Equities are the longest duration asset class in the world and you should not look to make money over a week or ten days or six months, Ridham Desai, Managing Director, Morgan Stanley India, tells Nikunj Dalmia of ET Now, in an exclusive interview.
Edited excerpts:
Just when I thought that bulls were extinct that mails comes and hit my mailbox and that was aha moment for all us.
See the point of maximum fear is the point of maximum return also. So when things get fearful, it is not the time to back down. Obviously, for every market participant, timeframe is relevant and I would suggest that equities are the longest duration asset class in the world and therefore you should typically have long duration on equities and not look to make money over a week or ten days or six months. If you have that attitude, then these are the moments when the market gives you the opportunity, gives you the bargains like a pre-Diwali sale that the market has put up for you. Make maximum use of that and pile up on all the stocks that you have wanted to buy for all these months but which have been trading too expensive and you made the right point about mid and smallcap stocks. Things are down between 30% and 80% and these are opportunities that comes once in a while.
We got one such opportunity in November 2016 which followed the opportunity in February 2016. I see this as a similar thing. There is obviously a lot to worry about around the world but share prices become cheap only when there are things to worry about, not when everything is going fine.
Good news and good price rarely come together and right now the news is bad. What is your understanding of how macros are changing and what impact do you think the changing macros would have on the underlying earnings projections?
The liquidity scare that emerged in the middle of September with the IL&FS issue, that fear or scare is behind us because both the government and the central bank have acted swiftly and in a manner which exceeds expectations. If you look at the postponement or the reduction of the borrowing programme, if you look at the OMOs that RBI is doing and at the SBI statement about the NBFC paper they are buying or the fact that the RBI chose not to hike rates, all together, this is far in excess of what the market may have anticipated at the end of September. The liquidity episode is likely behind us. If anything, we are actually awash with liquidity and if you get even the slightest of good news on say oil, or growth, you will find the share prices rally very quickly. You are getting one such rally this morning because oil is down overnight and that is the power of liquidity that is sitting in the system.
There was the fear that because of the liquidity constraint, growth in India may slow down. I do not hold that fear. I think growth should be okay. We will get some news by the early part of November from the auto sector but because of the divergence between the lunar and the solar calendars, everything is delayed this year by one month.
So these numbers do get distorted and things should normalise in November. Let us wait for those numbers to know if there was any immediate impact on growth. The caveat here of course is oil. If oil goes up, then it does reduce the flexibility that the government has. It does put pressure on the fisc. It brings some inflation pressures to the fore. It has impact on the currencies and all in all oil creates slightly vicious circle for India and therefore I am hoping that oil actually does not go up and if oil does not go up, then we should be okay on growth. This is with respect to the liquidity episode and its impact on growth. Otherwise, growth has already mended. Government investment capex is strong. We are seeing early signs of private capex but it will take some months for that to really show up in numbers in a major way.
Consumption is pretty okay and exports are doing fine. If you look at all the growth indicators, the pillars on which the economy stands, they are all fine. Corporate profits actually had started turning around and revenue growth is already at multi-year high. I expect that trend to continue this quarter when the earnings come out, the big problem in the corporate sector was the corporate banks because of the NPLs that they were reporting. We think the worst is over there. In a quarter or two, even the corporate banks start seeing better headline numbers. The headline Nifty growth should accelerate pretty quickly over the next two quarters.
Again, there are these risks and of course this caveat on where oil goes and to some extent where the election result goes which is a few months out but it is still a risk on the horizon if you have a one-year view.
What is your assessment of the flows from FIIs and DIIs and how would that evolve over next two-three quarters?
What made the difference to the market in the middle of September was neither domestic institutional flows nor foreign institutional flows. It was actually the unwinding of leverage positions that were held by high net worth individuals in the Indian market. And because share prices started getting marked down, we had some big margin calls which led to even bigger selling. That may actually be behind us because a lot of that has got flushed out of the system. The offer on shares may actually start reducing its power and certainly the bid is coming from domestic institutions and largely from domestic retail who have surprised everybody on the upside by what they did in September.
I do not think anybody would have expected retail investors to be net buyers in a falling market and if I go by the mutual fund flows activity in October, it looks like those flows have continued. So, heads off to retail investors for maintaining their balance and poise in what was a very terrible market. When you look at flows, you have see these three components and they seem to balance out.
Foreign investors are responding to global cues and the fact is that emerging markets have been knocked down really badly. Our emerging market strategist Jonathan Garner has been cautious on emerging markets all this year. A lot of the emerging market indices are now approaching his target prices and so they are all falling to those levels. We will see his fresh call when he makes one but a lot of damage has happened and now that damage is shifting to developed markets, trade is inverting. Who knows if emerging markets will start looking better relative to Developed Markets? In that case some of those flows may come back in the next few months. But I am not betting on that immediately since India has its own idiosyncratic event around the elections and foreign investors may want to trade cautiously into elections and then wait for the state election results to make a fresh move.
The last time we saw a similar set where macros were bad, rupee was weak and oil was high was in August -September 2013. That time also, we were about eight-nine months away from the election cycle. The settings are exactly the same. The last time when this happened, money moved into consumers and IT. Do you think the same could happen now?
This is 2013. India has come a long way in terms of its macros since 2013. We have significantly reduced fiscal deficit. We have a significantly lower current account but most importantly we have positive real rates. I do not think this is similar to 2013. The current account deficit then was 5% plus. Now it is in the twos and if oil comes down, the current account deficit will recede. The current account deficit ex oil, has not deteriorated in the last few months. It is oil that has caused this pain. So the picture is actually quite different from 2013. In fact, I would say very forcefully that this is not 2013. It is a very separate episode.
Now coming to the second part of your question, I do not think this is the time to buy defensive stocks. Technology has done its thing. It has had a great tailwind from strong business momentum from a depreciating INR and the valuations have re-rated. The tech stocks are no longer cheap like they were in middle of last year. We have gone underweight on tech and we are adding to that position and we are actually preferring consumer cyclicals. We prefer the corporate banks. We prefer the retail banks and we are actually buying industrials. At this point, there is opportunity in the market place and it is not really the time to be defensive about portfolios.
Trade has Shifted in Favour of Corporate and Retail Banks over NBFCs
Could there be a serious earnings downside risk for NBFCs across the board or should there be a select NBFCs which will only slow down, rest of them will remain strong?
Clearly, NBFCs are going to take a hit on growth, no doubt about it. This is not a very conducive environment for those who fund their liabilities by wholesale money. This is an environment which is very conducive to those who fund their liabilities using retail, the slightly longer duration liabilities that retail banks have. Clearly, trade has shifted in favour of corporate and retail banks over NBFCs which were market favourites for all of last year and most of this year. Their growth rates will slow down. The balance sheets will grow more slowly.
Suppose somebody was doing 13%, maybe that growth will come down to 15% or 20%. The stocks have also derated and so in large places, the stocks have also started reflecting that. The market has been pretty smart about this and quickly derated the stocks. Incrementally, you have to be selective. The NBFCs that we would like are the ones which have strong equity. Look at the ones which have recently raised share capital. They are obviously sitting on equity and the ones that have slightly better liability franchise can raise money at lower cost than other NBFCs. Those are the NBFCs that you need to be quite selective about, relative to say corporate and retail banks. My financials team has this view for several months now and it is nothing new.
What happened in September basically vindicated their position. So, we favoured corporate banks all year. It is not a trade that has worked in our favour but it will now start working quite nicely. On a relative basis, corporate banks have outperformed NBFCs but we will probably start working even on an absolute basis.
Why do you like corporate banks? Do you think the bad loan or NPA problem is history for corporate banks?
NCLT has been a success story. It was slow to start with. Any new law takes it time, gets tested in the courts and NCLT has got tested in the courts. We have had courts giving several verdicts around it. That has made the law more robust. We are seeing settlements happen and if you look back two years, the bids have actually exceeded expectations.
The underlying assets may have been quite good but their valuations may have been distorted and therefore there were some price cuts that had to be taken and the operations had to be re-managed. The NCLT process is going well. It is helping the corporate banks. What is also helping them is the cycle where we have seen a shift in liabilities cost. Most of the corporate banks have great liability franchises and are gaining competitive advantage over NBFCs who were outcompeting them with low interest rates.
Most importantly, most of these corporate banks stocks, trade at sub-one time book. They are looking quite attractive from a valuation perspective. The market is betting that their return on equity is lower than their cost of equity and over the next two or three years, they may be able to report ROEs in excess of the cost of equities. So, the valuations may also rerate. The trade in favour of corporate banks looks quite strong at least for the next couple of years.
Opportunity to Buy Insurance Stocks Again
Most of the insurance stocks have corrected. Do you have a buy recommendation on insurance company?
Thanks for raising this because it completely skipped my attention also because usually financial discussion revolves around NBFCs and the banks and we forget all the other types of financials in the system. I will make a broad point here, a long term point. I am very bullish on capital market businesses. The structural shift in the policy environment in India which promotes positive real rates where the RBI has the sole mandate of keeping inflation down is a great news for financial assets.
It is an environment in which I think financial assets will do very well. So companies that are linked to financial assets like insurance, capital market businesses, mutual funds, i.e., asset managers or even the brokers will have a very good run over the next few years. Insurance is in that bucket and we like insurance stocks and the opportunity has come again to buy them. Some of them had run up a lot prior to September and we have seen a correction so I think you should be buying insurance.
You mentioned that you have cut your weightage on IT. Minus the currency adjustment, what is your view on the environment for IT and do you think minus TCS, there could be a trade in the other stocks now?
There is no taking away. The environment is good because US capex is strong. US corporate profits are at close to all-time highs. They are spending on technology. And therefore, business flow should be quite good. The call that we have to make really is in the stock market which is a little distinct from what the businesses are doing. We have made the call on relative valuations which have shifted away from tech stocks in favour of some domestic names which have underperformed quite severely.
The relative growth for domestic names could also be better than technology. There is nothing taking away from the absolute performance that tech companies will report but if you go forward by one year, the likelihood is that corporate banks will have far superior earnings growth and trade at much more attractive valuations. We have to see what is priced in rather than just what is happening to the absolute growth rates and the tech stocks are pricing in a lot of what is coming in the next 12 months, whereas corporate banks or consumer cyclicals are not.
What could be a currency sensitive sector or theme where you think growth is decent, currency is a tailwind and valuations are also attractive?
There are select auto names that are big exporters and should benefit from this lower currency which also have domestic businesses that may experience good growth. I would prefer such companies or stocks over pure exporters where there is leverage to global growth and currency moves and there is no domestic business. My preference will be for the ones that have a balance of both.
What could crush your bullish assumption on domestic growth?
Lots of things can go wrong. The list is very long and some of them are obvious and in fact I can only tell you the obvious things because I do not know the things that are not going to happen.
The obvious things are; oil going over $90-95, we get election results which point to a fragmented coalition government rather than a strong government, some mistake from the US Fed which causes a big risk off and slowdown in growth. Plus nobody know how the trade frictions between US and China will pan out over the next 12 months and what impact that could have on the global economy and India may be a little less levered to that but there will be some impact on India. So there are so many imponderables. This is not a unique situation, the world always has to deal with imponderables. We have to look at what share prices are discounting and make a call accordingly.
Share prices especially in the broad market are pricing in a lot of those negatives. So you have a better risk reward today than you had say two months ago or three months ago. That is what we should be focussed on rather than calling the next disaster that will happen. There could be so many things that could go wrong.
Not Worried about Slowdown in Global Growth that May Happen in 2020
A lot of global market gurus — Howard Marks, Ray Dalio are making a case that the US economy could be in the last leg of its expansion and that could have repercussions and challenges because they feel that the sugar rush the US economy is enjoying could fade away after one year. What could be the implications of that?
That is quite possible. Suppose the US economy peaks next year and in fact, our US strategist thinks that US earnings have already peaked. He thinks it will be a struggle for US companies to raise their margins from here. Remember US corporate margins are at all time highs, profit share in GDP is close to 11 or 12%, and in India that number is 3%. We are at less than half of what we used to be so India is a counter-cyclical place on this planet right now.
In fact, even though the US markets correct, it is quite possible that India actually does not go through that type of fall because Indian corporate profit margins may actually be turning up. So if you take a two, three year view, if we do not get a nasty surprise from the elections next year, the chances are that these corporate profits in India mean revert over the next three four years and that is a lot of earnings growth that we will see in India.
I would not be so worried about slowdown in global growth that may happen say in 2020. In fact, a slowdown in corporate profits in the US is just around the corner and that is Morgan Stanleys view. It is not something that may worry me. In fact, if anything causes US interest rates to peak out, it may actually cause flows to come back into some fast growing emerging markets and India is right on top of that list.
It may not be such a bad thing. However, if the so called recession that is coming in the US is a deep one, then things may change because deep recessions produce major risk offs and then there is a complete shift in asset classes and people move away from equities and go to other things and that then brings collateral damage because at the end of the day India is not a small market. It is the seventh or eighth largest stock market in the world, it is a top five global GDP. It is like a largecap stock.
If the Nifty sells off at the end of it, almost every largecap stock has to fall. So you know India will also participate in that type of a deep sell off. It all depends on how deep that forthcoming recession in the US is — whether it is a shallow one or a really nasty one and then that will decide how India behaves. In a shallow recession, India will be fine. By the election results, in a deeper one, there will be more pain in India.
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