There was a crash in cryptocurrency last night and that brings to question what is happening in dollar. Perhaps the Bitcoin reaction is linked to what we are seeing on the dollar index. What could that mean for flows and for emerging markets?
The first thing to keep in mind is that the global backdrop is pretty solid. The kind of fiscal support which has been given in the developed economies is unprecedented and to that extent, emerging markets including India have not been that aggressive because we do not have the ability to be so aggressive on the fiscal side.
As we get through vaccinations, remember pretty much all the adults in the US will get vaccinated within the next two months. So we are increasingly looking at normalisation of the global economy. For India, this quarter is going to be difficult but the overall outlook, given the supportive fiscal policies and, monetary policies as well with the Fed still talking about rate hikes way out into ‘23-24 and waiting to see growth pick up before acting. All that leaves the global template very supportive for a pickup in global growth, which should be good for India as well.
We have been trying to dissect what the market is looking at in terms of data on recovery and the second wave seems to be peaking. Is it too soon to get comfortable with that thought that perhaps we are going to start to see a rebound by August, September or the fall?
I am not an epidemiologist so I cannot really comment on those curves and the way they behave but certainly the data we see suggest that things have started to get better in some of the states and metros which got hit early. But this is also a global context that we should be aware of. We are not the first country to experience the second wave. The US, Europe have seen second waves. There have been third waves also. It is not like those markets necessarily reacted.
I am not trying to understand the moral persuasion of the market or provide a narrative. It is what it is. Markets have powered through second and third waves in other parts of the world. We seem to be doing the same. I do not have an explanation for it. I do not need an explanation for this.
While we are struggling to understand which way the disease is moving, the second wave will have a higher collateral damage because of the impact on young people. Are markets factoring that in? There is a difference between optimism and complacency.
I will go back to what I said earlier, go back and look at the data. We are not the first country to have a second wave. The US had the second wave all the way through November and December of 2020. Look at the market action over there. It did not respond to that at all. So as I said, I cannot explain it but that is the way markets have behaved all over the world. This is very painful. There has been loss of near and dear ones. It has been very tragic but this is the way markets have behaved and so there is no point ruminating over it.
Now if you are coming to whether there will be a setback to the GDP data that was forecast a month or two ago, the earnings forecast, certainly there is going to be an impact. Depending on the part of the country, we have lost six weeks to upwards of eight weeks of economic activity. The year being of 52 weeks, effectively we are chopping 10% to 15% of that GDP number. So, real GDP estimates of 11.5-12% are set to drop well below 10%.
The only good thing from a data point of view is that the April-May period is any way a quiet period in terms of economic activity. So while there is a setback, it is not as dramatic as if the setback were to have happened in the Jan-March quarter. So if we are going to see those GDP estimates cut, the automobile company, the retail company — all are saying that only about 30-50% of retail outlets have been functional in many parts of the country in recent weeks. Is that going to affect earnings? Without doubt. You got a 36-38% Bloomberg consensus EPS growth for the Nifty50 in FY22. Is there a risk to that? Certainly, if you look at the domestic cyclical areas. There is risk to those earnings numbers.
Some of the commodity companies which are driven more by what is happening in a global context might actually surprise on the upside in terms of earnings. But domestic cyclicals are weak and therefore they will be cuts in those earnings estimates as well.
In the middle of February after the Budget, there was a lot of optimism and some of those factors have not gone away, whether it is record low tax rate or record low interest rates or whether it is supportive fiscal policy in India. Last year, the government carried out Some of the reforms. If the medium term economic uptrend starts to get questioned, that is when the market will run into a lot more in terms of challenges.
Last year, commodity prices were lower and now commodity prices are high and unlikely to give that kind of an uptick from these levels. So what will lead the recovery?
I do not think you look at commodity prices for recovery. You look for economic activity to pick up and we did say that by the time we got to Jan-March 21, which is the quarter where activity levels had more or less rebounded and was ahead of the pre-Covid levels of activity. There is continuing cyclical recovery as you see demand coming back in some of the consumer cyclical areas and you start to see some investment activity aided both by the government as well as the private sector.
Though I think it will be slower for the private sector, but as it starts to revive, that is the trajectory of the medium term improvement in economic activity. The reality is that even before the pandemic, in 2018-19 India was already in a period of deceleration in terms of growth and then the pandemic brought everything to grinding halt last year in the first quarter. We have been in some kind of a recovery since then.
If you look at the high frequency data that we have got in May, activity levels have come off but they have not dropped as sharply or significantly as they did in the first quarter last year. We can get through this in terms of normalisation of economic activity and we have seen the experience of the other countries as well. When the second wave tails off, that is the opportunity for the economic activity to normalise.
A lot of PSU stocks have got rerated. But because of the pandemic, a lot of assumptions will get challenged and the disinvestment of BPCL, Air India or SCI will run into rough weather. What happens to PSU stocks now?
My first input would be to stop thinking about stocks from an ownership perspective. By blindly saying PSU versus private, we are missing the whole point. It comes down to looking at companies which have the fundamental ability to grow and among the PSUs, it is a narrower set of companies which are fundamentally strong in the sectors that they operate in. That could make a bottom up case for investment but I am not a fan of this broad brush of PSUs as a whole.
The only good thing on the PSU front which comes from the ownership perspective is that the government of India has sold as much as it can in companies and brought its holdings down to 51% in a large number of enterprises. That flow of constant supply is something which has gone away. But that does not mean that you stop looking at individual merits of the companies before buying them.
I do not see things like a PSU wave or certainly not the way that I would approve of looking at investing in stocks if we find sectors in which some of the PSU companies are very competitive. If the government of India is genuinely looking to privatise them and they believe there is an opportunity, we own some of those stocks but it is got to be a bottom up case. It is not just a simple case of let us buy all PSUs or let us not buy PSUs.
What is the outlook on the commodities basket which has seen quite an unprecedented bull run globally?
Clearly the runup in commodity prices has been dramatic. Across the board, many of these — the whole metals and mining sector prices and profitability are at record highs.
Interestingly, even the FAO’s agri price index is up 70% over the last year or so and therefore there is a boom happening there as well. The only commodity which has not gone ballistic to record highs is oil which is not necessarily a bad thing. It is a good thing from everybody’s point of view. But I think there are some challenges here in terms of the interpretation.
If you look at things like steel, China accounts for 50% of global demand and supply roughly and that economy is now trying to readjust itself both in terms of the fact that they would like higher quality growth, more growth led by technology rather than the old smoke stack driven growth that we saw in the previous decade.
So to my mind beyond a point this sort of run up in commodity prices is going to run into a very simple challenge that the biggest driver of demand which has really been China is not looking to grow its economy the way it has in the past. Also, the transition from a very poor profitability to a high level of profitability has been very sudden.
Some of the EBITDA margins that steel companies are making in India today in rupee terms are absolute record levels and when you have gone to record levels in terms of profitability, then I would tend to get a little muted in my excitement about these cyclical companies.
Looking at the PEs or the EV/EBITDA at this point of time is meaningless. When you look at cyclical companies when commodity prices are high, when EBITDA margins or EBITDA per ton is at a record level, you will see valuations start to correct because they need to come back to the average cycle level.
You buy commodity companies when margins are very low and stated PEs or price or EV/EBITDA maybe very high because of surplus profitability. The cycle has been very dramatic and has already played out phenomenally over the course of a year, I would hold my horses given the transition in profitability and given the fact that China is not going to be a global driver of demand in this complex going ahead.
Do you have any thoughts then on some of the other sectors like roads, railways, urban infrastructure housing etc?
Housing is interesting. People do not realise that the housing sector is almost about a quarter of total capital investment that happens in the economy. It has been a soft spot for many years but nothing like record low interest rates and the sort of tax breaks and etc. which have been given both to at an individual buyer level as well as to developers to get the real estate cycle moving. That is something we would tend to be positive on incrementally. There is a part of capex that we are more positive on happening in real estate then necessarily with the private corporate sector at this point of time.
The other interesting area would be automobiles. Automobiles sector has been through a very difficult cycle going back all the way to the festival season of calendar 2018. In three years, volumes have gone nowhere or have gone negative and this is an area where we still think that the structural growth story in automobiles in terms of the demand that is likely to come from consumers as they move up the income cycle and look to improve their quality of life.
In automobile, the structural story is still intact and therefore this three year adverse cycle actually is creating a good opportunity to position for demand normalisation.
The domestic healthcare sector and pharmaceuticals the sector has done well in the last one year but really it is coming through a period of two-three years of intense pain. They have had to readjust their business structure, the domestic opportunity remain very attractive but they ran into significant challenges on the pricing side and the generic markets globally and also with quality related issues. One by one, we are seeing companies addressing these challenges and get past them.
Remember these companies are globally very competitive. It is one of the few sectors in which you will find a large number of Indian companies being globally competitive. We are quite excited about the entire pharmaceutical plus healthcare space; automobiles and real estate.
Is pharma a space you are not so bullish on or do you feel perhaps it has just topped out?
As I said pharma and healthcare is something that we still like and the domestic market opportunity is still very attractive. It is highly profitable, it has got very good growth characteristics. It is just unfortunate fact of life that as incomes go up you get more and more of chronic lifestyle related conditions which require a lifetime of treatment. So this is a good growth opportunity for the domestic companies and added to that, the organised sector of healthcare, which is the whole hospital diagnostic place, has been growing again on the back of spending ability and the development of the health insurance sector.
So we are quite positive on this domestic healthcare space. The export end of that had been challenged by safety issues and also quality issues and also by pricing issues we think the worst is sort of behind on that front as well. So this is a sector where we would stay incrementally positive on the medium term.
Within financials, what is the strategy you are looking at?
The financial sector has been the bellwether of this market. It is the largest sector in the benchmark but it has gone through a difficult period over the last 12-18 months because of the pandemic.
This is the first time in almost 20 years I am actually seeing that a handful of banks have been proactive in terms of providing for potential losses. They actually started providing for losses in the March 20 quarter when the pandemic had just about hit.
Secondly they have went out and raised capital as a pre-emptive measure to strengthen balance sheets.
Thirdly, many of them have built excess buffers within the P&L. We have not seen this kind of a behaviour from some of these banks in the previous credit cycle 2013-2015 or even if you go back to the late 90s credit cycle. Typically the attitude was deny, deny, regulatory forbearance but then you wait four to five years before you start to clean it up.
Now some of the points that I made may not be true of every bank within the sector or every financial lending institution within the sector but certainly it is true of a handful of these institutions. So while at a sector level it is hard to get dramatically overweight given that the sector is already 32% of the benchmark, within that, we are selectively very confident that a strong consolidation story is going to play out.
Some of these institutions navigated the credit side and asset side risks well over the last one year. They have built their buffers, they have got high capital adequacy and they have got the trust of depositors or the bond markets. The case for incremental growth accruing to them is far stronger than anything I have seen in the last few years. One has to be cautious within the aggregate secto because companies are very different but there are five or six where we personally and many of our funds are invested with a strong active weight. We think these guys are going to come out of this difficult period with their foot on the accelerator, better margins and gains in market share.
