Are you a bit surprised with the pace and the current positioning of the market? It has just been a straight line. What explains this kind of pace? It is not the level, but it is the speed at which the current levels have been conquered?
Every time it is different in a bull market. Look at the early part of the 2002-2004 move or even the recovery in the market from the depths of the Lehman crisis. All those moves have been very rapid. So it is not completely unusual to see a market rally like that.
As I said, every time it is different. Look at the price to book – whether it is the Nifty, the Nifty Midcap, or the Nifty Smallcap — all are trading at record levels in terms of valuations and that has created discomfort. There is a certain logic in the morning bell ringing at the stock exchange; that is when trading commences and when the bill rings in the evening, trading comes to a halt. But unfortunately valuations are not equivalent to a bell ringing.
We have seen in the past that in a falling market, the valuations bell can ring and the market can continue to be very despondent. It can get cheaper. Similarly, when valuations get elevated, it does not work like a bell. It is not that the bells ring and all investors leave the marketplace and then it starts to correct. The party can go on for much longer than what we have anticipated but we are not in the business of trying to catch market tops and bottoms. The important message is do not lose sight of your asset allocation, the framework that you have to achieve your financial goals. This is not a time at which you should be looking to raise your equity allocation because valuation is not supportive in a historical context. If I look at the alternative, what are the 10-year bond yields? If you compare that to the earnings yields of equities, even that actually has a negative message.
My simple takeaway would be do not look to over allocate just because the party is still on! Please follow the discipline of asset allocation. This is not a valuation level at which I would encourage anybody to increase their allocation.
When retail participation and NFO is high and the IPO market is high, is it time to get out? What is the right way of looking at this market?
I have spent up to 30 years in the market and the reality is that we are cyclical. You will always see liquidity in the rising markets, you will never see liquidity in the falling market. So there is no point trying to second guess liquidity. The minute you recognise that it is pro-cyclical, you will sleep better at night, rather than trying to develop fanciful models of how to predict liquidity.
One should be careful when the IPO market tends to get overheated or when you see a market which nobody is able to come out of and that gives you a reverse signal. But all these are anecdotal references. Eventually it is the valuations that should drive your framework, the anecdotal story about the shoeshine guy giving you a stock tip. These are good stories but that should not drive allocations.
I was reading a very interesting report about how capex is going to be a booming big time around the world, specially in software, retail, semiconductors. How do you see that play out in India? What are the sectors that could benefit from that?
There are two-three ways to think about this. First of all, do we have the enabling conditions in place for a boom in capex? Some of the enabling conditions that we would look at for a boom in capex are interest rates. When we look at the record low interest rates, certainly they are extremely supportive. From the companies point of view, the new tax code at 35% and even lower for new manufacturing entities is extremely supportive for people to put up new capacities.
The missing element in all of this is really two things; one is capacity utilisation. If you look at the RBI data, it is still not at the level where entrepreneurs would feel excited about putting in capex. Remember even entrepreneurs are coming through a once in a lifetime shock in terms of the pandemic and there is cautiousness in terms of how they would like to manage their balance sheets. So it is not very clear to me that even though there are record low interest rates and a very attractive tax code, the capacity utilisation is not at a level where it could actually push those investments.
Also, policy agendas in India in recent times are very important. Through the PLI scheme, the government has effectively been handing out Rs 2 lakh crore worth of incentives over a period of time to stimulate domestic manufacturing. Certainly this could make it a slightly more positive case for entrepreneurs to take the risk and put in capex. But again, the norms on value addition through PLI are not very clear and whether it is necessary for companies to make that large investments because the value addition norms seem to be more like 15%, 20%, 40%, not really at the level where you could drive massive capex. I think incrementally, certainly the PLI schemes are an incentive for investments.
In India, the part of the capex cycle which is less understood and less appreciated is the residential real estate part of capex. This is the part of capex which has actually been in a decline for almost six or seven years and just given the sort of disruption which seen on the supply side and those record low interest rates, one could argue that the pandemic has constrained the willingness of people to borrow money and buy new houses. But incrementally the data looks a lot more positive for real estate to actually drive capex. People forget that it is actually one of the biggest components of our capex.
It is useful to remember that the government is actually the smallest contributor to capex though it does have a positive multiplier effect. The biggest two components of capex in India are the private household sector and the private corporate sector. The government contribution is much smaller and the government is dominated by state governments where I am not sure they are particularly great help. It is good that the union government is putting its foot on the accelerator but I am a little bit more cautious about a massive pick up in capex in India.
What is the best way to ride the coattails of this real estate recovery? Should it be via NBFCs, home improvement or directly through real estate developers?
There is no compulsion to stick to only one. All of these are actually good ways to play real estate. Some of the developers themselves are in a much better situation than before. They have become more disciplined and certainly one would want to look at the developers but you do not have to restrict yourself to developers because this is a capital incentive business.
The whole building material space is good. One can talk about valuation challenges in some of those, but that remains an attractive way to play the increase or likely increase in real estate spending. Housing finance is a great way to participate as the demand for residential real estate is going up. Then we will also have growth in demand for loans from individuals and when we combine the demand for loans along with slight increase in property prices, we do not need a blow out in property prices.
It allows lending institutions to grow their books at a very fast or brisk pace. All of these are interesting ways to play a recovery in real estate spending — the developers, building materials, home improvement and even consumer durables. A lot of the durables that people buy are linked to new home purchases and are likely to benefit the whole sector. I should also add here that one of the things we are seeing in real estate is a shift and the consolidation in favour of the organised sector, again because of the series of reforms that have been carried out starting from RERA and also what has happened in the market in terms of the credit crisis in 2018-19 and our ability to play it through listed companies this time around is far superior than in the past.
From the March 2020 lows, 85% of some of the largest 1,600 stocks have outperformed the Nifty50 index. 33 stocks have jumped up more than 5X from those lows. Where would you be tempted to take profit or at least ease off your exposure?
If I were to look at where the valuations from our point of view look challenged at a sector level — and this could vary from fund to fund because every fund has a different strategy — then I would still say that one of the areas where we find the valuations slightly uncomfortable is the entire consumer staple space. The multiples are still way too high and that is an area that we would tend to shy away from.
The other sector would be technology even though these companies are seeing extremely robust growth after a very long time. I would say we are still neutral there but incrementally our actions would be to reduce IT exposure rather than ramp it up. It is a B2B business. Valuations look very attractive. Going back two-three years; the free cash flow yields were upwards of 4% to 6% and more. That is no longer the case today and therefore that is another area where incrementally we tend to take money off rather than add to it.
The area which still has some pockets of value, include the financials. These stocks still have value. The market is concerned about credit growth. But one gets stocks at an attractive valuation when there are other concerns. I would be willing to go along with the idea that this is a good time to buy them if they have done a good job managing their balance sheets and if the economy does well, eventually credit will also grow.
The other area where cyclically things have been very challenging for almost the last three years is the automobile area. Look at the sales of many of these companies. They are well below peaks that these companies had in 2018. We still think there is an attractive runway for automobiles in terms of penetration. Yes there is a challenge from the point of view of the whole transition to EVs, but one gets things at attractive valuations only when there are concerns.
We think there are some stock picking opportunities within the large automobile and auto ancillary space, where one could be de-risked from the EV related challenge and still look to benefit from a cyclical upturn in autos. So those are the two areas where we think there are opportunities and the earlier two are where we will have some concerns.
