The winter is not over

After writing the Modi bubble 2.0, I have some skeptics now, and with good reason. A strong government should be able to solve all our problems. Last week I sent out a very deep interview with two men from the debt markets and I hope you watched it. It touched upon everything that is going on without bias. Maybe that is why I would rate Quint on top of most business channels. Even as I do not speak there on the topics that interest me. Here are links to the two part interview

https://www.youtube.com/watch?v=_yEIDDyBwYM

https://www.youtube.com/watch?v=vqQWhGXt-fM 

Back to the point it was not more than a week ago that Anil Ambani was quoted in the ET stating that India's NBFC sector was in the ICU and needed more than just a pain killer. And you still doubt that we are in an economic winter? The reason for doubt only comes from looking at the Nifty. But maybe also because we are in an unusual period of time, one that you will only experience once in your lifetime. 

The Kondratieff cycle is a generational cycle so you will go through this season only once in your life. And since you did not live in the last one there is no reference point. As a student of the cycle I use it to forecast economic events that will follow. But I have no past experience of it and cannot because the last time this may have happened was 70-100 years ago. So while an Economic Autumn is a bull market in consumption aided by cheap credit, an economic winter is the unwinding of over indebtedness of an entire society. The level at which these extremes ar reached is not fixed.

Now no one will disagree that India has been on a dream run of spending and consumption driven boom. However from the first time I started to write about the coming economic winter in 2009, every listed stock that was high on debt/equity has crashed and not returned to the 2010 highs. The list can fit pages. It includes the popular ADAG group, PSU banks, Real estate stocks like DLF, and so on. This article from Business line captures it and shows charts from the 2010 top.

So while most will consider my winter call as a perma-bearish stance they will miss out on the utility of that view in asset allocation. For that reason I have "Value Wave stocks", as a model at Indiacharts, there can be trends that are cyclical or that belong to the moment that can offer investment opportunities. I found my niche in commodities and related sectors in this time.

That said it does not change that our non government debt/gdp ratio is over 100%. This is big by any standard. Getting the economy to then grow requires an ever increasing stimulus of new money. The reason why the market faces a dilemma in accepting the winter theory is that for some reason the Autumn cycle of consumption and the unwinding of debt ended up happening at the same time. So it is a tug of war between two worlds. The indices were restructured in good time to reflect the upside from growth sectors. The government did its bit by using OMOs, the pay commission, MSPs, and low interest rates with demonetisation, to allow the ever expanding pent up demand in consumption to exhaust itself.

Did I say exhaust? I mean there is a limit to how many cars I can buy. After 2 by the time I think of a third orr a switch to the latest model maybe my kids grew up and their education expenses took a front row seat. How many biscuits can you consume. You should know that the largest margin expansion in FMCG comes from the contribution margin which is price increases. In the late 90s the same companies suffered from down pricing. But eventually the inflation cycle kicked in and profits exploded. But inflation is also a cycle and there is a limit. 

No wonder that today post elections on the first RBI meet expectations are built in for a 50bps rate cut to save the nation. But will the additional savings translate into consumption? In the para above note that I brought a demographic angle into the discussion. Unfortunately we do not have data on all fronts in India else it should be easy to map it. Demographics change the consumption behaviour of a generation. The same generation that was buying homes and second homes will now find other uses for their money. Maybe retirement planning and education for their kids.

In the meantime this does nothing for our debt burden sitting on bank balance sheets. If RBI had not pushed it in 2015, till 2014 nobody even agreed with me that we had an NPA problem. Then NBFCs were the hottest sector. Even today some analysts in media believe that the NBFC crisis this time cannot be compared to that of the 1990s. Yes it cannot, exactly. It is different but it is not small. In fact my sense is that we are only skimming the surface. As below the government knows it. In fact this piece below sounds like we are discussing the Lehman crisis. Who is too big to fail? But Lehman was the one let go.

The reason I posted the video links above is for you to understand the inter linkages that exist in the financial sector. Contagion is a word that is real. One one firm fails it has a multiplier effect. And they it is game over. The negative sentiment on investment flows can quickly suck up liquidity from the system. For long this was debated with ILFS and banks were not marking it down as bad debt. The side effects are still a work in progress like below.

But the real talk of town today is DHFL, a payment delay at the lender followed by a debt downgrade has suddenly made its NCDs marked down and illiquid.

Meaning that a lot of mutual funds that hold debt from the lender have to mark it down and face losses. And if that gets followed by redemption pressures it will be something to watch on how the demands are fulfilled. If this is not contagion what is. This is a live example happening right now.

All this while growth in key sectors like Autos have finally hit the wall.

And Scooters

Another angle to the story is that overconsumption has lead to a drop in the savings rate. The side effect of that has been a spike in the credit deposit ratio. In the video above "Ananth" mentioned it to be well above 100%. With that we are still asking for credit growth to pick up and the panacea is supposed to be lower interest rates? Like that will push up savings. Macro economic factors are a complex matrix. For every pro there is a con. And we can play with the numbers as long as we can but at some point of time we have to face the old adage of "Mean Reversion"

And let me end by saying that many trends are global, the fall in Auto sales is now a worldwide phenomena over the last 2 years. And the negative impact of the NBFC crisis is seen in rising bond market spreads both in India,

and likely in the US, for completely different reasons. An earnings recession at a time when wage inflation is eating into margins. Hitting profit growth and thus raising risk for high yields debt. Its funny whether you like it or not many of the trends we witness now days are global.

I am well aware that everything I am writing here is the negative side of the story. A new strong government at the helm. A 100,000 crore spending plan and a 50-75bps rate cut is going to solve all our problems in the months ahead. That keeps the tug of war between the Autumn and Winter cycles going on a little longer. There is only one thing I can tell you with certainty. Winter always follows the Autumn and not the other way around. You can push it but just this far. My warnings about the debt cycle have proven true over the last 10 years even as markets have risen, this has shown up in every debt crisis one after the other during this time. That gives me no reason to discard the theory or the anticipation of what lies next. I think we will go from one NBFC to the Dirty Dozen pretty soon, and not necessary that all are listed entities. This keeps me on my toes for what follows and in search of the right opportunities for these confusing times. This is not a time cycle that you can put a date upon. It is a cycle of events that follow one another no matter how slowly they do so. The economic winter in India is real be aware and prepared, An economic slowdown would exacerbate the problems and bring more skeletons out of the cupboard. It is in the interest of the government to keep that from happening. But we are pushing on a string. You can spend too much and trigger higher interest rates or inflation. It is going to be a tight rope walk and hoping that the wind does not blow.