Errata: US 2012Q3 GDP number

The third scenario was to be read as

• Data positive, markets sell off - Opportunity to buy on decline with SL
  Divergence between corporate profits and GDP growth. One will eventually track the other. In the case of a correction, it will offer an attractive entry point as the bearish scenario remains unproven and central bank liquidity continues to overwhelm.

Disclaimer: Errata was published after the numbers' came out.

US 2012Q3 GDP number

The US 2013Q3 GDP numbers are expected in about 15 minutes. The consensus expectations are 1.9%. The market reaction to the numbers will be interesting and potentially a good indicator of whether to play long/short/flat.

The rhetoric in the past was that markets shrug off all bad economic news as it potentially indicated higher probability of QE3 being delivered. Therefore, bad economic numbers was good for the market as it implied higher chance of the Fed providing liquidity to stimulate the economy which would, in turn, drive asset prices higher. 

The GDP numbers are the first major economic data point in the post-QE3 world. The following possibilities exist

• Data disappoints, markets sell off -  Opportunity to buy on decline with SL
  This would indicate that the market looks at the present set of bad data as a confirmation of the poor earnings in the US. The recent sell off would be justified and would see another 2-3% downside to the markets before support levels are reached and bullish sentiment awakens again. Having already corrected, a degree of resilience will be built into the market.
• Data disappoints, market close firm/rally - CAUTIOUS..play the momentum buy short at higher levels
  This would indicate that the underlying sentiment continues to remain quite bullish and the markets will are actually in a 'buy-on-dips' zone where traders are looking to buy stocks in anticiptation of higher prices despite the poor earnings. Its a dangerous zone to be in. One should trade nimbly while watching downside risks very closely as markets could crash even at the smallest disappointment from leadership changes or changes in the situation in the Middle East.
• Data positive, markets sell off - Opportunity to buy on decline with SL
  Divergence between corporate profits and GDP growth. One will eventually track the other. Given the presidential elections, Chinese leadership change, etc, it indicates that the markets are in a cautious zone and might correcti
• Data positive, markets rally - BULLISH
  In this scenario the markets are probably going to remain in an uptrend, recapture their recent high, and potentially make a newer high. The sentiment can change to one believing that QE3 is working. This can add 7% to 10% upside to the SPX.

Overall my view leans towards being cautiously bullish. The present bullish sentiment has not yet reached the state of euphoria that precedes significant market declines. I'd re-assess the SPX another 3-5% higher. 

'Grexit' next week? Probably Not.

The most common debate doing rounds in the financial circles this week is whether or not Greece will be a part of the Eurozone a month from today? The prevailing view amongst macroeconomic observers is that Greece would exit the Eurozone eventually; the debate centres around whether the exit will be orderly or disorderly. The present conditions will not precipitate a Grexit. A Grexit cannot be orderly for Greece. It can be orderly for the EU, and indeed might be instigated by the EU, if a mechanism to stabilize the financial system can be agreed upon. Greece will initiate a move towards exiting the Eurozone only in circumstances resembling a revolution effecting a regime change. The present policy will be to award limited concessions to Greece. The focus will be on preventing the locking out of Spain and Italy from the bond markets. These are the most imminent risks to the future of the Eurozone.


The outcome of the Greek elections on June 17 is expected to be critical to the fate of Greece. The New Democracy is the market favourite as they intend to honour the existing bailout agreement while requesting for concessions in the existing terms. An extremely uncertain situation will emerge if the Syriza party wins the majority - they are openly critical of the existing bailout agreement and potentially intend to challenge, not request, the EU to ameliorate the terms of the bailout. The possibility also exists that the elections might be inconclusive like last time which would also leave market participants quite anxious. Whatever be the outcome of the Greek elections, there is very low support in Greece for abandoning the Euro or leaving the EU. 

The Greeks stand to lose a great deal from leaving the Euro. Their banking system will almost certainly collapse unless the exit is confidentially and immaculately planned with capital controls and withdrawal restrictions on existing Euro denominated bank deposits. Recent events makes it abundantly clear that the politicians in Greece, and elsewhere, are incapable of such planning. Further, a departure from the Euro will leave existing Greeks poorer by the 20% to 50% devaluation implied by the introduction of a new Drachma. This tantamounts to expropriation of wealth by the Greek state from the people of Greece - an unnecessary step unless the level of crisis escalates significantly. 

Further, an exit will cause the exclusion of Greece from international trade, tourism and international capital flows. The institution that normally step in to help a country after such a crisis, the IMF, is already fully engaged in Greece. Any exit from the Eurozone cannot be orderly for Greece; it will almost certainly lead to a strong negative economic shock.

The EU maintains that they will not negotiate or relax the terms of the bailout agreed to by Greece in the past. However, this seems like political posturing as EU has not denied the next bailout tranche though it is evident that Greece has not met completely its target for economic reforms and restructuring. The Greek bargaining position is further strengthened by the generous terms of the recent Spanish bailout. 

The EU will continue to indulge the Greeks and their demands as they have been unable to agree on a mechanism to prevent contagion from a Greek exit. An uncontrolled ‘Grexit’ would lock out Spain, and possibly Italy, from financial markets leaving the core countries, led by Germany, to foot the bill. This is precisely the situation that Merkel wants to avoid at all costs. However, once Germany is able to agree to a mechanism ensuring financial stability for ‘core’ and large economies like Italty and Spain, the PIIGS may be left to fend for themselves and a zero-tolerance policy may be adopted towards awarding further concessions. 

News flow from the Eurozone will continue to remain exciting with Greece being slowly overshadowed by Spain and Italy. There will be no exits from the Eurozone leading up to the summit at the end of June. The summit will probably fail in its objective of developing a mechanism for insuring the stability of the financial system in Europe. Instead of a concrete plan like the TARP in the US, the summit will conclude with promises of a commitment towards a resolution. In the meanwhile, the ECB will continue to provide liquidity to the banking system in Europe to keep it on life support. Credit markets will continue to remain frozen and GDP growth numbers will be negative for the Eurozone. We will continue to see phases of risk ‘on’ and ‘off’ in the markets depending on news flow from Europe.

The current policy of postponing the problem and spreading the losses over time might work. However, it is a dangerous policy with high chances of a sudden implosion. Bank runs have the tendency to work in jump functions - sentiment changes from a quiet mistrust leading to a sudden failure of a large number of institutions. Europe has not yet demonstrated the ability to competently deal with such exigencies. Deteriorating economic conditions, continued political unrest, an unstable government, high rates of youth unemployment are signs that often precede revolutions. Some of these can already be seen in Greece. 

The current mercantilist structure with Germany exporting goods to a periphery of less efficient economies is unsustainable without German support for the peripheral economies to the tune of 2 to 3 trillion euros either via joint-euro bonds, ECB monetization of debt, or other joint contingent liability mechanisms. Economic history has several examples where mercantilist exporters finance their exports by lending money to the importing nation. Germany need only look east towards China who is the largest holder of US debt today. Without this understanding in the German political establishment, political disagreements between the ‘core’ and the ‘periphery’ will eventually lead to the disintegration of the Eurozone and the potential shutting out of Germany from several European markets. In either case, the economic outlook for the Eurozone is negative and has potentially severe consequences for Asia.

Budget Trade Idea: Long Rate Sensitives Short TATA Motors

Going long banks and short autos might be a very interesting idea in view of the potential policy announcements over the next few days. Here's what may happen over the next few days

• Thursday - monetary policy announcement will have a symmetric impact on banks and autos
• Friday - union budget is unlikely to give out sops to either autos or banking. However, there is a strong possibility of a fuel price hike and rationalization of diesel pricing in India.
• Fuel price hike will not affect auto stocks too much since its will a one off event
• Diesel price rationalization will kill auto stocks with a tilt towards diesel - i.e. Tata Motors which wholly concentrates on diesel vehicles in both commercial and passenger segments. Other stocks will be hit as well but not to the extent Tata Motors will be. 
• In case there is diesel price rationalization, Tata Motors can deliver up to 10% underperformance vis-a-vis other rate sensitives

My bet, Long SBIN short TATA Motors

Crystal Ball Gazing: adrenaline rush; remain Long

I've been meaning to write an elaborate post on the budget, monetary policy, politics, etc, for the last 10 days but just haven't had the time. Quickly summarizing what I am thinking in no particular order -

• Union Budget will be reformist. 
• Power sector will receive attention - SEB finances and coal policy rationalization
• Fuel prices will be hiked to manage finances... and this can add to reforms
• FDI in retail will most probably not be put forward - politically unpalatable. Mamta and Akhilesh will never agree
• Infra and roads will receive thrust 
• Education and health will get focus especially in tier II and tier III cities
• Fiscal deficit will not be cut - there is no benefit to the Government right now. Think of the electorate and the Government as growth junkies.. Fiscal deficit is probably going to be the concern for the next Government when they put the economy in 'rehab'
• Monetary policy
• Inflation - noises to the effect that inflation is cooling off but risks remain on account of potential rise in energy prices
• Growth concerns will be voices in the policy statement
• Monetary easing almost certain 
• 40% chance - rate cut of 25bps 
• 30% chance - rate cut of 25bps plus some relaxation in SLR
• 20% chance - rate cut of 50bps
• 10% chance - no easing but dovish noises
• Politics
• SP will form an alliance with the Congress at the Centre. Direct support, outside support, whatever, doesn't matter. Mulayam will probably get a Union Cabinet post.
• Mamta and Congress will patch up a wee bit more. The Congress will accommodate her more, leave Bengal to its miserable state and stay away from FDI in retail which will not go down well with electorates in both UP and Bengal so it will be hard to get political support for this.
• The Congress will try to push through popular reforms like roads, infra, etc which will get the growth momentum rolling. It will stay away from FDI.

Budget Trade Idea: buy NTPC (Rs. 173.8)

Ideally the post with my views on the budget should come before this but I couldn't wait long.

To my mind, NTPC presents an asymmetric payoff matrix centered around the budget. Lets go through this step-wise:

• NTPC is an uneventful thermal power company primarily relying on coal to generate power which it sells to state electricity boards. Its owned and is under the control of the Government of India for all practical purposes. 
• Problems faced by NTPC (and other power producers as well)
• State Electricity Boards (SEBs) in India, NTPC's primary customers, are essentially bankrupt and do not make payments on time.
• The Government is very confused about its policy on coal which creates complications for producers
• There are two possibilities with the budget
• The government chooses to present a populist budget which does not augur well for the economy, power produces, and, in this instance, for NTPC.
  The people of India might cheer it on but when they feel the pangs of slowing growth 12 to 15 months down the line towards the end of 2013, they will not reward the government in the 2014 general elections. The people of India want a performance oriented, not a promise oriented, government - this is clear from elections over the last 3 - 4 years.
• The government chooses to reform. Even if they do nothing on the issue of power sector reforms, any inkling of reform will be enough to boost sentiments to the point where market participants become bullish on the power sector. In this case, power producers should benefit.
• Why NTPC?
• The above analysis assumes rationality on the part of the Congress. Their actions over the last one year have been anything but rational / sensible. 
• NTPC presents an asymmetric payoff structure due its limited downside potential. Downside in NTPC is limited - my reasons are dominantly technical supported by the fundamentals of the company. I do not think this asymmetric payoff structure applies to private power companies due to their unproved execution skills and weaker balance sheets.

The trade can be structured by going long NTPC March contract. Another way to structure it is by going short 160PE and long 180CE. Personally, I would go for a combination of the two depending on risk appetite. 

algo/systematic trading in India

People in India are aggressively getting into system based trading with algo trading driving about 40% to 50% of the trading volume on the NSE. From order-book data and changing performance of different strategies over the last five years, I think the following quant strategies have big money running on them in India -

• Momentum and Reversion portfolios based on ranking alpha factors - this is still in its earlier stages with simpler factors being used
• Pairs trading using Bollinger Bands and 2 sigma test. Many players have started to use co-integration instead of correlation
• Some basic use of ARCH/GARCH models in the options space
• Volatility arbitrage.. with poor gamma management
• Order-book balancing 
• Automated standard technical trading systems
• All manner of arbitrage strategies

This isn't a comprehensive list. 

Subbarao hints at easier policy. Why did markets not rally?

The RBI Governor, D Subbaroa, hinted at an easier monetary policy (see ET article on 6th Jan). The rate cycle turning will be positive for the economy and markets. Why did the markets not rally then? I think stagnancy in the markets is related to uncertainty about the date of rate cuts compounded by the risks posed by the earnings season.

The state of public finances is not exactly where the government wants, or the market expected. The government has overshot its fiscal targets and agencies like NHAI are making large bond offerings with more paper expected down the line. The prevailing sentiment is that the markets will not be able to absorb so much lending at lower rates and that the RBI, as the de facto debt management office of the government, will try to auction G-sec first and cut rates later. Essentially, this implies that rate cuts will not happen on the Jan 24 meeting but at some date after that.

To add to uncertainty related to the date of a rate cut, there are quite a few corporate earnings which will be announced in the two weeks leading up to the monetary policy meeting on the Jan 24. There is a fair degree of unease in the markets about corporate profits, bank asset quality, order book growth in infrastructure, regulation and scam in telecom, etc.

If you buy the markets today, and there are negative shocks to earnings between now and the policy, you don't really make any money. If the policy is good, you simply recover the intermediate loss. If they do not ease, well, then you lose some more. The compounded probability makes buying the market an unattractive proposition for risk averse traders.

Chances of a negative surprises for the dominant part of the NIFTY are low. The sectors with the highest weights in the NIFTY - financials (26%), energy and related (15%), pharmaceuticals (4%), software (14%), infra related (more than 5%) - have a small chance of further negative surprises with expectations already being very low, though IT can be complicated with the impact of the rupee still not known clearly. I think that there are low chances that the rate cuts will be deferred beyond the Jan 24 meeting - there is too much at risk for the government and the economy to be stupid about monetary policy any further.

This is a time to go long without leverage on quality large cap stocks which are oversold. Public sector financials and infrastructure stocks like Larsen and BHEL look good. Select midcaps like Biocon look very attractive as well.

Crystal Ball Gazing: Bullish for Jan-Feb 2012

2011 has certainly been an exciting year for most investors and traders. Exciting and painful thanks to the vacillating political and policy response to the sovereign debt crisis in the Eurozone, continuously deteriorating conditions in the shadow banking system and increased perception of systemic risk in the international financial system. The NIFTY has declined approximate 24% in rupee terms and approximately 43% in dollar terms!

This article is really focused on the next 30 to 45 days rather than a longer period. My view for the Jan-Feb 2012 period is unequivocally bullish on Indian equities. An important qualification - I am not making any claims for the next three, six or twelve months; just a short term view. A longer term view is reserved for another article.

Banks aren't going to fail

Globally, the macroeconomic news flow and data should hold ground over the next 4 to 6 weeks. No major financial institution is going to blow up in either Europe or America. Unlimited money is needed to prevent a systemic collapse and the actions of central banks around the world show that they are willing to provide exactly this.

The Fed has been printing money for quite some time with its balance sheet, with the exact figure debatable, certainly is in excess of $3 trillion. The Swiss National Bank has expanded its balance sheet and the Bank of Japan is a seasoned monetizer. The ECB, while making very all noises to the contrary, has printed even more aggressively and is already over $3.5 trillion.

The Euro isn't breaking up

 The Europeans are not going to let the Euro fail or change in the near term - much more civil and political unrest is needed for the shape of the EMU to change. Germany needs the Euro desperately to grow, banks in France and Austria have retail exposure to peripheral economies. Greece, Italy, Portugal, everyone needs the single market for their economies to survive. The integration is far too deep and intricate for politicians to simply pull the chord.

Too much damage will happen if the progression of events is allowed to become discontinuous in the current situation. The fate of Europe has not been decided, and perhaps rightly so. What is needed in the present is perhaps exactly the can-kicking which is happening since the pain from cutting debt sharply is not politically palatable or feasible.

The final outcome for the Euro will be a function of civil and political opinions which will change over time and no single decision making collective has control over this process. To assume that the problem can be simply 'fixed' is naive - it will find its own dialectic eventuality.

India: Rate Easing Begins

The Reserve Bank of India is amongst the most hawkish central banks in the world today. Perhaps also one of the few central banks who are presumptuous enough to believe that domestic monetary policy in an economy the size of India can influence imported inflation. Few central banks believe that food inflation in a developing economy, where large sections of population are malnourished or at subsistence levels, can be influenced by raising interest rates. The RBI is one of them.

Recent data shows inflation levels have started tapering off, especially food inflation. While growth is weak globally, the industrial production data in India has been abysmal thanks to RBI's aggressive tightening. Recent RBI policy statements show that the RBI is concerned about growth, but not at the cost of inflation.

Since inflation and growth both are headed down in India, the RBI ought to adhere to its economic ideology, and probably will ease in January 2012 marking the peak of the interest rate cycle - a huge positive of equities.


India: Political Cycle Potentially Turning

The political cycle in India shows the potential for turning if the Congress maneuvers deftly and uses the recent failure of the Anna Hazare led protest for the Lokpal anti-graft legislation. If the Congress plays its cards correctly over the next two months, it can fatally cripple the Anna Hazare led movement and disable the opposition which has not been the smartest political opponent this year with its own internal problems.

The public debate in 2011 has not been about poverty or growth or economic management; its been singularly focused on corruption charges against the Government. The Congress has the opportunity to capitalize on the present weakness in the protest movement, coupled with the convenience of the Parliament not being in session, to take executive decisions which can improve business confidence. This followed up with a reasonable Union Budget in March can turn things around very quickly.

While measures will take time to roll out, we feel that there is more than even chance that the Congress will take decisive steps in January can set the desperately required policy momentum rolling.

India: cheap valuations and potential near term triggers

Market valuations are on the cheaper side of historical bands in India. The prevailing mood does not assume that interest rates will start falling in January or that the political process has the potential to turn around before the UP elections in the summer. My bullish hypothesis rests on positive surprise on the policy front, positive potential on the political front, cheap rupee, cheap stock market valuations and exaggerated short-term pessimism on the global scenario where nothing decisive, positive or negative, will happen in the next quarter. The NIFTY can rally to levels between 5200 and 5500 while the rupee should not depreciate further.

blog revived from Jan 2012

Hello,

I could not post for the last 12-14 months due to a few personal and professional reasons . This blog restarts from Jan 2012 in its new avatar with a focus on international and Indian markets. The idea is to analyse policies, politics, economics, anything that can have a bearing on managing money domiciled in India while keeping an international perspective in mind.

Hope you enjoy reading it..

Varun.