You have just come back from a global tour. Has the world normalised?
We seem to be getting into the second phase of the bull market and the play book typically for that is rising rates, get good growth. The EPS growth should be fine but price to earnings multiples will start going down. One had an extraordinary stimulus last year which pushed up liquidity and which pushed up price to earnings multiple. The good part is India is probably a laggard in the global cycle in the sense that because of the second wave we started recovering later. India has more legs to go and I would be more positive on the Indian rather than the global cycle.
The developed market saw higher stimulus and on an 8-10-year basis also, the US had been doing well. I would be a bit more cautious on the global cycle. I would think that the Fed and maybe other developed markets, central banks are behind the curve and it is not something that they should be blamed for. None of them saw the inflation being as sticky as it is because while with growth, one did expect a pickup in inflation, the fact is China pulled out of a lot of manufacturing sectors and the supply chain bottlenecks.
The risk to my mind is that what is being seen as transitory inflation — India went through this in 2011-2013 — it feeds into inflation expectations and wage inflation which is here and we could see a steep rise in global interest rate at some point.
A lot depends on the dynamics of growth but also on how the central banks react. If the US bond yields were to go up even if there is a bit of correction, that will be healthy for the market in a medium to long term because making money cannot be too easy in the market. We had a very interesting phase. The outlook on the Indian business cycle is better. But yes, clearly it is going to be a phase where the price to earning multiples will compress.
So you are saying that now stocks like Asian Paints, IRCTC, Jubilant Foodworks, Bajaj Finance, HUL, Nestle are unlikely to give market beating returns?
I would broadly agree with that. Maybe more cyclical stocks can still work because from a growth perspective, this is probably India’s best moment in the last 10 years. because very simply put, four components – private consumption, private investment, government spending and trade — will work partially because of low bases. Private consumption has a low base because of Covid. Private investment has a low base due to the capex cycle. Exports were flat from 2010 to 2020 before jumping over last three-four months. So, that side has good potential but if there is not too much operating and financial leverage and if returns have been made by price to earning expansion over the last five years, I would be cautious.
If such a large inflationary pressure is kicking in, somebody is making money and those are metal companies, resource companies. Should one stay with that trade?
The risk reward is better in that trade versus very stable companies. It is a fairly standard thing towards the second half of a bull market that the more operating and financial leverage stocks perk. The only risk there at some point is that the cycle will break down. I would back Indian cyclicals where operating and financial leverage today is more than in global cyclicals or defensives.
How about buying autos and commodity consumers rather than producers because markets are about investing in future not about analysing past?
I would balance it with slightly upstream companies only because maybe these prices will hold more. The market is probably expecting a very sharp fall in prices. Maybe aluminium will fall, steel prices will correct. Very few people actually believe these prices will hold. What is built into earnings versus how it plays out in the market may be different. It may still be correct but what is being built in is outlandish to a certain extent. We have seen massive price to earnings expansion in staples. Even if commodity prices stabilise or correct, given that interest rates may go up, I do not think you will make too much money.
You are saying that even if interest rates go up, we will not make too much money. You made a case of the cyclicals; you like financials. In a recent interview you had said that Indian equities are likely to go home at the end of this year with the 25% return which is enviable! Do you still hold that view?
I really do not talk about return expectation but I can only say that from a two year-three year perspective, earnings growth will be very robust but returns are likely to be less than earnings growth. Now how much earnings growth? The market is expecting high to low earnings growth. At this point, the US 10-year yield is 1.6%. It is safe to expect that US bond yields will go up now. Even US per hour wage growth is about 4-4.5%. The fact is the crack in the bottom from inflation pressures seems to have exceeded what everyone thought may happen. It can play out in a couple of ways. One, is that there needs to be a kind of jump in interest rates to get real rates to rational levels. The other way we could play it out is if there is a massive slowdown in growth but given that a lot of the world is still to open up — India, Brazil, may be Europe — and the real time data on things like Korea exports, one can see that growth as of now is not an issue in spite of some delta variants narrative in some places.
General global growth is not so much of a concern. Domestic growth feels strong. There is a good pent up demand on travel, hotels and airlines. When one looks at returns, globally equities price to earnings multiples have expanded. A lot of it is because of lower discounting rates or lower interest rates. Some part of it has to be given back, but yes the good part is the earnings cycle outlook continues to be robust.
Would you now look at auto more favourably? The reason I asked this is because a lot of the fund managers we have been speaking to have started adding auto to their list of likes.
Between domestic cyclicals we have financial, autos, cement, retail, etc. Now, there are nuances to them. Auto is a classic Indian cyclical but the only thing is we clearly have this issue of technology disruption in that sector, maybe more on the two-wheeler and four- wheeler side. A lot of our exposure is more towards commercial vehicles which are more cyclical. But yes, even in two-wheelers and four-wheelers, if we get a strong cycle, stocks can do well. If one wants to play the Indian cycle, I can understand being bullish on autos. It may not be my top pick because the price to earnings multiples of the four-wheeler OEM is a bit tricky. A lot of it depends on how the policy will roll out for EVs and how the charging infrastructure roll out happens. But clearly there are some very large groups pushing for all that quite strongly. but at the same time, if there is a sudden pickup in demand over the next two years, these stocks will work.
