The global selloff could not have come at a worse time. Just when we were anxious about the big event on 23rd of May, you have a global selling stampede to deal with. So, as an Indian investor, are you stuck between rock and hard surface now?
If you are an Indian investor, you have always had to deal with what is happening in the global markets for many years now. I would argue that the whole global rally which started somewhere in the last week of December in the global markets, resulted in a large amount of capital flowing into all EMs, including India. You saw those very large flows come through in late January, February and that really lifted the market right through up till a few days or maybe a few weeks ago. Global trends have always been part and parcel and I do not think you can sit here and presume that what is happening in the rest of the world does not matter or will not cascade through your own marketplace.
What does one do in this kind of an environment? There are real risks now; one is that if there is a non-friendly election verdict, it could not change the short-term outlook but it could change the long-term earnings trajectory for India. If the trade war fear is real it could jeopardise global growth for a sustainable period of time
Yes, my view is that as far as the elections are concerned in India, we have elections every five years. We are going to have them and we have seen how markets have largely held their ground. The overall direction of policy in India has been steady and consistent over a period of time. Some governments may press harder in some areas. The other governments may press harder in other policy areas, but broadly, the trajectory has been more or less okay. I would think that the bigger challenge which India’s growth model is likely to experience is the fact that you are seeing this outbreak of massive trade war between China and the US.
We know that China as well as other EMs have always used exports as something to give them that additional zip in terms of growth for their economy over a longer time period. In India’s case, we have always aspired that we could use the exports as a tool to grow much faster but we have not had much success on that front and frankly the environment to use exports as a tool to lift your overall growth trajectory for the economy does not seem to be something that is available in the playbook anymore, because of this pushback that is coming through on global trade.
Remember that India is actually sitting pretty. We have a trade surplus with them. It is not a very large one but the US is even making noises about that small trade surplus. This is a global environment in which using exports as a method to boost your overall growth prospects is a strategy which is unlikely to be available and therefore we will have to reorient to see how we can make our own pillars of the economy stronger.
I would primarily look at the extent of household financial savings and the extent to which we can drive the domestic investment cycle, simply because, we still have under investment as far as the economy is concerned in infrastructure. There is scope to raise the investment rate. Consumption has been on a reasonably healthy wicket, maybe currently facing some headwinds. The first two — financial savings and investments are the area in which any new incoming government will have to focus on.
Some of the sectoral plays we are closely tracking this morning. In pharma, a lot of the pain points were priced in. Given the recent news flow regarding the lawsuit in the US and the extreme reaction we have seen across the board on pharma names, we want to get your perspective once again.
The pharma names have not really had any positive news flow for a while and I think to that extent the valuations also reflect that. Some of the stuff related to the US states moving against the pharmaceutical companies has been in the works for a while. Yesterday, the market got a little bit more clarity about the extent to which they are looking to sue the pharma companies.
We will have to see. It is still early days in terms of how this all plays out and what the financial implications of this might be but obviously markets do not wait to see the exact number and they start to price it in much earlier. At this point of time, frankly it will have to be a wait and watch. We do think that the worst of what we were seeing in terms of the continuing pressures on quality related issues, on pricing related issues in the US. The majority of that is behind us. The growth in the domestic market in the chronic segments continues to be reasonably good, companies are experiencing good growth over there. Our sense is that valuation comfort is still there in this area. It is slightly contrarian today, given the news flow but we are happy to be contrarian over there.
This is a time where we can talk about the long-term averages and say that when you buy bad news, you are rewarded handsomely. If I look at the lay of the land, there are a lot of concerns which remain un-addressed and valuations are not that attractive which may just push back the market recovery also?
I agree with you on that and in fact valuations are not attractive, Even after the recent selloff, frankly the market is still trading positive for the year. The valuations are still trading at a premium to the long-term average, if you look at the PE multiple and I am looking at forward earnings because the trailing earnings frankly have been distorted way too much, by what is happening in the banking arena. Presuming that we are seeing some kind of credit cost normalisation and signs of that are visible in the numbers that have been reported for the March quarter, I do think that on a forward basis, valuations are more reasonable but are they at a discount to the long-term average. They are still at a premium to the long-term average and therefore you cannot really say that valuations are giving you a great amount of comfort in terms of trading at extremely cheap valuations.
We are not trading at a discount to the long-term average in terms of price earnings multiples. We are still trading at a slight premium on forward earnings to the long- term average. I cannot really call the market cheap and therefore to that extent cannot say that everything is in the price.
There could be pockets, there could be sectors, there could be individual stocks where we could make that case. Let us say in pharmaceuticals we look at the price to book multiple. There are all sort of trading at multiples both related to the market as well as their own past history, which are very reasonable and it is a long time since we have looked at price to book multiples in the pharma sector where typically we have trended to look at price to earnings multiples.
So, there could be pockets like this out there but the aggregate market certainly is not trading at a discount to the long-term average. I would share your concerns on the valuation front. We may have had a few bits of bad news come in, but it has not yet caused the aggregate market valuations to drop into the cheap territory.
Are we staring at some more downside or lots more downside from these current levels?
We tend not to think about too much of these issues of where the market is going and what it will do. Our job as mutual fund managers eventually is to manage the portfolio, try and create alpha over time and not get too perturbed about whether the market is going to go up or down. We think over the longer termm equities will remain attractive asset class. It has delivered good returns over the medium to long-term adjusted for volatility. Those kind of outcomes are very likely over a longer period of time, but shorter time, we tend not to think too much. It is not part of our investment process to worry about where the market is headed in the next 10 days or 20 days. We do not find it to be a source of creating alpha over the longer term.
Domestically what are some of the macro cues you are tracking currently? There have been questions about data points, the slowdown. We are still tracking inflationary trends. What do the overall data points on the macro front indicating to you”?
The delta change in the economy is a big concern and this is really the third time in three years where the economy is once again experiencing a setback. We had demonetisation, which led to a clear slowdown in growth for quite a few businesses and industries. Then we got the GST transition. Again, we saw a bit of soft patch in the economic data and over the last six months, we have seen a significant tightening of credit availability because of what is happening in the entire non-bank lending space. Once again, this is translating into softness in the economic data.
For the first time it is showing up a lot more acutely in the consumption area. We have been in an economy with a great runway but we are just not getting escape velocity in terms of take off. EBITDA and the growth rate looks in terms of GDP trying to be climbing higher, something comes and sets a back and once again we are entering a soft patch. I am saying most GDP estimates for the first half of this year now drops significantly below 7%.
In fact, quite a few estimates are at 6-6.5%. So, for the third time in three years, we are back to saying that the economy is in a tough situation, it is going through a soft patch. The fisc is under pressure. The only good spot that we have is really in terms of inflation which means that the central bank has a little bit of monetary muscle available to it, but otherwise we are once again in a soft patch and are looking for a recovery for the third time in three years. That is quite a disappointing outcome in some senses.
When demonetisation happened, everyone said black money will become white money. It is a short-term pain, but there will be benefits after two to three years. Same with GST. You are looking at unorganised becoming organised. In hindsight, these are the things which have derailed the economic growth. It is just lot of confusion and chaos, I guess?
It is a tribute to the political system that we managed to agree to come together to this Federal system of GST, but from an economic point of view what we were hoping for was a buoyancy in tax revenues come into the government fiscal and help to readjust the fact that our fiscal remains under strength. But we have not got that benefit for whatever set of reasons and therefore since this is an economy still hunting to figure out how to put the pieces back together, to get back to that magic formula of growth that we did experience almost a decade ago. Unfortunately, in 2003, 2010, the globe was a lot more supportive. But this time around, the world is not supportive either and therefore we will have to figure out how to do it with a lot more local elements to the policy mix. Yes, it is disappointing that we have not managed to get it right in the last three years.
Real estate in India has been in a 5-7 year downturn. Gold prices have been in a 5-7 year downturn. For equities, while last three years have been painful, it has done much better than gold and real estate. Even worst of the midcap schemes have given better return than gold and real estate. What are the chances that we may see a reversal in cycle?
I am no expert on gold or real estate to be able to make a comparison there. What I really understand much better is the equities. So, I will stick to that. If you look at it from a point of view of valuations and medium-term returns in equities, we are still not at a point where I would say this is the kind of valuations from which equities can give you very attractive returns. Having said that, I think we all need to readjust our expectations from asset classes because one of the big delta changes which has happened over the last five years has been the lowering of inflation with RBI and MPC in particular targeting inflation at 4%.
The whole return expectation curve needs to come down and therefore even from equities, when you look at those five-year returns and six years return and people talk about 18%, 25%, 30% CAGR returns in equities, I do not think that can be return expectation from the asset class anymore. The whole curve is moving lower as inflation is moving lower.
My own long-term return expectations from equity now is 11% to 12% and given that valuations are currently at a slight premium to the long-term average, I would have to moderate that 11% to 12%, given where we are on the valuation cycle.
Given the current scenario, there has been some talk about moving from NBFCs back to corporate banks. The PSUs are still looking a little heavy even after stabilising some of their balance sheets. On the private side, let us keep certain names aside but overall where would you look within the financial basket right now?
Actually there is a wide variety of opportunities available. We have got large set of banks with high quality liability franchise and eventually banks is always about the quality of their liability franchise. Given the clean-up that has happened in the banking system of the old NPAs — NPAs that got created during the previous investment cycle — today when we look at the banks, we find that so-called corporate-focussed banks do not look corporate-focussed any more. 50% or 40% to 50% of their book is now retail and therefore there is a large variety of banks available with strong liability franchises and book which is well distributed between corporate and retail.
The old corporate infrastructure project loan book is largely cleared up. That is certainly an area of interest to us. I would say as far as NBFCs are concerned, they are facing some challenges in the liability side but NBFCs have always been about their ability to originate customer assets. They have never been about the quality of their liability franchise. When you look at it from that prism, we do think there are some NBFCs which will come through this fairly trying period quite well. But what will be key to them is how unique is their asset creation ability. Is it retail, is it granular? NBFC running a pure wholesale to wholesale business model, our sense is that that business model has come under tremendous pressure because of what is happening in the overall liquidity situation of the markets.
But if you are running an NBFC, which has got largely retail granular amortising loan products which the banking system is not very good at originating, then you may have an issue in terms of your net interest margins in the short term. But the business model will survive. That is the way we sort of look at the landscape today.