Is the market driving you crazy? It refuses to come down irrespective of what is happening on the valuation front, on the demand front, on the Fed front and on the inflation front.
Well, markets are always going to be confusing. The market knows a lot more than all of us put together. So the collective intelligence is a lot better in the market and it disseminates. If you just focus on the hard facts, may be what the market is doing is probably rational. It is trying to price the expected growth going forward.
So what is the justification for someone to buy stocks now given that the market is already pricing in 2-4 quarters of earnings?
A lot of investors are asking this question. Let me put it in the context of why would you prefer an asset class over the other. It was always going to be an opportunity cost.
Look at where we are in terms of global interest rates. They are near zero. Even if that goes up a little bit in absolute terms, it would not be significant. In addition to that, you have to remember that inflation is rearing its head everywhere over the world. This should tell you that real returns are really negative at this time, which means there will be scramble for yield. Now look at our stock markets and ask what is my expected return even if valuations are at an all-time high. Obviously, future returns are impacted because of your current valuations. I think we will expect sub-average returns.
For example, the average return in our market in the last 10 years prior to 2019 was around 8-9% compounded average. The last year made a significant change in the average by going up 60-70% on an average, depending on whether you take the financial year or the calendar year. That has improved the compounded average return over the last 10 years to around 12 to 13%.
The returns may be lower than normal, but then look around the opportunity cost for you. We have to be ready for a low return world.
Once a bull, always a bull. We are programmed to think that in the equity market returns will always be higher, whether it is in double-digit or late single-digits. What is the risk? Could it be a third wave, Fed, valuations or inflation?
The single most important factor for markets to collapse from here is an unchecked or uncontrolled wave of inflation. Covid is obviously going to be an uncertain contagion. We do not know whether the third wave is going to come or not, but that is more in the known risk perspective.
Will the large amount of capital sloshing around lead to a capital cycle, an overheated economy and high inflation? I think that is a very big risk. If that happens, you are going to see valuations evaporate because at a higher cost of capital the opportunity cost picture shifts. The returns on equity will not be that high. So that is a big risk.
However, having said that, the world knows how to control inflation as long as it has the tools available in the monetary kit.
Reliance’s big announcements on their new energy foray has put the sector under the limelight now. How do you see this?
It is a blue sky scenario at the moment. We have to rely on how things move in the next 1-2 years. It is a very difficult to call at this time. Investors are very keen to use the word sustainability. Now you can argue that these are buzzwords just like Y2K was a buzzword. But it engendered a generation of software exporting companies in India. So something similar can happen here. Who knows? However, this sort of industry requires a huge amount of capital. I am optimistic that this will become a much larger force and there will be a broader participation in this theme.
