In your last note, you have said that this is a stock pickers’ market with ample alpha opportunity. What are the tactical investment thesis that you are going by? Where does alpha opportunity resides and where can one make money if one were to buy afresh at these levels?
Structurally, you want to buy discretionary consumption and industrials. Discretionary consumption because India has now passed the point where the share of basic necessities like food, shelter and clothing will decline in the rural consumption pool and there will be a lot more disposable income available to do discretionary spends. So, there will be faster growth in the discretionary consumption sector. This includes a whole lot of sectors in India — from autos to paints to housing effects to education to travel to leisure.
.A large portion of the population does not have access to these consumption opportunities because they do not have the disposable income that has changed over the past few years. It was triggered by direct benefits transfer and real cash is going into accounts of poor people because the economy is turning around. So that is one.
The second is industrials because of the point that I just mentioned earlier about India becoming a more attractive manufacturing destination. Industrials may be poised to do quite well. In fact, we have already written a few months ago that after declining for almost 25 years, the share of manufacturing is likely to rise in GDP and that could be interesting for industrials.
From a cyclical perspective, one cannot avoid the financials. We like the large cap as well as the midcap financials. The midcaps may outperform the large caps keeping in mind the overall theme that smaller firms do better than large firms but the whole financial sector has to do well if the economy is turning up.
So these are the three places where I tend to advise investors to park their money. One can be underweight on global facing sectors because they will likely underperform in terms of growth relative to domestic cyclicals.
Wouldn’t discretionary spend thesis get challenged in the near term because of high crude prices and high commodity costs?
It will becomes a challenge again like interest rates when oil is outperforming copper with both being signals of what is happening to global growth with oil has an additional signal from its supply dynamics, When oil is outperforming corporate, it means the supply factors are overarching for oil relative to demand factors. When that is happening, India’s growth and macro stability tend to fault, otherwise it does not. Rising oil price is just a signal that growth is in great shape and so incomes rise faster than the cost. Do not look at costs in an isolated fashion and inflation is clearly a risk factor for the market as I highlighted earlier. We have still not gotten where inflation has become a problem. It may become one and it could happen quicker than what we are thinking right now. We have to keep a very close eye on it but not for now. For now, income is likely to rise faster than input cost and therefore there will still be increasing disposable incomes.
Even within discretionary, are there any particular segments where you feel there could be opportunity and also when it comes to some of the leaders? We are getting a lot of mixed reports.
I am not the expert on all this but I do think that fatigue has built up because of the lockdown and because of the restrictions on people’s movements which has lasted for almost a year now. So there will be a lot of eagerness to move out and go to other places. Human beings do not like to get stuck in a certain place and so that will happen.
Likewise, there has been too much screen time, especially for the middle and the upper middle classes and they will want to move away from screen time and go for other forms of entertainment, In the next 12 months, consumption in these categories may surprise us.
The longer term trend that remains intact because more and more people will move up from the bottom of the pyramid and go one level higher than like to spend on things that they have not historically spent on and this includes stocks like education, home effects, travel, leisure, media and a whole lot of things. Within that, auto parts look quite interesting. These companies have gone through a pretty big down cycle for the past several years and as auto demand normalises, auto parts will do very well. So, that is one place that investors can look at.
Of course there are some places over there where valuations have become very rich and so be careful. Ans also be careful of electric disruption. So avoid auto parts where electric can disrupt and I think electric will come much faster than what we think right now.
I completely see the picture that you have described and the rationale behind it in the near term. You alluded to volatility on the global front. But even in the nearer term, you are confident of the domestic story remaining intact. Wouldn’t global factors impact flows?
One can never be 100% sure of anything and when one is talking about the future. In fact, one should never be more than 50% sure. I am never more than 50% sure. There are two risk factors that we should keep in mind: One is the likelihood of inflation coming back globally and it is a very pertinent risk factor so keep that in mind. Two, any slowdown in policy impetus at home. A lot of the benefits that we are likely to see over the next several quarters is due to the change in government policy. Keep an eye on that as it could change.
So far I have not detected any change and which is why I think the markets celebrated the Budget because it re emphasised this policy shift that we have been seeing for the past several months. Covid was an interruption and if Covid had not happened, India’s growth might have already gone back to above trend and may have been a multi-year peak. So, Covid has deferred that by eight or nine months because this policy impetus change did not come during Covid. It came before that, in September 2019. Through Covid, the government had the enormous courage to continue that policy shift. This policy shift has experienced a lot of resistance. Look at the farm laws. It is not going to be easy and we are keeping a watch on that.
EV is the buzz word today, but I distinctly remember we spoke about it about two years ago on the sidelines of the Morgan Stanley conferences, How does one really invest and participate in this megatrend?
Unfortunately, I do not think the investable opportunities have still come in the listing space. A lot of them remain in the unlisted space but one way of looking at it is to look at auto part companies that are not disrupted by electric vehicles. So go for those companies that do not get affected whether we have ICE or electric. The other is to look at companies that are migrating to an electric platform because some companies are doing that faster than others. So those are the two ways of looking at it.
We had that conversation three years ago but there are a lot of other disruptions that are happening; there is disruption happening in the financial space, there is blockchain, there is fintech, there is rideshare happening. So along with electric, autos are also facing the challenge of rideshare. No doubt rideshare has taken a backseat because of Covid-19, but it will come back and these are structural changes that are happening in global economies and in India as well.
The pace of change is no different from other places and so India is experiencing that change as quickly as other places on the planet because of porous borders. We have to keep a watch on all these disruptions that are taking place. Disruptions are not unique, they happen all the time but they leave a mark on certain sectors more than others and if you are invested in those sectors that are getting disrupted, then you may end up losing money.
I also remember that you were not bullish on tech. Are you surprised somewhere with the ability of tech companies to generate demand?
Yes, it has been totally wrong. The call has gone wrong and I think Indian software companies have responded remarkably well. I could have had a better call on that. Now I think the cycle is a little bit against them so it is a relative thing. On an absolute basis, they will still be doing okay but on a relative basis, domestic cyclically facing businesses may actually end up reporting much better growth and may offer better valuations. But in terms of the structural undertone in technology, Indian companies have engineered a remarkable shift over the past few years and almost without any exceptions. Hats off to them, they have done a great job.
Two types of changes are happening in the financial world; first financial companies are adopting tech and there are tech companies which are trying to become fintech. How do you see disruption moving out and who will be the eventual winners?
The challenge is that financials is a heavily regulated sector not anybody and everybody can set up a financial business. You come under the supervision of the RBI straightaway. So there are barriers to entry because of regulations. Outside those barriers, there are opportunities for disruption and there is an overarching technology of blockchain. There is a very important legislation which is sitting in the House on blockchain and I am keenly watching as that could define how government policy around blockchain is framed.
Blockchain is not a technology which we will be able to avoid. If it goes its natural course, it removes the requirement of third party trust which is what a bank serves in the system right now. So if blockchain is very successful, it actually completely alters the way of the financial system and this is not just the banks but even stock exchanges, the currency markets, the lenders, the credit card companies. Everybody’s business will get altered.
I do not know whether we will reach that extreme point and I do not know how we get there, but along the way not just banks, but every entity in the financial services sector needs to adopt technology and be ahead of the curve. And those who do that, will obviously fare better than those who do not and it is early days. It is very hard to predict the winners and the losers. Just as a side note, the work that is happening on the fintech side, which is the non financials who are doing technology, is amazing and I am just watching some really good start-ups that are sprouting especially in Bangalore which are introducing technologies which are far ahead of the world. Keep a watch on this space. An unannounced disruption may come and hurt some players in the financial services sector along the way.
