In a detailed discussion with Amar Ambani and Anil Mascarenhas of IIFL, Nilesh Shah says, “Volatility sure will be there but if you take March 2017 view, earnings will be supportive, FII selling will be behind us, domestic institutional investors’ participation would support market and that makes the case for equities to far outperform other asset classes.”
Why fret over US Fed rate hike. Will a 25 basis points matter that much? Also, doesn’t a rate hike mean things are looking up for the biggest economy in the world?
The US is the center of the universe for financial markets and when their interest rates go up or down, they mostly follow a trend. They never stop with a 25 basis points hike. It is generally followed by 10, 12, 14 similar steps. The fear that the market is expressing is how much will the US Fed rate rise? If the US interest rates rise a lot and we have to deliver risk premium of being an emerging market and above all, deliver forward premia to give dollar return, then the asking rate becomes too high for our market to deliver.
But my guess is that 6 to 8 hikes of 25 basis points each are already factored into the US yields as well as Indian yields. Looking at the present conditions, it does not appear that the Fed will revert back to its historical average of 10 to 12 hikes in a row. The quantum and pace of the hike will be far more calibrated and moderate. While we have to keep a watch on the Fed rate hike, it should not be more than what is priced in by the markets.
Fed will raise interest rates only when the US economy is doing well. We have a large trading position with US. If US does well, our pharma and technology sector benefits and exports to US benefit too. Hence, in some sense, the Fed hike will be more beneficial to India over medium to long term rather than negative in the short term but we do have to live with the volatility of the market. When the dust settles, one will realize that all the volatility caused by the Fed rate issue were great opportunities to buy.
You have often advocated befriending volatility. Do you suggest investors should catch falling knives now?
This is the time to catch falling knives. From a psychological point of view, Indians have been selling equity since 1994, when FIIs were allowed to invest. Now retail ownership of equity has been left at 8% of market cap. A section of sellers that sold their shares are realizing that they sold something, which was giving them a compounded return of 15 to 16 % for investing in something that gave a return of 8 to 9 % like gold, real estate, fixed deposits or tax free bonds. They have realized they made a bad choice of getting off a fast train and shifting into a slow train. The fast train may have experienced some jerks but eventually it has gone so ahead that the slow train will find it difficult to catch up.
From a fundamental point of view, the only BRIC standing is India; Brazil is in recession, Russia the less said the better and China is now slowing down too. India has its fiscal deficit and current account under control, growth is picking up, investment potential is high, inflation is falling, rupee is stable and it is one of the few countries where interest rates can be brought down even after half a percent cut. On a top-down basis, India looks like an oasis in a barren desert.
From a technical point of view, even though FIIs have sold more in two months (Aug and Sep) than what they have sold in entire 2008 in rupee terms, the correction is only a fraction of what happened in 2008. The selling has been offset by domestic investors led by mutual funds. Similarly, over the next 5 years, there will be a tsunami of domestic flows coming into the market through ongoing SIPs, fresh inflows into MFs, LIC and private insurers, PFs and direct retail investments. These will more than offset supply through IPOs and disinvestment. Indian promoters will sell their shares only at higher prices; so they contributing to supply is ruled out. Unless FIIs become sellers, there will be a demand-supply gap. And with India favourably placed, FIIs are likely to be buyers as well.
But don’t you feel in the near term, domestic liquidity may not continue to offset FII outflows if lured by disinvestment and tax free bond issuances?
Yes, markets are likely to remain volatile but that is more to do with fundamentals and less to do with flows. Our earnings recovery has not taken off as anticipated. The market movement has been more driven by the domestic fundamentals where the earnings have been delayed compared to the expectations. Then of course there is the FII selling and additional demand for tax-free bonds. We need to take a dispassionate view without trying to time the market. In the coming six quarters, corporate earnings will improve. One percent drop in interest rates can translate into 7% improvement in earnings. Policy rates have been cut by 125 basis points and only part of it has been transmitted so far. Another 25 to 50 basis points cut could come in CY2016 and this will translate into higher earnings.
In 2015, the government got a US$50 billion bonanza from lower oil prices, which they used to clear the fiscal mess. The economy will benefit in the long term but has lost out in the short term because that US$50 billion could have rejuvenated the economy. Now the government is spending on the front foot. From April to Aug 2015, they have spent an additional Rs.90,000 crore over last year. Sectors which benefitted include road, railway, mining, transport and infrastructure among others. We will see the benefits of these percolate into the economy over the rest of the year. The other benefit will come on the exports front. In FY15, the rupee had been relatively strong. The rupee has depreciated in the first half of FY16 and will give some competitive advantage to our exporters. The next important factor is the consumption, which is being unleashed on account of wage revisions announced in recent times. The Seventh Pay Commission will release about USD 34 billion (post tax) in the hands of central, state and public sector enterprise employees. This will push consumption. It could be in auto, white goods, housing, FMCG or consumer staples. We will have to see where the money is being spent. All this put together, I think earnings recovery is due in FY2017. It will be slow, calibrated and back-ended. We have a good chance of earnings picking up pace compared to last nine months. Optically also, Dec 2014 was the first below expectation quarter. Therefore, Dec 2015 quarter on a lower base will optically provide some amount of comfort. Same will happen in the ensuing quarters. Hopefully, nine months of optical improvement will be followed by the real improvement. Volatility sure will be there but if you take March 2017 view, earnings will be supportive, FII selling will be behind us, domestic institutional investors’ participation would support market and that makes the case for equities to far outperform the other asset classes.
What is your take on the rural economy then, given that lower MSP and monsoon have hurt sentiment?
Rural economy is under stress. Lower MSP and monsoon are impacting them. Leakage stoppage in the subsidies has had an adverse impact on the consumption in the short term. Economically, rural India is under stress compared to the urban India and we have to see what steps the government takes to help them. Appropriate corrective steps taken by the government and late revival of monsoon seems to be creating some respite for us but we still have to be cautious about the companies, which are dependent upon rural areas.
Would you look at infra, power, cap goods now or stay away?
In consumption, technology or FMCG, you don’t have to be worried about government policies. However, in infrastructure , we not only look at the fundamentals but also at the government policies. Sometimes, the policies are good for one, sometimes it’s good for another. It’s the speed of execution, which will deliver returns to you. Many of the companies in infrastructure and capital goods space are extremely leveraged. A six to eight month delay in execution will change their entire equity scenario. So that’s a riskier bet. The safer bets today are in urban consumption, rate-sensitives, technology and pharma rather than infrastructure, metals and other utilities sector. This is not to deny that metal, infrastructure space is in value zone. They just need a catalyst to unlock the value.
What about metals and minerals?
If the question is are these stocks in value territory, then the answer is yes. But Metal sector would truly be catching a falling knife. On a fundamental basis, steel is going to be challenging to the equity investors. China has a large capacity and if their economy does not have demand, they will eventually have to dump it somewhere in some form or the other. This could put tremendous pressure on our steel companies. Until the metal companies are available at even more beaten down prices, one could resist the temptation of buying this space. Even if the metal cycle turns around, you would not have missed the bus because other sectors may compensate.
Do you think the real-estate prices will fall and if yes, can equities rally in such a scenario?
The reason that real estate prices are not correcting is because there is a lot of vested interest and supply remains choked artificially. Lenders appear fine to restructure and refinance debts of real estate companies rather than selling their assets. Real estate sector is not seeing free flow of supply. There are complex processes and approvals, which do not allow speedier approval of projects. The need for housing is rising but sales of flats are falling. Hence, all this has led to Indian real estate prices remaining higher than the fair prices, which corresponds with the economy. Looking at the leverage that these real estate companies carry, they will have to sell at a price that the people can afford. Wherever the market pressure exerts itself, the demand and supply will have to match. We see a corrective price of 25 to 30% in such markets. The market forces will play out eventually because the real estate in India is expensive and it needs to be corrected. The HNIs are much overexposed to real estate and less exposed to equities. As they see their real estate portfolio falling, they may look at deploying that money into equities.
Where do you see Gold prices headed in $ terms, especially after the Government’s monetisation scheme? Some say it is close to its cost of procurement price.
After 40% correction in $ terms from top, it becomes difficult to say if gold will go down further. What is possible is that in a rising dollar interest rate scenario, it will be tough for gold to go up. It is in a range where it will neither go up or down meaningfully. In rupee terms, you may see a slight uptick in the gold prices but you also have to remember that when you invest in gold you have to pay a 10% percent import duty on gold. Instead of buying physical gold, investors should put money in gold deposit scheme or gold monetization scheme recently launched by GOI.
You briefly touched upon commodity prices and about China. Warren Buffet says invest in China. You have earlier said our funds managers are better than Warren Buffet. How do you view China’s economy and its impact on investors?
Let me first correct about Warren Buffet; he is God, we are mortals. Our fund managers’ performance does outperform Warren Buffet in terms of benchmark indices and it’s a mathematical phenomenon. But to reach Warren Buffet’s level we have to have many incarnations. China is in a peculiar situation where there are certain events, which are shaping up the country. Here you have one kid coming to work who has to take care of two parents that are about to retire and 4 grandparents that have already retired. Every kid that enters this cycle has to take care of 6 parents and with medical advancements, lifespan has increased. This kid, with family bondage, has to think about how he can have enough to save for his grandparents too and hence that kid is a saver rather than a spender. As a result, China ends up saving US$ 5.5 trillion dollars a year which is 2.5 times India’s GDP and 8 times India’s savings. You can imagine the kind of money they are saving. Till sometime back, that money was spent in building roads and infrastructure, factories and other things under the sun and that enabled China to have a steel capacity that is more than half of the world’s steel capacity. Their consumption of steel in three years was more than America’s consumption of steel in 100 years. China now has malls where no one visits, cities where no one stays, roads on which no one travels. Gradually, investment will get lowered. China has to change the mindset of this kid who is a saver rather than a spender. They will have to create opportunities where they have to direct their savings into investments into other countries. In Africa, China is saying they will build the infrastructure and wants to invest there. They will replicate this in other parts of the world too. More jobs can get created for that kid and better return on investments too. Another important factor to note is that in an economy where the youth do not have enough jobs and are insecure about the future, their political leanings could change. Today, being an authoritarian communist country, China may have to face one more Tiananmen Square. Hence the political leadership of China will be quite cognizant of this fact and hence their execution to transit from consumption to investment to investment overseas will be something which we need to watch. China is the country, which is like a King Kong in the group and we have to keep watching very very carefully. If things turn out well, the whole world will be benefited and should things turn ugly, the whole world may have to pay a price for it.
We assumed an economic recovery will solve the problem of projects stuck. With NPA issue still looming large and 1/3rd of CDR cases having failed, do you see this as a big risk?
NPA is a serious issue in the Indian banking system, especially public sector banks. Credit quality has deteriorated over the last years due to a variety of reasons. It could be as simple as promoters siphoning out money from the projects. It could be economic cycle whereby the commodity correction has made certain projects unviable. It could be due to huge overrun in executing a project; interest during construction being a large component of the projects. The worst part is that NPAs are not fully recognized. Unless you recognise a problem how will you sort it out ? Everyone knows that the PSU banking system has not recognised their NPAs correctly. Today, things are being swept under the carpet hoping that the recovering economy will clear the mess like it did in the late 90s. If we open the Pandora box and face the problems head on, we have a far better chance of sorting the issue.
US didn’t have a problem putting General Motors, the flagship corporate company, into bankruptcy. They sorted the problem and today General Motor is a prospering company. We also need to take similar steps whereby, people, who have siphoned off money, better make it good. Projects, which have been on the wrong side of economic cycle, should be given support so that when the commodity cycle turns for better, they prosper and benefit. In projects where the interest during construction and delay in execution have made them unviable, let there be a haircut for the equity and debt investors so that thereafter these companies becoming functioning entities and not sick companies. There will be pain. A meaningful difference can be made if we pay attention to it rather than hope things will get sorted out on its own.
Brief us about your investment philosophy. How has it changed over the years since you worked in so many places.
Over the years, one has made so many mistakes that one tends to become conservative. Earlier, we did not care much about the promoters. Now, we give far more weightage to promoters. Earlier, we were more driven by quick gains philosophy. Now, we resist the short term temptations. Earlier, we never bothered about the global economy but now we are as informed as the global fund managers. Earlier, everything was on hope; valuations were futuristic but now it is filtered with the exception of some companies. Over the last 20 years, we have become wiser in terms of selecting a promoter, giving valuation and understanding global trends. Now, it is far more about quality, long-term performance and disciplined investment. Most of us fund managers have developed in this way. What each one of us needs is a competitive edge vis-à-vis our peer group and benchmark indices. It’s much easier to beat the benchmark indices but to score over the peers requires a disciplined approach.
Has over-regulation with regards to commissions etc choked the growth of financial services industry?
We need regulatory oversight. It is that oversight, which has brought the industry the trust and confidence of investors. We may all claim to be getting the investors’ confidence based on our performance. Our performance does play a role. But nobody gives their money just because of performance. They also look at the trust and confidence and that only a regulator can provide. People happily invest in the banking system despite not getting as much returns like equity because of RBI’s brand and image and of course the efforts of the banks. We also manage to get money because of the trust and goodwill of SEBI besides our efforts.
What is your advice to Retail investors?
To all retail investors, my recommendation would be that you have already lost an opportunity to make money. In the last 20 years, stocks and stock market have multiplied many times. You now need to be disciplined and become an investor rather than remain a bystander or a trader. Bystanding doesn’t allow you to participate and trading does not allow you to make money. Just be an investor. Choose the SIP route. If you like stocks and wish to do it yourself, please research and then do SIP. If not, do SIP through the mutual fund route. Do not stop your SIP account even if markets have sharply corrected. In fact, those are times you will do well if you allocate a higher amount to SIP and let the India growth story take its own turn. Eventually, this long term investment will help you create a lot of wealth.
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