By Ajaya Sharma
This is not a black swan event but a black crow event. There are crows everywhere who took bad credit portfolio risk and it is coming home to roost now, says the Founder of Quantum Advisors.
How are you overall observing the global landscape? What exactly has happened to the world in your view; if you talk about the finer details? What are your observations on the global environment right now?
You have to go back a bit in history and recognise that after the
Lehman collapse in 2008, the entire world has kind of been reflating and printing money and trying to get the economies to move. They have got
markets to move for sure. There has been a phenomenal run up in share prices, very good run up in bond prices because interest rates have been coming down; interest rates and share price and price of bonds move inversely. So we have had this massive asset run up over the last decade or so and for the last two-three years, everyone has been waiting for something that will slow down the markets and the economy and nobody thought that the collapse would come from something happening in China.
They thought that there is something wrong in the Euro zone that would actually erupt, something would go wrong somewhere or even in the US with excessive debt, there would be failure of student loans or auto loans, which also picked up recently the last two years. So everyone was expecting something to happen which would slow down world growth and would cause a collapse in stock markets.
What has this pandemic done to valuations in your view, both globally and India. What are your observations on the commentary coming in from various parts of our market?
On a worldwide scale, if you look at the S&P, when it fell to its lowest point in March, it was close to where it was at the time when Trump came to power. So that is where the S&P was and it has recovered from there. Look at our market. So our market was about 18000 on the BSE 30. I am an old school guy. Zo I will refer to BSE 30 numbers; it was about 18000 in September 2013. That is the time when we had the kind of Fragile Five crisis because Ben Bernanke, the then US Fed governor said he may raise interest rates and that caused a massive problem across the emerging markets, including India and the Indian stock markets fell; the rupee went from Rs 55 to Rs 66 to a dollar within a few weeks and at that time we had a planned transition of the RBI governor. We had Raghuram Rajan who came in September 2013 and coincidentally we had Prime Minister
Modi who was nominated as the BJP candidate for the prime minister; so the markets were at about 18,000 levels then.
Prime Minister Modi gets elected in a landslide victory in May 2014 and the markets are at 24000. So we have a situation where if you look at the market floor, in some sense it would be the day Prime Minister Modi was elected and that was 2014 and we have had a massive inflow into domestic mutual funds. The phenomenal win of the Modi government has been the confidence that people have by moving money back to equity after all the redemptions that happened after the Global Financial Crisis. And the markets tested that level on 23March; we came down to 25,000 on the BSE 30 index, very close to where we were at the Modi inauguration time in 2014. So in some similar way, you had Trump and then the markets run up and the markets came down nearly to his levels and then you had Prime Minister Modi use that as a base; the markets ran up and came back down there.
But on a PE ratio, the markets are still nowhere close to they were either at SARS or at the Lehman crisis; the PE ratio of the indices or the NSE 50 or the BSE 30 was 8 to 9 times at the time of SARS in 2003 and again 8 to 9 times PE ratio historical at the time of Lehman; now we are still at 17.
Are you indicating that there is a downside scope?
I am suggesting that people who are talking about this market being a disaster have not seen history; history is in terms of valuations not index levels. So yes, in my view unless the government steps in and comes in with a definite and firm plan to rescue the economy, can the market test lows? Of course, it can. Will it test lows if the international markets recover, which they are, and if international investors plan to put more money into emerging markets like India, that could act as a floor. So now I have to again look westwards to see if money is going to come in to keep our asset prices alive rather than relying on our own domestic policies and our own domestic vehicle market strength. That is the sadness; we are fiscally vulnerable is what someone outside thinks about us as opposed to what we think ourselves about our own economy.
What kind of companies in your view would be able to weather the storm and which are the fragile business models which will crumble under the pressure? What is your hypothesis?
Let us look at the pluses. You go into technology because they have high cash and no debt, you are going to pharma because healthcare is now going to be the focus and it looks like a defensive bet. You go into FMCG because they have no debt by and large and people are still going to consume stuff even sitting at home. So I may be sitting at home but I am still eating food, I am still trying to shave whenever I can. So the FMCG sector is seeing sales.
I may not be eating food at a restaurant but I am still buying the dal and chawal to cook at home. So the sales are still there. The volumes are still there. The restaurant guys lost the value add but the guy who is making me the rice or the dal or the chapatti or the ingredients are still getting their sale of volume. We are not eating less, we are just eating differently. So that is why it is defensive.
But let us dwell some more time on the financials. Now that has been broken as you know for a long time. Under the UPA 2 government we had excessive capex; a lot of it could have been crony capitalism. So all the unwinding of that through the NPAs, through the change in the RBIs, all that has come to fore now and on top of that you have a real estate sector that has been protected by the government probably because a lot of politicians own or have connections to real estate companies.
In any market, everywhere in the world besides India, after the Lehman crisis in 2008-2009, all the bad real estate companies with unsold apartments were cleared out. They were forced to sell their properties or they were taken over by the banks and the market cleared it. In India what happened is the PSU banks and the private sector banks kept these real estate zombie projects alive and for the last decade, you have lower sales in real estate but you have got these companies sitting there borrowing money and refusing to bring their price down; refusing to give millions of Indians who want property a break in the price because they want the profit margin. So you had the NBFCs supporting zombie real estate. With the collapse of IL&FS, all of that has come to the fore and you have had the entire NBFC sector unwinding its position to high credit risk. So whether it is a mutual fund; believe me Franklin is not the only fund house that has problems in its portfolio. This is a pandemic across the
mutual fund industry. The fund managers on the debt side, on the fixed income side have made idiotic bets on high credit to show higher rates of returns and could gather more AUM. And that is now how it is breaking.
So I know that people are coming on your channel and saying this is a black swan event. That is a lie. This is a black crow event. There are crows everywhere and they just took bad credit portfolio risk and it is coming home to roost. The pandemic and the fact that we are all sitting at home is a black swan event. The fact that fund houses have taken excessive risk to show higher returns, to fool investors and capture the theme into AUM is a black crow event. It happens every time; that is what the fund industry by and large does. So I would like to divorce the two by saying that the NBFC system is broken because we have not fixed the Lehman problems and now the pandemic is the straw that breaks the camel’s back and we are in complete shambles in some sense and it will take a lot of effort from the RBI and the government to get money to flow to the right places yet again.
So if one were to take all these facts and data into account and build a hypothesis for Indian equities three to five year far, what is the kind of hypothesis you have in a base case scenario, in a worst case scenario and a best case scenario?
Firstly, I want to move to the individual. The individual is sitting locked down at home unsure whether they have a job to go to. April is a month when you normally get a salary increment in India and now you do not know when lockdown is over whether you will get a job at all and what kind of salary you are going to get. Will it be the same or high or lower? So firstly, I hope that individuals have kept enough money aside in their savings bank and in their liquid funds to ensure that for the next six-nine months, they are safe in case they do not have jobs.
Moving to markets, our assumption is that for the next few quarters, the economy will be back and we do not know how it is going to all evolve but as you spoke about FMCG and a few other sectors, there is still demand for products. So if valuations are sensible, it is a great time to buy good businesses at sensible prices. They are not inexpensive. For the market to be inexpensive or to go back to the Lehman levels, it needs to go back to 18,000 to 20,000. If the index is at 18,000-20,000 on the BSE 30 then on a PE ratio you are back to where you were at the Lehman time. We are 30,000 plus at this point in time. So that fall may not happen; do not wait for it.
In my view, if you have excess cash and you own that position where you kept money aside to invest in the market, then please do. If you are fully invested in the market and you are losing money and you have no money in the bank, save money in the bank despite the fact that you are losing money. First please build your buffer for six-nine months of expenses because these are very uncertain times and you must have money to look after your family and to look after yourself; forget about the markets in that sense.