Why the Bihar poll matters for stock markets: A BJP win will allow stockbrokers to sell ‘ache din’ again


The assembly elections in the state of Bihar are scheduled to happen across five phases between October 12, 2015, and November 7, 2015. The constituents of the stock market are closely following the run up to these elections like they had followed the run up to the Lok Sabha elections last year.

While the stock market following the Lok Sabha elections is but natural, why is it following the run up to the assembly elections in Bihar? Bihar is the poorest state in India as measured by the per capita income. Data released by the Ministry of Statistics and Programme Implementation shows that for 2014-2015, the per capita income of the state was Rs 36,143. This was the lowest among the states and union-territories, which had declared their per capita income when the data was published in July earlier this year.

During 2013-2014, the per capita income of the state was at Rs 31,199, the lowest among all states and union-territories. The state of Uttar Pradesh came in second from the bottom at Rs 36,250. This when the per capita income of Bihar has grown at greater than 15% in each of the last three financial year’s.

Data from the India Brand Equity Foundation points out that the per capita income of the state is around 43% of the Indian per capita income. The gross domestic product (GDP) of the state is around 3.25% of the Indian GDP, even though the state has more than 8% of India’s population.

The installed power capacity of the state is 2759.8 MW, which is around 1% of the total capacity in India. Over and above this, given the many years of lawlessness and the lack of electricity that the state has faced, it barely has an industry.

Data from the ministry of finance shows that the state has 26 public private partnership projects. This is less than 2% of the 1409 projects all across India. The India Brand Equity Foundation points out that the “total FDI for Bihar and Jharkhand combined during the period from April 2000 to May 2015 stood at US$ 59 million.” On this my guess is that even this miniscule amount would have gone more to Jharkhand than Bihar.

The state barely contributes to the Indian GDP, has virtually no industry and almost no FDI is going into the state. In this scenario why is the stock market worried about Bihar? As Shankar Sharma, Vice Chairman and Managing Director of First Global recently told Business Standard: “Bihar election is important from the context of whether the Modi government still enjoys popular mandate or not.”

And how will that help the stock market? A win in Bihar for the Bhartiya Janata Party(BJP) led coalition will allow the stock brokers to sell the Narendra Modi “ache din aane waale hain” story all over again to foreign investors as well as Indian investors.

As Philip Tetlock and Dan Gardner write in Superforecasting—The Art and Science of Forecasting: “The one undeniable talent that talking heads have is their skill at telling a compelling story with conviction, and that is enough.”

Stock market investors love a good story and Narendra Modi in control is a compelling story that can ‘still’ be sold with some conviction by stock brokers. What works for it is the fact that it has already been sold once between September 2013 and May 2014, in the run up to the last Lok Sabha elections. The BSE Sensex ran up 33% between September 2013 and May 26, 2014, when Narendra Modi was sworn in as the prime minister of the country.

This was purely a sentiment based rally based around a compelling story that was well sold. The stock brokers are hoping to repeat this in the time to come. The trouble is that unlike the last Lok Sabha election this election remains too close to call. Hence, up until now, various opinion polls have swung both ways. Some have suggested that the BJP led alliance will win, whereas others have suggested that Lalu Prasad Yadav + Nitish Kumar + Congress (or the Grand Alliance) will win. Let’s see which way things swing.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Oct 6, 2015

What business news channels have in common with Chacha Chaudhary

I normally don’t watch business news channels given that I find them quite flaky and get put off by their lack of depth. Nevertheless, these days with nothing better to do while having lunch, I sometimes do end up watching these channels discussing the vagaries and the volatility of the stock market.

And one of the things I have noticed is that the anchors as well as the stock market experts who offer their opinion on these channels speak with a lot of conviction and confidence. They appear to be in control of things. They appear to know what is happening, when the world around them is probably going crazy. We never hear them use words like probably, maybe or phrases like I don’t know. Further, they seem to have this uncanny ability to understand and explain something just as it has started to unravel. Their story telling abilities are simply terrific.

The uncanny ability of these anchors and experts to explain things at the speed of thought reminds me of a thought bubble in the Chacha Chaudhary comics, which used to say: “Chacha Chaudhary ka dimaag computer se bhi zyada tez chalta hai (Chacha Chaudhary’s mind works faster than a computer).These anchors and experts are perhaps the Chacha Chaudharies of this day and age.

How is such speed possible? If the anchors and experts are so much in control and seem to have so much insight with such clarity, why are they not making money out of it? Why are they offering their advice for free on TV?

As the British economist John Kay writes in his new book Other People’s Money—Masters of the Universe or the Servants of the People?: “We deal with radical uncertainty through storytelling, by constructing narratives…The reality of market behaviour…relies on conviction narratives – stories that traders tell themselves, and reinforce in conversation with each other. Such narratives are the means by which we cope with radical uncertainty – the unknown unknowns that characterise… business and securities markets.”

The anchors and the experts appearing on business news television are in the business of telling us stories, which offer an explanation for why the market moved the way it did on a particular day. These days the most offered explanation is that economic jitters in China caused the stock market to fall. But this explanation is always offered after the stock market has fallen. No anchor or market expert ever says: “The stock market will fall today because there is economic trouble in China”.

As Kay writes: “The ‘explanations’ provided…by…market commentators…are little more than rationalisation of the noise generated by…market volatility.” And given this, it is worth asking that how useful is it for investors to listen to these explanations and make investment decisions after that.

Bob Swarup calls this phenomenon the illusion of explanation. He defines the term in his book Money Mania as: “Believing erroneously that your arguments…explain events.”

Further, how is it that the anchors and the market experts have an explanation for everything that happens in the stock market? And what is even more surprising is how they are able to come up with explanations so quickly. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Commentators…provide a neat post hoc explanation for every rally, every sell-off, and everything in between…Because so much information is available—business pages, companies’ annual reports, earnings expectations, alleged scandals, on-lines sites and commentary—something insightful can always be said.”

Over and above this there are many data releases which can also be used to come up with explanations. These data releases include inflation as measured by the consumer price index and the wholesale price index, index of industrial production, export and imports numbers, bank credit growth, and so on. And if all this does not fit into a convincing narrative you can always blame the Reserve Bank of India for not cutting interest rates.

Investing in specific stocks is not easy as it is made out to be by business news television. In fact, what anchors and market experts specialise in is making things simplistic rather than simple, given that they have limited time at disposal to say what they want to say. In this situation, where everything has to be said in thirty seconds to a minute, it is hardly surprising that things ultimately become simplistic. And this is clearly not good from an investor point of view.

What works for these anchors and experts is the fact that while coming up with explanations and predictions, their past record is not available for examination.

As Jason Zweig writes in Your Money and Your Brain: “Whenever some analyst brags on TV about making a good call, remember that pigs will fly before he will broadcast a full list of his past predictions, including the bloopers. Without that complete record of his market calls, there’s no way for you to tell whether he knows what he’s talking about.” This is a very important point that needs to be kept in mind when listening to anchors as well as experts on television.

Also, it is worth remembering here that which way a stock market will go is impossible to predict regularly on a day to day basis.  Nassim Nicholas Taleb in his book The Black Swan—The Impact of the Highly Probable lists a certain category of experts who tend to be…not experts. In this list he includes economists, financial forecasters, finance professors and personal financial advisers.

As he writes: “Simply, things that move, and therefore require knowledge, do not usually have experts, while things that don’t move seem to have some experts. In others words, professions that deal with the future and base their studies on the nonrepeatable past have an expert problem…I am not saying that no one who deals with the future provides any valuable information…but rather that those who provide no tangible added value are generally dealing with the future.” Given this, the stock market experts clearly have an expert problem.

Hence, the next time you switch on your television to try and understand what is happening in the stock market, do remember all that has been pointed out above.

Happy investing!

The column originally appeared on The Daily Reckoning on September 25, 2015

Will Federal Reserve spoil the stock market party by raising interest rates?

The prospect of future company earnings are supposed to drive stock markets. But this basic theory has broken down in the aftermath of the financial crisis that started in September 2008.
Western central banks led by the Federal Reserve of the United States have printed an astonishing amount of money over the last six and a half years and some like the Bank of Japan and the European Central Bank, continue to do so. The idea was that money printing would lead to lower interest rates, and at lower interest rates banks would lend more and consumers and businesses would borrow more. This would lead to businesses and in turn, the economy doing well.
But that hasn’t turned out to be the case. As the following table clearly shows, bank loans to small and medium enterprises(SMEs) in the United States have been falling as a proportion of total loans, over the years.

The shrinking importance of SME lending

Nonetheless, lower interest rates in much of the Western world, has allowed investors to borrow money at rock bottom interest rates and invest it in stock markets all over the world.
This is why stock markets including the Indian one have rallied big time over the last few years. For this rally to continue it is important that Western central bank continue to maintain low interest rates.
The economic situation in Europe continues to remain bad, and as of now there is very little chance that central banks of Europe will go around raising interest rates any time soon. In fact, in Switzerland the short term interest rate currently is at
 − 0.75%.
Japan also continues to remain in doldrums and the chances of the Bank of Japan, the Japanese central bank, raising interest rates any time soon remain minimal. This leaves the Federal Reserve of the United States, the American central bank. And this is where things get a little tricky.
The Federal Open Market Committee of the Federal Reserve which decides on the interest rate is supposed to meet today and tomorrow (i.e. March 17 and March 18). The rate of unemployment in the United States has come down significantly over the last one year. In fact,
the USA Today reports that in 2014, job growth hit a 15 year high.
Typically, a fall in unemployment leads to an increase in wage growth, as employers compete to recurit employees. But that doesn’t seem to have happened in the United States. The Fortune magazine reports that the average hourly pay of an American worker has risen by just $0.03 in the last one year. This basically means that wage growth in the United States has been more or less flat over the last one year.
The overall inflation also remains much lower than the Federal Reserve’s target of 2%. The Federal Reserve’s preferred measure of inflation is personal consumption expenditures(PCE) deflator, ex food and energy. For the month of January 2015, this number was at 1.3% much below the Fed’s target of 2%.
This number falls further once the imputed(i.e. made-up data) is excluded. Before we go any further I need to explain what imputed data is. Take the case of an individual who owns the house he lives in. As the Statistics Bureau of Japan points out: “B
uying a house or a piece of land is a form of property acquisition and not consumption expenditure. Such a purchase, therefore, is not counted in the CPI. Still, it is an undeniable fact that a household living in a house it owns receives some service from the house…Also, many households are paying a mortgage. Here, it leads to an issue that, one way or another, the housing expense of an owner-occupied house should be counted in the CPI calculation.”

Hence, such a situation needs to be taken into account. It is done by assuming that the “house-owning household is renting the same house from someone else.” “Then, the household has to pay some rent…An “imputed rent of an owner-occupied house” refers to the rent paid to owner-occupied houses assuming that owned house were rented. Such imputed rents are taken into the CPI calculation,” the Statistics Bureau of Japan points out.
If such data were to be excluded from inflation calculation in the United States, the results would be significantly different from the way they currently are. As Albert Edwards of Societe Generale points out in a recent research note titled
Forget the ECB: A key measure of global liquidity is now in freefall, published on March 6, 2015: “We use a variant of this core PCE where the US statisticians exclude imputed (i.e. made-up) data..Five out of the last six months have registered zero inflation with only one 0.1% rise! Headline core PCE is being inflated by made-up data.”
As the fall in price of oil seeps through the system Edwards expects the inflation rate to come down to 0.3%. The other major reason for low inflation in the US is the fact that dollar has rallied majorly against all major currencies. This ensures that imports to the United States become cheaper, and thus drive down inflation.
In this scenario of almost no wage inflation and low overall inflation, will the Federal Reserve start increasing interest rates?
If the Fed does not raise interest rates then foreign investors will continue raising money in dollars and investing that money in stock markets all over the world, including India.
But if the Fed does start to raise interest rates then this carry trade may run into some trouble and fresh money from foreign investors may not come into India at the same pace as it has in the past. The way things stand as of now, this remains too close to call. Nevertheless, I will stick my neck out and say, the Fed won’t raise interest rates in June this year, as it is widely expected to.
Having said that, I have my fingers crossed!

The column originally appeared on The Daily Reckoning on Mar 17, 2015

Do company earnings drive the stock market or is it something else?

bullfightingAn interesting piece of analysis, which is carried out almost every time the quarterly results come out, caught my eye on January 26, 2015, in the Business Standard newspaper.
The combined net profit (adjusted for exceptional items) of 290 companies which have declared their results for the period between October to December 2014, grew by just 2.2% in comparison to the same period last year.
Interestingly, this set of companies had declared a profit growth of 12.6% during the same period last year and 9.8% during the period July to September 2014, the newsreport points out.
When it comes to the growth in revenues of these companies the results are worse. The combined sales of the 290 companies which have declared results fell by 4.4% in comparison to the same period last year. This is the first drop in eight quarters.
In fact, if banking and financial companies and IT exporters are taken out of this sample, the combined revenues fell by 11% in comparsion to the same period last year. The net profit fell by 4.8%.
These are not great numbers at all. While, the sample size may not be big enough it is a cause for worry nonetheless. Further, the projection on revenues growth isn’t great either. Crisil Research in a recent report said that it expects revenue growth of India Inc to “slip to a 6-quarter low of 7% on a year-on-year (y-o-y) basis in the December 2014 quarter.” “Revenue growth was around 9% in the preceding quarter and 13% in the December 2013 quarter,” Crisil Research pointed out.
Nevertheless, the stock market has continued to rally. Financial theory tells us that stock prices are ultimately a reflection of discounted future earnings of a company. But that doesn’t seem to be the case here. If the stock market was expecting quarterly results to be bad then it should have been falling, as per theory. But that doesn’t seem to be happening.
Having said that we are looking at data for just one quarter. How strong is the link between earnings growth and Sensex returns over the long term? Ambit Research has the answers in a recent research note titled
The Three ‘Stories’ That Drive the Sensex. As can be seen from the following table there is”no meaningful relationship between Sensex returns and earnings per share growth between financial years 1992-2014.”

No meaningful relationship between Sensex returns
and EPS growth between FY1992-2014

Source: Bloomberg, CEIC, Ambit Capital research

How do things look if we plot Sensex returns of a given year with earnings per share growth of the previous year? Again there is no meaningful relationship between Sensex returns and lagged earnings per share growth between financial years 1992-2013.

No meaningful relationship between Sensex returns
and lagged EPS growth between FY1992-2013

Source: Bloomberg, CEIC, Ambit Capital research

In fact, the relationship between Sensex returns and economic growth (measured in terms of GDP growth) is also not meaningful, the research note states. This is something that valuation guru Aswath Damodaran also told me a few years back when I had asked him:
“How strong is the link between economic growth and stock markets? “It’s getting weaker and weaker every year,” he had replied.
So what drives the Sensex? “Over the last 30 years, there has been a pronounced tendency for the Sensex’s returns to revert to the mean, with the mean being around 17%,” the Amit Research note points out (See the following table).

Rolling five-year Sensex return CAGR

Source: Bloomberg, CEIC, Ambit Capital research

Another very good predictor of Sensex returns is the political-economic cycle. “The Sensex seems to move in sync with India’s political cycle (which in turn seems to have a profound influence on India’s economic cycle). In particular, the Indian economy seems to move in 8-10-year economic cycles, with the beginning of these cycles coinciding with decisive General Election results (eg. 1984, 1991, and 2004). Then in the first three years of these economic cycles, the Sensex seems to appreciate sharply as investors discount the decade-long economic cycle. So, whilst the Sensex’s 30-year CAGR is 16%, its CAGR during the first three years of each of the economic cycles (1984-87, 1991-94 and 2004-07) is ~33%,” the Ambit Research note points out.

The remarkable synchrony between political and economic cycles in India

Source: CEIC, Ambit Capital research

These rallies stem from the Indian middle class’s hope of finding a strong leader and that in turn leads to the Sensex rallying for the next three four years. Using this theory we can say that the current Sensex rally will last till 2017-2018.
Also, for the past few years we have been living in an era where the narrative of central bank omnipotence holds. As Ben Hunt who writes the Episilon Theory Newsletter puts it:
central bank policy WILL determine market outcomes. There is no political or fundamental economic issue impacting markets that cannot be addressed by central banks. Not only are central banks the ultimate back-stop for market stability (although that is an entirely separate Narrative), but also they are the immediate arbiters of market outcomes. Whether the market goes up or down depends on whether central bank policy is positive or negative for markets.”
Over the last few years central banks of developed countries like the Federal Reserve of the United States, the Bank of England and lately the Bank of Japan have been running an easy money policy by printing money. The European Central Bank has become the latest central bank to join the money printing party.
While the Federal Reserve has stopped printing money in October 2014, the Bank of Japan and the European Central Bank are still at it. And this “easy money” has been driving financial markets all over the world. In this world, earnings and economic growth do not matter. What matter is how much money is coming into the stock market.

(The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on February 4, 2015)

Of Yuvraj Singh, stock markets and the Vietnam War


Vivek Kaul

 It is in the last week of March 2014 that I am writing this piece. The stock market in India is flirting with all time high levels. At the same time in the T20 cricket World Cup that is on, Yuvraj Singh’s bad form with the bat continues (as I write India has played two matches, and in both, Yuvraj has failed with the bat).
Despite the fact that the stock market is flirting with all time high levels, there are still a lot of investors who are holding onto stocks they had bought at the peak levels reached in 2008. Real estate and infrastructure stocks were a favourite among investors back then.
Once the stock market started to crash in 2008, these stocks crashed big time. They still are nowhere near the high levels they had achieved way back in 2008. And more than that, the prospects for these sectors(particularly real estate) in India, are not looking good either. Nevertheless, there are still some investors who have held onto these stocks bought in 2008, in the hope that these stocks will make money for them one day. So what is happening here? Barry Schwartz explains this in his book The Paradox of Choice. As he writes “People hold on to stocks that have decreased in value because selling them would turn the investment into a loss. What should matter in decisions about holding or selling stocks is only your assessment of future performance and not (tax considerations aside) the price at which the stocks were purchased.”
But the price at which the stock is bought does turn out to matter. This fallacy is referred to as the sunk-cost fallacy by behavioural economists.
And what about Yuvraj Singh? What is he doing here? Vijay Mallya owned IPL Royal Challengers Bangalore bought him for a mind-boggling Rs 14 crore in a recent auction in the Indian Premier League(IPL). The tournament starts in mid April, right after the T20 World Cup ends. From the way things currently are, Yuvraj doesn’t look in great form. But despite that he is likely to be played by Royal Challengers Bangalore in all the matches that they play.
And why is that? Simply because the sunk-cost fallacy will be at work. The Royal Challengers Bangalore have paid so much money to buy Yuvraj that they are likely to keep playing him in the hope that he will eventually start scoring runs. Schwartz discusses this in the context of professional basket ball players in the United States. “According to the same logic of sunk costs, professional basketball coaches give more playing time to players earning higher salaries independent of their current level of performance,” he writes.
The sunk-cost fallacy is a part of our everyday lives as well. Many of us make instinctive expensive purchases and then don’t use the product, due to various reasons. At the same time, we don’t get rid of the product either, in the hope of using it in some way in the future.
Richard Thaler, a pioneer in the field of Behavioural Economics, explains this beautifully through a thought experiment, in a research paper titled Mental Accounting Matters. “Suppose you buy a pair of shoes. They feel perfectly comfortable in the store, but the first day you wear them they hurt. A few days later you try them again, but they hurt even more than the first time. What happens now? My predictions are: (1) The more you paid for the shoes, the more times you will try to wear them. (This choice may be rational, especially if they have to be replaced with another expensive pair.) (2) Eventually you stop wearing the shoes, but you do not throw them away. The more you paid for the shoes, the longer they sit in the back of your closet before you throw them away. (This behaviour cannot be rational unless expensive shoes take up less space.) (3) At some point, you throw the shoes away, regardless of what they cost, the payment having been fully `depreciated’.”
Along similar lines people hold on to CDs they never listen to, clothes they never wear and books they never read. Keeping these things just holds up space, it doesn’t create any problems in life. But there are other times when the escalation of commitment that the sunk-cost fallacy causes, can lead to serious problems. As Daniel Kahneman, writes in Thinking, Fast and Slow “The sunk cost fallacy keeps people for too long in poor jobs, unhappy marriages, and unpromising research projects. I have often observed young scientists struggling to salvage a doomed project when they would be better advised to drop it and start new one.”
As far trying to salvage doomed projects go, CEOs and businesses seem to do it all the time. As Kahneman points out “Imagine a company that has already spent $50 million on a project. The project is now behind schedule and the forecasts of its ultimate returns are less favourable than at the initial planning stage. An additional investment of $60 million is required to give the project a chance. An alternative proposal is to invest the same amount in a new project that looks likely to bring higher returns. What will the company do? All too often a company afflicted by sunk costs drives into the blizzard, throwing good money after bad rather than accepting the humiliation of closing the account of a costly failure.”
A similar problem afflicts a lot of government infrastructure projects as well, where good money keeps getting thrown after bad. It also explains why the United States kept waging a war in Vietnam and then in Iraq, even though it was clear very early in the process that Vietnam was a lost cause and that there were no weapons of mass destruction in Iraq.
To conclude, it is important to understand why human beings become victims of the sunk-cost fallacy? “Sunk-cost effects are motivated by the desire to avoid regret rather than just the desire to avoid a loss,” writes Schwartz. And if you, dear reader, do not want to become a victim of the sunk-cost fallacy, this is an important point to remember.

 The article originally appeared in the April2014 issue of the Wealth Insight magazine.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected]