What do you make of this sudden volatility?
We are living in a very different world. The way the world has been stalled for about six months, is a kind of rude shock to the economy and none of us were prepared for this. And to top it, there is a pandemic and there are issues around it. Most economies are trying to grapple and find out ways to get out of it and so there is a lot of fiscal prolificacy and that brings in a lot of other variables which we are not aware of and we are seeing for the first time.
So volatility is a key function of uncertainty and in these times, when economies are shut for about six months, you have no support in terms of falling back on numbers. So we try and normalise numbers looking forward to numbers in FY22, FY23 and you see through the aberration that we are going through. The idea is to wade through this muddle but you have to think about being normalised in the next couple of years because the number of variables that we are grappling with is unbelievably large.
The market can be divided into two pockets – a pocket which is led by Reliance and has IT and pharma and in it, IT is outperforming. The other pocket has got value and banks which are underperforming are in it. Is it important to look at beaten down names?
We tend to be a little contrarian which you are reasonably aware of and we try to sit in places where people are not normally there and there is a runway to take off. so whatever it is. The fact is earnings growth is a little away and possibly a little elusive for the next couple of quarters at least, maybe three, maybe four. Be there as it may, what you got to think about is there are pockets which are getting completely smashed. IT and pharma had completely bombed out about a year back. It has all come back pretty strong. I am not very sure whether I want to buy earnings growth at this point in time but I really want to be in pockets where there is a serious mismatch or a sharp divergence in terms of valuation compared to history.
Commodities and materials are pretty shunned words and obviously the fiscal condition is not suggesting that there is going to be a massive capex through recovery with pump priming. But we are looking at that space thinking that that is the space that nobody wants to talk about, the analysts are ignoring and the valuations are deep in the trough. Having said that, IT is one name where we think that there is a change in the world equations which will result in IT sustaining a little while longer.
Having said that, I believe that the new IT paradigm will be different from the past IT paradigm and hence there will be changes in the equation but Indian IT services is a very promising piece. But in the equation, we are avoiding expensive momentum, high growth forecasts for reasons that they are very prone and the margin of safety is negligible given the uncertain world that we are living in.
Even private banks are smashed. But some would argue that Indian banks are still very expensive. If everything is falling globally, are Indian banks simply following a global phenomenon?
Whatever is happening to Indian banks is of their own doing. Indian banks are terribly expensive for a variety of reasons. Partly the ownership is kind of an issue but having said that, think about the Indian banks as a structure, as a piece of thing that you will need to value buy itself. In the last four years, 30-40% of the corporate loan book has gone bad. Another 25% of the book which is retail which has been holding up and has been driving it all. The MSME piece was about 15% and that is the segment which is probably going to get smashed now and people are already pricing that there is a bit of bump there. Retail is also not sustainable after growing five years at the rate of close to around 20%.
The second part is there is no capex and so there is no recovery. There is no credit growth and there are vulnerable sets of pieces — MSME and retail — waiting to fall. So the expensive bits will get corrected and there is no reason to believe that the retail and MSME space is going to look smart for very long. Put that in the context that the Indian banks will see a massive churn. Credit cost will remain elevated by about 3% to 5%.
The second part of the story is I am a bit tired of hearing from SBI post every result that the worst is behind us. I do not know what is the worst and what is better than the worst coming up? It is still at the same price as we saw in 2016. The stock price has done nothing. So the fact is that the Indian banking is a bit barbelled. The cheap are very cheap. The expensive ones are a little pricey but they are getting corrected. I cannot see any reason why you will pay a spectacular price to a book of maybe about 1 to 1.5 for a 10% ROE business.
We are less than 40 days away from the US election.What could be the possible market reaction of either Trump or Biden victory and are we bound to see heightened volatility and weakness in US equities and thereby the rest of the world closer to the elections?
The only way I will not be wrong is if I do not answer that question. The fact is when Trump was elected, there was absolutely a consensus opinion that the market is going to crash if Trump comes in. The market actually corrected for exactly about five hours, the next day it was back in full glory. Elections make for a bit of volatility because people are speculating and conjecturing about the outcomes but honestly there is a lot more to it beyond politics and elections. We attach too much importance to that.
What is possibly in mind is what economic policies and what the Fed might do post the election? Whoever comes in, I cannot believe that the China rhetoric is going down/I cannot believe that the desire to get inflation back, the desire to get full employment is going to be anywhere away from the agenda for whoever comes in. Having said that, I mean, rates are zero you cannot change that and there is no massive impetus for the rates to move up. That is what people will look out for irrespective of whether it is Biden or Trump. We attach too much importance to wherever they are but both of them will possibly work on similar thoughts though one maybe a bit different from the other.
The Democrats as we understand are now mulling a sizable relief package of perhaps $2.4 trillion could come in next week. Do you sense that it is going to take care of the near term temperament of the market?
Everybody is aware of that and money is reasonably cheap, capital is available and rates are zero and people are getting money for not working as well. It is as free as it gets and that is to sustain the markets and so that you do not kill the goose which is laying golden eggs. The fact is that if the economy is in trouble and everybody is aware and you do not want to kill equity markets because that is possibly the one last source of capital which is available and which enhances the asset values globally. You have a venue to increase the personal wealth of people and it is like a game which is well known to all. And you probably will not let that go away and as long as money is cheap or free, equity as an asset class will sustain and people will keep looking out for incentives, economies will keep crumbling but it does not matter, I think it is a game which is going to go on for a while.
Most auto and consumer companies are saying they have gone back to near pre Covid levels. Would you take that with a pinch of salt or do you think the economy has surprised us and we should be happy about it?
The economy has not surprised us, we do not need to be happy about it but the fact is I had a few calls over the last couple of weeks and there are some very interesting thoughts. We will know what it is in about six to 12 months time but there are two pointers which are important; there is a lot of pent-up demand, part one, six months of lockdown people are coming out, there is a pent up demand which is unwinding. The second part is I think the entire Covid and other things have resulted in a bit of social distancing and mode of transport and people are getting into the cheaper end of the motorcycle for commute purposes.
Going into the festive season, I am given to understand that there is a follow through. It is reasonably decent but I have been cautioning myself though we have been on the contrarian side where we thought one year back that things were negative 25%, whereas we thought six months back when it was negative 25%, we thought there was an opportunity. But the opportunity is probably waning or will wane very quickly.
There are two reasons for that; first is we picked up a data point. I am not sure why it is not widely publicised that about 10 million people withdrew Rs 40,000 crore of money from EPFO. The interesting part is they are all with monthly salaries of less than Rs 15,000. When you dip into your EPF, you are clearly dipping into savings and assets which is meant for the longer term. This suggests to me that a fair bit of unemployment is maybe hitting the MSME space which possibly is not very well documented.
The second part of the story is that there is a rural impetus. Agri has been decent and there could be a demand propelling there. But the urban story is clearly wobbling. The urban story is more premium and the rural is more massy and the rural can possibly hold up but I am not sure whether it has a follow through over the next 12-24 months so that it can carry the entire economy. There is a bright spot in the entire rural space but in the discretionary space, the rural demand can see through the next two to three quarters and sustain it going out.
There is a mega trend that big companies are becoming large, large companies are becoming super large, and super large companies are becoming mega. It is evident in every sector and in every part of the world. If that is the trend then what is left for stock pickers and mid and smallcap investors?
Yes, that is why you have the regulators who tells you that you need to buy more than 25% in small and midcaps to save them but jokes aside, it is a very challenging situation where large get larger and stronger overtime but the mid and small will struggle. India is a country where we have a lot of mid and small sized companies generating employment and GDP growth. It is ironic that the world is going through an economic divide as well as the lockdown persists. The rich do not get very affected, they get richer and the poor get poorer because of the environment that we are in. The lockdown does not impact the rich.
In the same context I feel that the mid and small space are finding it difficult to get capital, to go out and keep their shops running. It is a difficult situation and what is happening in the US, Taiwan, Korea, even China and India too for that matter is that the entire system is getting barbelled. They will have to find a way to pay interest moratoriums and those things are very short lived. They do not provide the boost and impetus that is required for a sustainable three to six months, 12 months, 24 months to navigate out of this troubled waters.
So what is the big trend which has emerged out of the last six months of lockdown is that IT as well as healthcare are the two places you need to be in for the next foreseeable future?
I am not sure about healthcare as much but IT is clearly a space to be. There are other smaller trends which we have been following and tracking down. One is the awareness of the way health and health trends have been and the lockdown has clearly upset the wiring of people quite significantly. In the developing world, we never took insurance very seriously and this is the time that people will wake up and say that insurance is a bigger necessity than anything else because if there is a situation that we are in, it will be imperative.
Having said that, IT will continue to be a very strong player over the next 12-24 months because that is changing the world quite a lot.
The third thing is the model where I feel there is a little bit of value in terms of people staying at home and figuring out that they can work a lot more. There is a subscriber model for entertainment/other home based activity which can be delivered through either broadband or otherwise. So the subscriber model will become a very interesting model for longer term.
So, there are three parts; first is healthcare is exaggerated, insurance is a better piece; both SAS (software as service) and IT as a delivery platform will become far more important and sustainable for the next few years or may be longer; the third is the subscriber model for delivery of either entertainment or other services into households will become extremely relevant.
But real estate will probably see collateral damage. People will realise that travel is far overrated, business travel is even more overrated than what it has been in the past.
How can one get rich?
If I had the answer to that, I would not be here, I would have been quite rich by now. But we all are in the journey where we try and get there. There are a couple of things which I have learnt, a)you need to be away from the PAT. Sometimes consensus is not necessarily right and if there is consensus and if everybody is on the same side, there is no trade.
The second part of the story is that I think you need to be careful. Your horizons have to be a bit longer. One must think that I buy merits of a corporation and believe that earnings will flow through and businesses will kind of survive through turbulence and you know in my opinion it is very difficult to get money quick but last but not the least, it is possibly not so difficult to become rich but it is very difficult to stay rich.