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Shankar Sharma of First Global feels that the current evidence points towards a bear market in India. The global bear market is underway and can last for two-three years, he added. The markets have seen a price correction and can see a time correction now, he said.
According to Sharma, there may be at least a year before the bull run resumes. One may see intermediate bounces, but it is unlikely to be sustainable, he said. He added that it is quite possible that india may fall up to 50% from its all-time highs.
A: On the balance, the evidence is clearly pointing towards a bear market not just in India. In India, for a variety of reasons people are inward looking, and in that they expect that bull markets in India are a phenomenon in their own right and that the whole world has got nothing to do with the Indian bull-market or vice-versa.
That’s not the case. Right from 1997-98 to the present date, every single bull and bear market in India has coincided. It is not a cause and effect. It’s just that it has been part of the global bull market in the technology era, prior to that it was part of the global bear market in the Asian melt down. Thereafter, the bull market that followed after the Asian crisis in technology squarely reflected in India. The bear market across the world post 2002-01 squarely reflected in India. The big rally in emerging markets from 2003 as well as in the developed markets equity squarely reflected in India. A global downturn happens, and India is down. We are absolutely in lock steps with what’s happening in the world of equities.
The weight of evidence suggests that it is a bear market. It has nothing to do with India, it’s a global macro perspective. Equities from the lows of 2002-end, 2003 beginning have rallied extensively across the world. Some equities have rallied more than others. India for one has been leader in the pack. It has delivered a CAGR of 53% or thereabout from the bottom of 2003 till the top of 2008, while the US markets didn’t do much. They didn’t go up. But that’s more in dollar terms. They didn’t do as well because the dollar was depreciating in this period. So, all the gains that the foreign investor would have made in the US was canceled out by the dollar’s depreciation.
That is not the case though and emerging markets are now hurting. For a variety of reasons, India is also hurting, reasons are global as well as local. In China reasons are global, but the global equity bull market is in deep trouble and it definitely points to a bear market which could last anything between a year to three years.
Q: What defines a bear market? What tells you that this is not a bull market correction and we have tipped over into a bear market?
A: We were doing some arithmetic on this and what comes up is actually very interesting. We have gone back 100 years to the US and as far back to Japan and Europe as we have data. Any market that has had 4-5 years of unbroken bunched up equity returns are not going to be seeing it again for many years to come. In the US, for instance, it is from 1924 to 1929 and elsewhere it has been for varying periods. Without exception the next three years are negative return years. It is not just the next one year, the next three years are negative return years, which tells you that the peaks you see at the fifth or fourth years are not seen again for many years to come.
When the peak happens the conditions are still terrific. So, there is no evidence to suggest why the peaks won’t be conquered again. But the reality is that for the subsequent 2-4 years, the market just flirts with the peaks but never takes it out, never resumes a bull run. This is empirical evidence and has nothing to do with India.
In India, people get too emotional about opinion that is not comfortable. We get paid to be right, not to be optimistic or pessimistic, and get paid to look at the data. The data is just so clear. When you have unbroken spells of stock market returns going beyond 25-30% ‑- in India it is twice what the US enjoyed in 1924-1929 -- there is almost no chance that the market will give you positive returns for quite a while to come subsequently. That itself is the most damaging piece of evidence against this bull market. One market can stand out and continue doing it, but till date no data for any market in the world suggests that that has happened.
Even in India, the best periods of returns were 1987 to 1992 and we compounded 62%. We all know what happened after that. 1991 was the year when India opened up. So, the whole case could be made that this 4,600 Sensex peak will be taken out like a knife through butter. It didn’t get taken out for eight more years, despite terrific industrial production numbers. In the first half of the 90s, IIP numbers used to be anything between 9-14%. They were pretty good numbers by those standards, they are still very good numbers even if we do them now and still the market never took out the highs.
In equity markets, returns are not evenly spread out over the measurement period. They come in bunches. They are compressed in very short spans of time. So, if you miss out that period and have come at the end of that period or came too far before the period began, your returns are very sub-optimal. In India we have seen long-term trends at 17%, and short-term trends at 53%. Now, the market will regress to the mean of its long-term returns. I am not making the case that India’s long-terms returns always need to be 17%, maybe it could go to 20% because India is growing. But that still means that the market gives you negative returns incrementally from hereon for quite a while to come.
Q: We are 3-4 months into this bearish spell; do you think there is whole long period left before we get over this hump?
A: I am not opining, I am just reading the data. That is really what I like to focus on rather than get emotional about these things. If there is a three-year bear market, then we are all sunk, us included. Emerging market equities have given way away from trend returns. They will regress to their trendlines, and that regression to the trend will be painful. It doesn’t happen overnight.
It is not as if India will correct 70% just in four months and then go back to its bullish ways. It will be a time correction as well a price correction. We have seen price correction but we haven’t spent enough time in this mini bear market.
So it will test us through the time correction as well till the trend line catches up with the Index levels and that period to our mind is at least 12-18 months away, before we even start thinking of resuming the bull run. But in the intermediate phase the market will have several rallies that will masquerade as new bull market rallies but they will not be rallies that will be durable.
I am pretty sure we will flirt with the 20,000 levels probably in the next six months time. It won’t be durable because the weight of evidence suggests that after five years of way above trend growth in equity returns, the market will definitely give you negative returns for a while to come.
In 1999, Warren Buffett had said get ready for a period of sub-par returns from the US market. At that time, it was a supertanker economy. We have now seen that from 2000 to 2008 the market has gone nowhere. In fact, the S&P has not even reclaimed its highs of 2000. The Nasdaq has practically no chance of ever getting there. The Dow, which is not really a representative index, just flirted with it and came back off. This is only in local currency terms. In non-US dollar terms, it is probably never going to get to those highs for the next many years. That is the nature of this beast. Returns come in bursts. If you miss the burst, get ready for a period of sub-par returns. That is where India is today. That is where emerging markets are today.
Q: Would you be surprised if markets took out its old high in 2008 calendar?
A: There could be a situation where one market probably defies a hundred year history and that market could be India, but then that leads us to the situation that if India where to be that one market that defied a 100 year historical weight of evidence, then what does India need to have in her to defy history.
India needs to have a situation where earnings growth should be higher than the 20% that people are budgeting for. Inflation should be under control, interest rate policies have to be very benign and there should be no political uncertainties. There are many factors that need to be corrected for us to go back into the bull trend and more important defy history.
So in order to defy history one has to completely play out of ones skin. I don’t think India is in that situation, it is not anywhere close to playing out of its skin and again the weight of evidence, given all the stuff we see on politics, on the macro front, slowdown in earnings, so it’s very hard to make a case that India on its own can play out of its skin and defy history.
China is a very interesting case in point. China’s market from December 2005 to the peaks of last year gave a compounded return of 122. Those are terrific returns. But do you know why those returns came? From 1997 till 2007, returns in China are only some 17.5%. This includes 2-2.5 years of 122% growth. This bull market in China was nothing but a corrective move of what was actually a pretty flat performance. SoIt had to do this in order to normalise the long-term returns to about 17-18%. And you can see how China has done after it kissed that peak. Now, it is down 40-45% and is not stopping.
Returns will come although I don’t know which year they will come but they will come for just a few years and then many years of tepid performance will follow.
Q: In past bear markets if indeed this is one, we generally lost 50% from the peak level; do you think that is likely out here, 21,000 to go back to 10,000-11,000?
A: That is very likely. In India the bear market that followed after the 1992 crash, I think India fell from 4,600 to 1,900 at the bottom which was approximately 55-60%. But the median stock falls a lot more. In India this time we have given returns approximately the same levels as what the market returned from 1987 to 1992, i.e. 53% growth. So the things that give you the maximum pleasure will also give maximum pain.
China is already down 40-45% and India is down about 25%; so it’s very possible that we lose 50% on the Index which means you will lose a lot more than that on the median stock in the market.
In India, we have a very strong sense of entitlement towards a bull market, but the market doesn’t give a living to anybody. The market doesn’t know a bull market, we read the data and have to react and make changes in our game to suit the condition.
Q: There is one view in the market though, that there may not be too much more price damage from here on these 15,000 kind of levels at best we’ll correct time wise and this is a good time to go out and accumulate stocks, do you disagree with that point of view?
A: No, I don’t disagree at all. I think there is terrific value in many-many pockets. The Index is one thing and there is terrific value outside of the Index, in the Index it is hard to pick value for IT services as a broad pack. We think there is terrific value there. But outside of it there are good values and now the interesting thing will happen is that this market will again define what has been conventional wisdom; in that it will compel you to sell your winners that gave you lot of pleasure last 3-4 years and it will force you to look for value, and most people will get to value kicking and screaming because nobody likes value, ultimately people want growth. But the fact to the matter is that, like I said, the game has changed this year is the year of value and there is value even in this market now.
In so far as whether the correction can go beyond 15,000, I think there is at least one big leg down left in the market, after that we will see. But the time element on this correction is definitely not over. We are still just three-months into this game. It will test our patience, there is no doubt about it. In the interim, it will reward us by making terrific moves of 30-40%, even 50%.
A market that goes to 12,000 will make you see 18,000-19,000 in the course of the year. We will all keep thinking that this is the resumption of the bull run but those will be sort of big bear market rallies. But bear market rallies are terrific places to make money. We will keep an eye out for those situations.
Q: What's the key domestic risk to our market? The ones which are common perceptions of the key risks for this bear market aside of the global problems that you outlined are earnings deceleration, higher interest rates and something external like may be politics? Which of these three presents the biggest risk to our markets domestically?
A: Ultimately, markets will run on the basis of earnings. We can have political issues and problems, but India has had its share across many decades. If the earnings picture were very clear and visible, then the markets would shrug off any other problem including higher interest rates. When earnings are robust and balance sheets are not that leveraged, then people will make a case that look it doesn’t matter if RBI tightens because not too many companies have much interest burden on their balance sheets anyway.
To that extent, why start bothering about any tightening effect on the EPS numbers of companies. If the core earnings numbers situation were good then this market would be in just fine shape. The problem is that that’s where the problem is. The earnings distribution has become extremely patchy. People talk a lot about the Sensex earnings of Rs 1,000 or whatever that is. That’s just a whole lot of fluff because looking at a Sensex EPS is completely absurd way of analyzing the market. If there are five companies in the index, each company makes Rs 10 crore in profits.
That’s a index earnings of Rs 50 crore and the market capitalization of the index is Rs 500 crore, so the index trades 10 times earnings. But suppose the entire Rs 50 crore profit came from one company and the four companies had zero, the P/E multiple would still be 10 times, the profit would be Rs 50 crore, and the market cap would be Rs 500 crore. It is completely against all norms of understanding markets to lump together everything and make one EPS estimate for the Sensex. If you look at the actually desegregation of EPS, it is largely coming from 7-8 companies in the Sensex. A reasonable part of the Sensex is actually going to delete from the earnings growth. In that situation, what's the point of looking at Rs 1,000 EPS estimate because you are not going and buying an Exchange-Traded Fund, or ETF, on the Sensex.
You are going to buy the stock and the stocks that are going to contribute like the Bhartis and R-Comms of the world are not the places where you are going to make money from hereon, because the scenario for that industry is just waiting to get worse. There are a lot of new guys coming and other guys who would offer rates of Rs 100-150, flat fees, and unlimited calling the way its in the US now. So, this cozy 42% EBITDA margins situation has to give. That’s where your big earnings growth is coming from and then you have Reliance which is a different kettle of fish. But by and large, it’s very patchy.
So, the problem is patchy and skewed earnings. If that situation were not to exist, then I would be a big-big table thumping bull in India, irrespective of macro or politics. But the real concern is actually earnings.
Q: So, what's your base-case scenario? I know these things are always difficult to predict. If you had to construct one base case scenario of how long this problem will continue, how long would this bear market last and when can we start recovering again? We won’t hold you to it but what would your view be?
A: No, you can hold me to it. We get paid to have a view, rightly or wrongly. It’s too early days. We have just getting into one right now. I know again this is not a comforting thought or prospect. We are an emotional nation. We do believe that India deserves a lot more than what statistically its suppose to deserve. We deserve a lot more than the US got in its best five-years. Let us hope all that comes true but the weight of evidence suggests that we are just getting into one, and not getting out of one, troublesome period for the market.
We have had terrific five-years, it is definitely not replicable. In the next 12-15 months, one will get terrific rallies to make money in, but not a sustained situation where one can compound your returns from the stock market. That will actually be a terrific market for everybody who believes that markets are places where one can differentiate the men from the boys, because that’s the market where one will be able to pick a sector which is gone from nowhere to becoming a great sector and the old great sectors will bite the dust. That is an inevitable process of the markets.
So, IT could walk on water 5-7-8 years back. Now, nobody wants to hear about it. Capital goods are the place where people have parked their money. That will give you the maximum pain this year, but it will take you a while to adjust the mind to accept that new reality that capital goods are not the place one can preserve capital. It is probably somewhere else, so this is going to be a very interesting phase and I am looking forward to it.
Q: If you were given a certain amount of money as a HNI or reasonable investor, how would you distribute that in 2008? What is the place to put money in this year?
A: 70% in Fixed maturity plans (FMPs), 30% equity exposure. Equity exposure in sectors, where you have dividend yields between 2-6% - that is the recommended strategy for this year; not the growth market strategy that has worked for the last 4-5years.
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