italians who can restore their economy to health through a currency devaluation but continue with the union given the massive short term disruption and the free money keeps the politicians hooked on;
• The French have slipped into recession and the continue to hope in their 35-hr weeks will suddenly get more productive with more doses of free money from the ECB;
• Finally, the Germans which held back their wage growth through better settlements with unions post the German union (unlike rest of Europe) and is in effect underwriting the union however much they do not want have slipped into a recession as majority of their exports are to EU countries with bond yields a quarter of what they used to be 10 years back;
• Europe as is currently will continue to paper over these problems (Growth and inflation will remain below 1%. Euro-area EPS is at 2009 low!!) and chug along as far as they can. They fear caused by two wars of independent jockeying continue to haunt them as moribund their current economic situation be. They may head to fatal Japanese concoction of high leverage and bad demographics.

Country	Current 10 yr bond	10 yr back
US	2.58%	4.12%
UK	2.54%	4.84%
Australia	3.73%	5.47%
Japan	0.56%	1.39%
France	1.39%	4.06%
Germany	0.99%	4.03%
Italy	2.36%	4.21%
Greece	5.72%	Does it matter
Spain	2.20%	4.05%
Brazil	11.60%	-
India	8.64%	-
China	4.16%	-

The Japanese want to get inflation, currency devaluation and with that growth to withstand Chinese aggression. But given the debt situation, demographics and lack of productivity growth this strategy while creating an environment for corporate earnings expansion is slowly resulting in a situation where BoJ maybe the only buyer of the bonds. This will surely result in continued depreciation of the yen and potentially a point where bond sales gather such pace that the BoJ loses control over monetary policy.

Towards end July I had written, “Only alternative central bankers have to manage the scale of the adjustment is to keep running behind market expectations” and Yellen did exactly that but before that cut productivity estimates by a quarter for the future and saying she is still concerned about labour market. This game of building expectation and then pulling back will continue.

China’s economic troubles continue to get worse. “Issuance of trusts for real-estate projects, which target wealthy individuals, slid to 30 billion yuan ($4.9 billion) this quarter from 67.8 billion yuan in the three months to June 30, the least since the start of 2010, data from research firm Use Trust show. Borrowing costs are rising as developers face $9.1 billion in bonds and loans maturing by year-end.” Total financial credit has surged to 251 percent of gross domestic product from 147 percent at the end of 2008 (US had hit 350% in 2008 and is now down to 260%). But they are stuck with their addiction to leverage to ride over their issues. Three days back PBOC let another US$81bn to the 5 top banks at very low interest to create some more “methamphetamine” (for those who have not yet seen Breaking Bad these is a synthetic drug abuse substance).

As the Chinese economies slow resource countries like Australia / Brazil are already seeing the impact. Their bond yields should continue to see downward pressure.

We are seeing a global phenomenon of excessive liquidity keeping rates below normal with the central banks acting to counter balance the moves of the other which creates currency related stresses. This bond yield suppression will cause severe stress to retirees as their pension plans will result in serious deficit or they will need to work much longer.

Don Draghi: Why did you go to the police? Why didn't you come to me first?
50 year old European: What do you want of me? Tell me anything. But do what I beg you to do.
Don Draghi: What is that?
[Gets up from his seat and whispers into the Don's ear; for a long moment the Don is silent]
Don Draghi: That I cannot do.
50 year old European: I will give you anything you ask!

Post Scripts

• Uttar Pradesh has 80 seats to Lok Sabha. UP’s per capita income Rs.37,359 while all India is Rs.74,920. Now imagine adjusting seats for per capita income of the state, UP will be down to 40 seats. Imagine the positive impact this will have Indian politics pushing politicians to become more development oriented and this adjustment can be carried out for every Lok Sabha election.
• The Chinese President Xi Jingping visited India. India should have offered to build a pipeline to transport Middle-Eastern oil & gas via pipelines running from Bay of Bengal to Southern China reducing the dependence on the Malaccan straits. This could give them some respite from the American navy in Malacca straits and would have been an interesting back drop to the US trip. Anyways, our Russian friends would have taught us how to manage the pressure in the pipelines!!

Political Timing

“Patience is power. Patience is not an absence of action; rather it is "timing" it waits on the right time to act, for the right principles and in the right way.” - Fulton J Sheen

Since the Modi government came in, expectations while remaining high have continued to be belied. But it seems more a case of political campaign during elections seamlessly coalescing post government formation to create these massive expectation (magic in 3 months!!) and the media with lack of sensational news provided by the previous UPA regime (Anna Hazare, CWG, 2G, Coalgate, Pawan Bansal, Ashwini Kumar...the list is endless) helping in the process.

Modi seems keen on laying the ground prior to rolling out the key reforms:

• Getting the right advisory infrastructure and IAS staff in place i.e. replacing the Planning Commission and getting an expert team to recommend course of action;
• India's defence and international relations in place which creates domestic room as well;
• Winning the upcoming assembly elections in Maharashtra, J&K, Haryana and Jharkhand;
• Revamping governance at PSUs to be able to deliver on the change plan when implemented.

When this basic ground work is in place pretty much in time with the 2015 budget, one should expect the real work to begin - the move to a more open economy and realignment of laws and governance to a post-modern economy of the 21st century. The man from Gujarat with its tradition of commerce and globalization from millennia should begin to change India. Gujaratis have used their ports for thousands of years to do commerce with Africa, Middle East and beyond with large numbers settling in these countries. This historical openness of mindset that Modi hopefully brings comes at a time when the interiors of India has been pried open by media and telecom revolution of the last 2 decades.

While this is at play the change in global dynamics need to be navigated. The euro zone is battling the twins of recession and Russian aggression in Ukraine. With no appetite to resist Russia, the Europeans are providing limited resistance to Russian designs. The Middle East continues to convulse with ISIS redrawing borders pressuring the Turks, Iranians and Kurds and leaving the Sunni Arabs unsure to let this go on to what extent before it becomes a real threat to them. Syria and Iraq, which were agglomeration of different religions and cultures (Allawites, Kurds, Shias, Sunnis, Christians) with allegiance to respective tribes kept together by dictators in so called countries formed by the British and the French post WW1, are now re-aligning.

The Americans with their energy security (shale gas) and tired military have developed (and in perfecting phase) the doctrine of talking more and doing less and correctly so. As much as the Chinese and Russians would like to see them involved in the Middle East, the Americans are not likely to oblige unless a 'coalition of the willing' comes in place from the threatened Middle Eastern countries. If the Americans can get the Turks and Iranians to coordinate, it would not only check ISIS but also initiate putting in place a balance of power which devolved when Saddam Husain's regime of crushed. The Arabs will resist but it's an affair that has to be managed and will also force them onto the table for the fear of losing influence.

The Chinese economy continues to suffer the downturn in property prices and construction activity, threatening growth and their banking system. Rebalancing from very high investment to a consumption driven economy will likely result in sub-5% growth. Any attempt to push growth with additional credit will only make future slowdown deeper. With Europe and China below trend, global growth consequently should be below OECD and IMF forecasts with deflationary pressures continuing.

The US economic recovery will create divergent interest rates scenario with ECB likely to embark on further loosening. The Chinese are also likely to push up interest rates as beginning of the end of financial repression. With interest rates differentials widening in favour of US and low cost / safe energy supplies playing their role it should create a strong push towards US investments and a strong dollar.

The strong dollar (already heading to the north end of the 3 year band) and lower aggregate global growth will put massive pressure on emerging market economies through lower capital flows and weak export markets (though the depreciation against Chinese currency of ~15% in the last year helps). India needs to counter this trend through a pre-emptive build-up of foreign reserves and re-start the reform process (education, labour, electronic manufacturing, coastal infrastructure, defence industry and many others) to accelerate growth and attracting capital. One of the major tasks will be correcting the bad asset malaise in the banking system which makes it unable to support credit creation. Reducing government holdings in PSU banks to help raise capital and developing bond market to reduce pressure on banks for long term capital are two critical steps.

Since antiquity political strategy has been a function of military prowess and economic strength and these two variables have in turn been a function of the other. As Modi buys time to build the former, he needs to leverage the latter in a world desperate for demand and growth.

Indian Punch

Investment firms have used different philosophies developed from Benjamin Graham and before and to the hedge fund greats of today. But India demonstrates its own unique features which are tweaks to these approaches. This article is to outline those unique aspects.

a) Very unlike western economies (not completely though) government direction can create significant change in fortunes of a firm. Inability to understand government direction and political pressures render large swathes of market capitalization less understood:

• public sector banks – clarity of government stake and recapitalization, approach to bad debt;
• power generators – no tariff adjustment due to elections (i.e. Torrent Power);
• real estate companies – approval delays (i.e. Mumbai builders);
• infrastructure builders – stalling of payments by authorities like NHAI, delays in environmental clearances.

b) Large promoter holdings – Indian corporates mostly are held significantly by promoters groups which makes renders them to a very large extent immune to pressures from minority shareholders resulting in them not being ‘public’ in the true sense of the word. Reliance Industries for the longest time was one monolith having pretty much all businesses under them until the brothers had a fight. This unlocked massive shareholder value which no minority pressure would have brought about. Tata group companies have significant cross-holdings which get valued at discount but are believed to necessary to ensure group control. Consequently, knowing or judging the mind of the promoter becomes important. This also creates a large network of brokers who peddle stocks based on ‘inside track’ rather than better understanding. Multi-national corporations with their arms in India which had been forced to list in the 1970s have also tried to dodge corporate governance standards i.e. Maruti Suzuki parent setting up an auto plant in Gujarat not under its listed subsidiary, large royalty payments by the likes of ABB, Siemens etc, P&G has a unlisted subsidiary doing significant business in India (despite having a listed entity).

c) Subterranean KYC and dodgy accounting – Given the large swathe of underground economy and political influence knowing ‘real’ reputation of the promoters is super important. There are well-known examples of Satyam Computers, Financial Technologies etc. Even lenders try and protect the mistakes they have made (and regulations help) like Deccan Herald or Bhushan Steel keeping issues away from public view longer. While mainstream companies (including MNCs) are relatively easy to check on but it is the smaller companies and the potential 10-baggers which are more difficult to glean.

d) Regulatory overdose – Interesting and large segments like telecom (remember 2G license), media (FDI restrictions in print, radio shareholding), pharma (price controls, clinical trial related norms) are hobbled by regulatory maze which restricts ease of operations and changes in regulatory environment create significant valuation changes. The strong arm of government trying to force-fit the economy into the regulations is evident creating friction costs.

e) Unbalanced market – In effect the two key drivers of market valuations are FII interest or promoter’s direct to indirect interest. The domestic players are not and are not seen to be valuation drivers. Consequently, market participants in essence look for clues at these two ends.

f) Some more examples of atypical characteristics:

• Benjamin Graham ‘cigarette butt’ has a smaller sliver of followers given the low level of non-promoter holdings which make hostile M&A, restructuring regulations etc all the more difficult. Significant numbers of Promoters have no incentive to get the firm to fair value unless they have some benefit (i.e. raising incremental cash). CEO compensations have no correlation to stock or company performance.
• Generally, declines below book value for real estate & infrastructure builder lead to attractive opportunities – Here one needs to be more than careful given most have political patronage and, therefore, where is the wind blowing.
• Lenders want to keep working with the promoter despite significant breaches in leverage arrangements. As regulatory lax in NPA recognition and limited history of taking strict action against defaulters result in creating illusory sense regarding firms cash flow stability until it reaches the cliff. Kingfisher Airlines is an example where the general public was for a long-time unaware.
• Doubling up on leverage – NBFCs and special situation desks lend to promoters on their shares in structures which do not require disclosure.

Having said this, the core judgment parameters of good companies remain universal:

• Whether product has repeat usability?
• How well is the product plugged to the customer value chain?
• Is there high switching cost?
• Are the revenues annual or lumpy?
• Can the firm pass on cost inflation?
• Does it provide critical infrastructure?

..Consequently, results in good return on capital supported by valuation and macro. This typically in the Indian context have been B2C players like Nestle, Marico, Godrej Consumer, Dabur, Astral Poly, V-Guard, Page Industries, Eicher Motors and few exporters like Balkrishna Industries, Motherson Sumi with good management and low leverage.

“October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” ― Mark Twain