Starting from a belief that the markets would remain in an ultra-low interest rate regime where bond yields will remain in and around 1% for a long period of time, there is a sudden departure in market positioning now that yields are strengthening. Is it time for global liquidity watchers and investors to get worried?
A lot depends on which geography you are in. The US has a peculiar set of circumstances because of the sheer quantum of QE that has been given. Fed’s balance sheet has expanded almost 14% during this QE. The manner in which it was done was largely in terms of payouts and not really investments. It has been the same for Europe and Japan but for the rest of Asia, that has not happened. India has been very conservative. So, should one expect higher inflation and higher rates? My own sense tells me that most central banks will be still quite reluctant to raise rates very suddenly. It might happen but it will happen gradually.
There might be supply-constraint inflation in the world which might stem from the fact after the global financial crisis, there were no investments in the commodity ecosystem. A lot of commodities are running out of order right now, the extraction rates are falling. There are supply constraints and you might get a push to enable the next round of reinvestments and that is just the way the commodity cycle behaves. It is nothing to be concerned about.
That is a reality and that is there to stay. That ecosystem is going to generate returns. We are due for a bout of supernormal returns in the entire ecosystem. I would say that is true globally simply because of the large lag in the investment cycle. In a place like India, if interest rates were 200-250 bps higher, then valuations would look stretched. Now can they go up 200 bps? There are scenarios that make sense and that can play out, but to me that is not the most likely scenario. Our inflation basket is largely driven by food and if food inflation is there, I do not think that is going to actually put more purchasing power in rural hands.
We will live with that slightly higher end of inflation and I do not think RBI would like to raise rates in a hurry. That is probably the right policy prescription at this juncture. I also believe that with that kind of mix, in a place like India, we will end up with another capex cycle and that would be pretty much across the board.
Capex in India peaked around the end of 2011 and first half of 2012. After that, we really have not had a capex cycle and it has been almost a decade now. Once we get a wider capex cycle, jobs will be created, growth will be stronger and we will be okay. I do not expect rates to go much higher. Lots of capital is going to come in. A lot of reforms happened over the last several years but none attained critical mass in reforms. But the cumulative impact of it has definitely been quite strong and the benefits can be seen. I do not know how far the government will be able to give a boost with privatisations which they have announced very strongly.
I applaud that but if they cannot get through with that, the increase in productivity in the economy will also allow for higher growth without higher inflation. So, we are in a delicate position at this moment. But I am optimistic that we will get through this without too much muddle. When we have strong earnings growth, even if it is discounted, rates go up. What tends to happen is that earnings catch up very quickly and instead of getting very steep price corrections, one might end up getting bouts of time correction. I think that is the way it will play out. There will be short-term volatility all the time. That is a part of the market and we should expect that.
Given the way the economic recovery is moving, would you say that you are safe in sticking with the cyclicals?
It really depends on your timing perspective. If you are trying to generate alpha over the next two or three quarters, probably that might be a good play because a lot of the cyclicals earning multiples are of very depressed earnings. From a structural basis, the earnings are very depressed. But there are so many opportunities today. One of the things that the very low cost of capital has done over the last 10-12 years is that there has been a lot of innovation. Innovation is usually capital hungry and when capital is low priced, it tends to accelerate.
So we are seeing disruptions across a whole bunch of ecosystems and for any investor with a slightly medium to longer term horizon, that gives ample opportunity. For somebody, playing with public markets, maybe the cyclicals make sense. I would put in a word of caution on the cyclicals though that the highest beta companies usually tend to be media and financials. Media is going through a lot of structural changes. A lot of advertising money is not being captured in the older platforms. It is moving to digital platforms. It is getting fragmented. So the old time bets that people take may not work quite as well this time.
In case of financials, we have to be cautious of the fact that when the RBI gives a moratorium, some of the bad loans get pushed out. That might come back and be an impediment in terms of how quickly these banks come back. But in case of the best run banks with the strongest balance sheets, the growth opportunity is going to kick them along and therefore the market favourites will do very well.
Banks are essentially deposit takers with a regulatory architecture to protect the deposit holder and then they are transaction enablers and they are risk assessors and they have some kind of customer UI. I find banks are becoming technology plays, more of a technology company which is allowed to take deposits. The ones which transform themselves along those lines are going to do very well from a 5-10 year perspective. But right now, the ones with the strong balance sheets and the relatively conservative accounting will do very well.
Would gold loan finance companies make good longer term bets?
We have been very large investors in this company called Manappuram for over a decade. The thesis has played out extremely well for us and it has a long runway going ahead too. We are talking about a business which has over 6% return on assets (HDFC Bank’s return on assets is 1.6%), which has capital adequacy of 26%, return on equity of over 30% and growing it over 20% a year and is available at multiples which are in single digits. I find it very hard to figure out how you can go wrong in such an investment and that is why we are investors. This is my own perspective.
Now there is this entire thought process that the digital oriented companies like a Bajaj Finance, etc, will eat up everybody’s pie and I believe that digitisation is very important and to my mind what the market misses with a lot of the gold loan companies is how digitised they already have become and how much of data mining they are doing vis-à-vis their customers and using that to expand their footprint and client lifecycle engagement. That would make their entire models quite sustainable according to me.
You have invested a lot in midcap IT. Now that the runup in some of the IT stocks is 50-100%, do you think it is time now to reap the benefits?
Let me differentiate a little bit of what might be right for us. We have compounded money just short of 30% per year for 22 years. So if you are looking for those kinds of returns, midcap IT at this juncture may not afford you that. There may be companies which are extremely niche and operating in very specific areas of the cloud and digitisation or cyber security which might still give you those returns. But broadly, the midcap IT pack will not give those kinds of returns.
But for an average investor who is getting 4% or 5% on his deposit rates and is looking to make 10-12% compounding returns over the next four-five years, midcap IT will give you those kinds of returns quite safely. So it is a different sort of menu for different people. But there is still a lot of growth left for large cap and midcap IT. We are not running out of growth any time soon.
