Market is trying to find a balance between hope and fear: Nilesh Shah

Things were looking great till about 12 o’clock and now the sudden reversal has come in. What is your sense? Do you think in the medium term and the short term, best of the gains are behind us? I am asking you a difficult question but I guess the situation is also difficult.

Undoubtedly, these are unprecedented times. On one side, the market is looking at the flows which would come courtesy index rebalancing by both agencies MSCI as well as FTSE. On the other side, the market is weighing the extended lockdown and its impact on GDP growth and corporate earnings.

Between this hope and fear, the certainty and uncertainty, the market is trying to find a balance and which is why we have seen extreme volatility. Since this is a medical crisis, it will be difficult to say markets and economy have bottomed out till such time we find a medical solution, which allows economic activity to resume on a normalcy.

Let us talk about the important index rebalancing. Just break it up for our viewers, why should one focus on FTSE rebalancing because we are conditioned to always think and look at MSCI rebalancing? What is the importance of this and why could this be a turning point for flows coming back into markets like India?

Essentially, there are two large index providers MSCI and FTSE on whose indices people build their portfolios to outperform or passive funds track those indices to make investment. Now, there was a time when our weight and China’s weight in this benchmark indices were in line with our marketcap.

Over a period of time, China changed their structure in a manner where their weight would have crossed more than 50% from about 25-26% and correspondingly, every other country’s weight would have come down. Now China’s market cap is roughly three times that of India’s. In benchmark index weight, their weight would have grown almost eight times more than India. Fortunately, our regulators and our government took corrective action. In February I had written an article in Economic Times as well as discussed with you advising MSCI not to give overweight to China and not to convert MSCI emerging market into MSCI China and emerging market index. There was persistent follow up by our government, our regulator and taking corrective action.

In the July 2019 Budget, we increased the sectoral cap for FPI to the FDI limit; any company which wanted a lower limit had to pass a separate resolution. This pushed this index constructing agencies to increase FPI limit. MSCI would have done that in September 2019 but they pushed it back to April 2020. FTSE has now considered that and because of the steps taken in the Budget of July 2019 and follow up thereafter, India’s weightage in benchmark indices will go up, which means all those guys who are tracking emerging market indices passive side will have to come and buy in India immediately.

Typically, as your weight goes up, even active fund managers are likely to be overweight India at this point of time. This is partly also possible as two of the oldest civilizations China and India in the eyes of the world; one has sent Wuhan virus, other is sending hydroxychloroquine tablets. This change in the perception about the image of India probably is also going to put more people to increase their active allocation to India and we could see higher FPI flows in the days to come courtesy MSCI and FDI index rebalancing.

This is one spectacular success for India and I would like to mention specifically Sanjeev Sanyal, principal economic adviser at the finance ministry, who has led this from the front.

Now on paper, it is a great point that India’s weightage goes higher, flows come in, something which a lot of market veterans like you have argued and luckily and thankfully the finance ministry has acted on it. But the FTSE benchmark or the FTSE model portfolios are model portfolios. There is no compulsion for a fund manager to map it or to follow it. How does one figure out that what is a benchmark would also be followed by investors and they would have a compulsion to invest because this is something which is a benchmark; it is not a compulsive model which they need to adopt.

Undoubtedly. We have to build our house in order so that people look to overweight India compared to a benchmark portfolio. If our house is not in order, then obviously people will prefer to be underweight in the benchmark portfolio. This was the starting point for us to have as much higher weight as possible but at the end of the day, there is no substitute to be investor friendly or to be in a position where investors will be confident of making money in India.

So benchmark weight is just the starting point but after that, we have to ensure that our communication, our treatment of foreign capital is good so that they can make money. Here, I would like to highlight the success story of Maruti and Suzuki. Today Suzuki owns 53% or around that in Maruti and a lot of their value is coming from Maruti holding and Maruti does not own anything in Suzuki yet Maruti’s market cap is far more than Suzuki.

Clearly, India is an attractive investment opportunity where local companies, local subsidiary companies’ marketcap one day could be higher than their parent market cap. This is the opportunity for global investors and by increasing our benchmark weight, we have a reasonably good shot of getting higher active allocation as well as passive allocation from global investors.

I am being a Devil’s Advocate here for the benefit of our viewers even though that is not the view of the channel. Some of the foreigners who have invested in India have not had a good experience. That is largely because your markets have been flat and currency has also depreciated. So a foreign investor who is coming into India would say, look I need to take two risks. First the market risk and then the currency risk and given the fact that currently Indian economy is going to be slowing down and fiscal deficit concerns would be ignored, the currency could remain weak. Could that be a deterrent when the allocation changes?

Undoubtedly. At today’s level, experience of foreign investors in our market is not good due to the combined effect of falling prices as well as currency depreciation but is it a great time to invest because now the currency is fairly valued and your growth is almost rock bottom. If we go by IMF projections, they have cut down calendar year 2020 target GDP growth to 1.9% but in the same way, they have increased India’s GDP growth target to 7% plus in CY2021.

Now the market is always forward looking. They would like to discount the future once the medical solution emerges. India has an advantage of lower oil prices, lower trade deficit with China and the rest of the world. Third, the world will be awash with liquidity. In the month of March, FPIs withdrew money from India but they took money into those countries where interest rates are lower than India, where coronavirus patients are more than India and where GDP growth rate is negative even though in India, it is likely to be moderately positive.

Fourth and the most important thing is the image. As I mentioned earlier, two of the oldest civilisations, one giving Wuhan virus to the world, second giving hydroxychloroquine tablets to the world. Somewhere, the world will recognise India for the effort it has made in containing this virus and companies which were moving away from China for supply chain diversification would come to India despite stiff competition from Southeast Asian nations and Latin American nations. Today, market is not discounting benefits of lower oil prices, lower trade deficit with the world, better potential capital flows and supply chain diversification but tomorrow ,when there is a medical solution and there is no uncertainty, markets will start discounting those positives and this is the hope at which foreigners will be looking to invest in India.

What is your view on the IMF? Do you think they are slightly harsh in comparing 1929 to when the shape of the world, economy, liquidity, interest rates and there was no globalisation. There were no large central bankers operating the way they are in terms of stimulating the economy. Do you think the IMF has been extra cautious when they are commenting on the economy and when they are comparing the current state of the economy with what we saw immediately after the Great Depression?
I think what we read in the book Lords of Finance which describe central bankers around the Great Depression, one line summary of that book is that central bankers converted a depression into Great Depression. Undoubtedly the economies of that era crashed in 1929. Central bankers cut interest rates, provided liquidity, the government took corrective steps and by 1932-1933, things were looking to stabilise. Central bankers rushed in to withdraw support before recovery was strongly established and that converted depression into great depression.

In those days, the maximum unemployment rate in the US was 25%, one in four employable people were unemployed. In the 2008 crisis, in a month, the US lost a maximum of 800,000 jobs and in the first 14 days of the current crisis, they have already lost more than 10 million jobs. If this run rate continues in about six weeks, the US will have the same unemployment which they had in 1929 during the Great depression.

Undoubtedly the IMF is right in pointing out the seriousness of this crisis with 1929. However, I am sure central bankers are aware of the mistake made by 1929 era central bankers who withdrew support too prematurely and converted depression into great depression. This time we are seeing government and central banks betting aggressively. They are putting an unlimited amount of money in intervention. In the 2008 crisis, the US Fed balance sheet had increased by $4 trillion; this time some estimates are talking about an increase in the US Fed’s balance sheet by upwards of $7 to $10 trillion. So my feeling is that while this crisis is as serious as 1929 or even more because 1929 was a financial crisis, this is medical cum financial crisis but the tools available and the knowledge available in the hands of central banks and the government is far more and they will use every conventional and unconventional tool to contain the damage and hopefully they will be successful.

Right now, we are experiencing four things; the biggest pandemic in last 100 years, the biggest crash in oil which the world has ever seen, a contraction of the economy, the worst we have seen in last 100 years or 80 years and biggest central bank intervention on a collective basis the world has ever seen. So when people come and say that this is the worst for the stock market and things will recover, do you think it would be a difficult call because these four factors have never happened together?

I would just like to present a hand drawn document. It is very crude but stay with me. On the Y axis, we have fiscal and monetary stimulus and on the X axis, we have medical solutions. Early medical solutions with high fiscal and monetary stimulus will create V-shape recovery; that will result in a sharp drop in the first quarter of GDP. But thereafter, it should bounce back quickly because of early medical resolution and high fiscal and monetary support.

On the other hand, in the unlikely scenario where fiscal and monetary stimulus is low and medical solutions are very late, we will have L-shaped recovery; markets and the economy will crash and will take a long time to recover. We have to pray to God that medical solutions emerge early and then our fiscal and monetary stimulus should be high so that companies and the economy can survive the downturn and come out of this quickly.

Given that with each crisis, the trend and the leadership in the market will change, where do you think the next leg of leaders, multi baggers and outperformers will emerge?

If we go by the 2008 experience, small- and midcaps outperformed the largecaps by a large margin over a period of time. The same thing is likely to get repeated in 2020 also. Second, this is the period where leveraged companies will suffer maximum; so in your portfolio, you will have to avoid leveraged companies; the equity value in a leveraged company will suffer severely during this downturn.

Third, from a company or sectoral point of view, there are huge significant behavioural changes being made due to this lockdown and companies which will benefit from these behavioural changes should do well from a growth point of view. To give you an example, low ticket consumer staples will witness reasonable growth, big ticket consumer durables will see deferment.

A value for money brand will see decent growth, ultra luxurious brands may witness down-trading, cab sharing experience like Ola and Uber might get replaced by personal vehicles as people are afraid of contagion of coronavirus. There will be a boom in savings as people who were living on credit cards will now curtail expenditure and would like to have some money for the rainy day and would like to have some money for medical emergencies.

Companies which are focussed on this savings pool, be it an insurance industry, be it in the mutual fund industry, should do well. This is a period where people have realised the importance of health, wellbeing and companies which are focussed on providing health insurance, providing immunity boosting services, wellness, medical equipment, are engaged in development of healthcare infrastructure broadly should benefit in the coming environment.

So you need to ensure that you are in those companies which are not leveraged, which are at the forefront of changing behaviour in the consumer preference and they are able to participate in the upturn to the maximum extent because of those changed behaviour.

You mentioned that one should avoid companies which have a leverage. Yes, there is no existential crisis for an Asian Paints and HUL or a Britannia but the valuations are so out of whack that one is forced not to buy them. So the choice of buying non-leveraged companies, non-leveraged balance sheets is important and crucial but as an investor, does it make sense to buy these stocks when PE multiples are 30-40-50-60-70. I know stocks which are trading at PE multiples of even 90 and 100?

Undoubtedly, we have to invest looking at valuation also. There is no point in paying a huge price. For buying a good company, you have to combine valuation also as part of your investment decision. Essentially, if I say, you have to buy good companies, run by good managers at good prices, these are very easy words but far difficult to execute and clearly, we have seen extraordinary valuation in some of the companies in absence of supply.

These are safe companies, there is no supply emerging in those counters and hence, limited buying has also pulled up prices and increased valuation at almost 100% premium to their 10-year averages. When you are buying expensive stocks, you have to reduce your expected return and you also have to increase your expected holding period in order to materialise those returns.

I was scanning through your Twitter handle two days ago and you mentioned the combined marketcap of autos is actually equivalent to the combined marketcap of HUL, one FMCG company. So where do you think the excess is in the FMCG sector or in the auto sector?

I think from a valuation point of view, excess is undoubtedly in the FMCG sector than in the auto sector. But these are extraordinary times and clearly right now premium is paid for safety. If we find early medical solutions and if we find appropriate fiscal and monetary stimulus and the recovery is V-shaped, then more return has to be made in the auto sector than the FMCG sector.