Edited Excerpts:
Do you agree with the view that the 2020s could be similar to what the 2000s were for emerging market equities?
Emerging market equities have historically been correlated over market cycles but one should be careful in using a broad brush. Yes, overall there are similarities in the form of markets recovering from crises, strong commodity prices, and lower borrowing rates. However, there are differences as well. The glide paths out of the pandemic vary across emerging markets and versus the developed world. Any external sector that supports exports has both near-term supply challenges and longer-term geopolitical challenges in pockets. The fiscal room across EMs is also not as uniform.
Finally, we have to see how the entire QE withdrawal process plays out. The US dollar weakness is going to generally augur well for emerging market flows and result in robust performance. However, to say that every emerging market is going to be on fire in the coming years because a lot of them are primary resources-based economies and are fuelled by debt — may not play out that way as in the 2000s.
What is your view in terms of the upside for benchmark indices, do you think that there is much of an upside left?
Valuations are stretched for the narrower indices like Nifty 50. We have a very similar situation in smallcaps but, interestingly, midcap index is relatively cheaper. Midcap index is only about one standard deviation above the long-term average valuation.
Will valuations limit the overall market growth story? A lot will depend on the breadth and pace of earnings revision here. There were nascent signs of an economic recovery just before the pandemic hit us, prior to which, we had below-trend growth for several years owing to excesses of the previous cycle and disruptions caused by demonetisation and GST implementation.
What you are seeing now is both a post-pandemic recovery and an economic cycle revival. Balance sheets are a lot cleaner today and government spend quality, too, has been improving. Urban consumption and services sector is still to revive fully but it does look like we are going to have a meaningful private sector capex revival after a near nine-year period. This makes it a more sustainable growth path and should support robust fundamentals for the next three to four years, which can support earning revision and, thus, valuations in general. Eventually, however, it will be a more stock-specific story.
Central banks are now going towards policy normalisation. In terms of India’s real interest rates, do you think that it is a problem in terms of attracting investment and what sort of impact do you think the taper will have on India specifically?
We are pretty clear on the timelines now. The only uncertain element is whether there is going to be a taper tantrum or is it going to be a relatively smooth taper. For now, it does look like that the markets will be able to absorb this QE withdrawal with relative comfort. India has seen far higher FII flows than other emerging markets over the last year and a reversal can lead to some pressure on the Rupee and on interest rates. However, on the other hand, overall credit demand in the system has not really come back to the extent that was expected. Even while the capex cycle is kicking in, if credit demand is not shooting through the roof, QE withdrawal can be accommodated relatively easily.
From a real interest rate perspective, fixed income markets have seen yields harden over the last 12 months and that trend will probably continue as supply-driven inflation continues to tick up. Bond yields may not go up very substantially from here, but they are not going to come down meaningfully till these bottlenecks clear out.
Even if there are certain hiccups for the equity markets on the back of it, FDI flows are likely to remain strong. With a benign growth backdrop, the rupee should find support. Mind you, the call is not that the rupee will appreciate from here – just that the depreciation is going to be manageable and orderly.
What is really driving the regulatory upheaval that we are seeing in China and is already making investment firms like you look at other destinations to probably relocate some of your portfolio investments?
The regulatory upheaval in China is something that surprised most of the market participants. The impact was all the more pronounced as a lot of the proposed changes concentrated around the technology sector, which made up almost 40% of most China benchmark indices. Just like most of the things for China, you cannot really take only a near-term view based on a few months or even a few years. The current change is a philosophical shift in so far as the overall economic model of China is concerned. It represents phase two of China’s economic growth journey, where the focus is set to be on more equitable and sustainable growth.
By no means would we look upon these changes as anything that says the end of the China investment story. From an investment perspective, it is essentially a re-set that will lead to a shift in profit pools across factors of production and emergence of newer themes that will lead to their own set of winners and losers. We are absolutely focussed on riding this wave out, and understanding how this is going to impact different sectors.
How do you value the new-age businesses that are entering the stock market?
For all businesses, one eventually needs to value future earnings. But then near-term earnings streams have no value here because these businesses will either not have any profits in the near term or the margins would not be representative of the long term potential. So the way out is to look at the long-term target market potential and the expected market structure.
In the case of Zomato, for instance, you would want to understand how the entire food delivery dynamic marketplace is going to look like. Rather than extrapolate historical data, you try to anchor on what the overall wallet spend pattern is going to look like in 10 years and what percentage of that can a food delivery entity take. You then discount that particular profit pool to today using a generous discount rate because there are still a lot of uncertainties involved.
Firstly, you need to have a view on whether it will emerge as a highly concentrated marketplace even on a large scale. Then whether Zomato will be one of those large market share players. The next step is then to understand the market size potential and the pricing power through the value chain.Out of the Rs 100 that a customer is paying, what percentage of it goes to the restaurant, what percentage of it goes to the platform and what part will need to passed to delivery partners.While you may not have a lot of confidence in the near term earnings but in the long run, you can do a fair bit of analysis on what the market size is going to look like and what percentage of the market can this particular business take.
Lastly, it is important to triangulate those findings with other valuation metrics. While some of these businesses are new in the Indian context, there are global counterparts who are ahead in their lifecycle and can provide a clue on relative multiples. Also, at times, instead of putting in a multiple, finding out the implied growth based on the current prices will give you a better sense of the valuation. Ultimately, it will come down to your comfort level on the long term growth rate and whether current stock price justifies that.
