West's easy money propping our mkts, is it a bubble?

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I certainly have been one person for long time who is been saying that the index is suffering from heavyweights which are really tired and they probably need 2-3 years of base building or capacity creation to give them that next fillip up. Because if you turn to fundamental side of the market and let's forget the PE for a while, you see there is operating leverage in a company or there is financial leverage.

Financial leverage is really interest rates falling which one can't build a case for India today.  But over a three year timeframe I can't see why our interest rates should not be lower than where they are today given what's happening to savings rates and attractiveness to rest of the world. On the operating side unlike the 2003-2007 bull market you didn't come into the phase we are in now with excess capacities waiting to get utilized or prices which took off for lot of important commodities.

So you don't have those levers yet coming into our companies in the immediate foreseeable future. To make a case for an index to work on a sustained fundamental basis is tougher. On a PE basis therefore the more likely outcome where money comes and just forces India's PE multiples higher, makes it from the most expensive market in the world and even more expensive market compared to the rest of the world.

Q: Do you see the broader market continuing to outperform like it has for the last one year?

A: It has become like the 1990s. It is interesting that you asked this because we do this work all the time that the top six or seven companies are 25% of India. The next 10 are another 25% of India so you cover 15-16 companies. You pretty much got 50% of India's market cap covered. What alarming is that 50% of those heavy weights are really energy resource type stocks which makes us no different from the Brazil's and Russia's of the world.

Unless you have bullishness in commodities you can't make a case over there. Another large component which maybe another 10% of that is banks. They benefit as well when interest rates are trending down either on their bond books or there is great demand for credit and people are building out. That is not happening as yet. Another large component is in the three large IT companies which is given what is happening in the rest of the world and that the PE multiples are already at fairly exorbitant levels.

Q: That is 70% gone?

A: It is very difficult. What you are left with is ITC , Bharti , BHEL and L&T . These four have the gun powder in them to lift this market up on the India story per se looks difficult. So the index on a fundamental basis I cannot make a case or even these are the top 50% of India's market cap.It is very difficult to say that the market cap is going to lift off on a fundamental basis in the short run.

 But what it also means is that there is no reason for most of these companies to decline and if they stay range bound the way they have last year you are going to keep having the midcap mania of the type one has seen and there are opportunities around.

When one turns around and looks at what people have done on investing side, one's own portfolio and so on, portfolios are for most people are at new highs. Sensible new highs and they have been in stocks which have not been what people would term as very capital intensive.

It has been in the traditional FMCG, autos, telecom and even some IT, engineering, media and retail. So there is a wide basket out there within India where people are doing interesting things. Return on capital is high, PE multiples continue to be between 50-60% of their long term sustainable return on equity (RoE) or growth rates and it is not completely stupid valuations over there.

Q: Why is infra not participating right now?

A: I think it is a matter of time because if you need this country to get build out and you will need to attract capital to get it build out. These are businesses which are typically a 15-20% return business which for the average Indian investor is not exciting enough to come into.

From the foreign investor perspective there is nothing you can directly play. So you have seen, it is again surprising, you take the largest engineering company in India is L&T which is about USD 23-34 billion of market cap. The next one straight is JP Associates some where at USD 5 billion. It is very alarming that if we think infra opportunity in India is large and we want to put USD 150 billion to work every year who is going to build the infrastructure.

So the whole space of this people who are going to be the picks and shovel providers is a space which is very interesting and exciting for the next five years. The second category is when you do an infrastructure creator like an Adani Enterprises , you get USD 850 million QIP done like that.

So the money is there, the question is it's not there in the market and therefore lot of it is being met by issuance so you have seen Adani or GMR or even JP, Jindal, people of that nature coming and taking capital. This capital will get deployed over the next two-three-four years and that's the hump in capacity we will seen in India in 2013-2014 onwards because it's clearly moving from public to private hands and its going to be these set of stocks which will then start becoming part of the indices and we will start seeing money chasing them.

So the longer-term oriented money which can afford to sit two-three years and say it's a 15% return. India looks like the currency might be appreciating 5-6% a year so you can be 20% dollar  in this kind of businesses and these are bets worth making. You see private equity investors, you see the large long-only investors coming in there and for the local investor community its not an exciting space.

Q: You are saying tactically oriented money is just giving it a pass at this point?

A: Yes because in the short run there is nothing very exciting going to happen there unless you say it's a 15-20% RoE and I can buy at 1.5 time book. Most of them whether its ITNL or IRB taking the road construct as an example would tend to trade around 3 times book which way the foreigners are pricing it. The locals would come in and say I would rather buy this closer to 1.5 at best 2 times book.

Q: What is happening with the domestic liquidity situation because it was comforting for the last year or so, the insurance, mutual fund situation, that's something which the market has had to do without this year?

A: Its one of those mysteries of India that every year for the last 20 years I have been in the market, one has talked of how the Indian saver is putting a very small tiny sliver of his or her saving into the equity markets. In some sense it turned out not to be a bad strategy because people had money in gold and they had money in real estate and if I look back from 2003 to now gold is up 5X, our index is up 5-6X, so we you haven't done that badly if you are just sitting on gold.

If you had bought property, also property prices are probably 5-6X in the time period we are talking about so from a asset allocation perspective if you are just purely in the index it's not been that exciting for people and they didn't have to see gut ranging prices everyday which maybe one reason why people haven't come to market over here.

The second is just surprising that the saving rate has trended to go up from 26% of GDP to close to 40% and one still isn't seeing risk appetite being taken up by Indians to say that this is where wealth will get created and I want to be participant in this. It's a bit counterintuitive that we are happy to lend money through our reserves to the rest of the world at 2% and we are happy when they come and buy our equity which is our future growth and we aren't very terribly despondent about the fact that Indians ownership of equities is staying at all time low. I don't have an answer to that.

Q: Do you see that changing at all or is it once in a while will get 2008 kind of experience and that sort of takes away the gloss on equity for five years?

A: You had a sustained bull market between 2002-03 and 2007 and even in that period its not like significant asset allocation shifts happened in India. So what is going to cause this tipping point over the next four-five years hopefully the younger generation of Indians who have come out were much more white-collared who can look to invest and understand what investing is about and its not about people coming on television channels and giving you stock tips - buy this today and it will be up tomorrow. 

But it is about owning parts of the businesses which as the country will progress you will make money and I also think the second phase of growth in India is going to be a bit like it happened. Analogy is maybe with the cricket team or with politics that it moved from the national level that earlier you just see the Bombay players dominating the Indian cricket team for e.g. and it went into the smaller towns and even today when I look around at consumption, the consumption is not happening in the products which you and I or presumably lot of people watching the channel are focused on but its happening in what one refers to as the Bharat bit of India and its happening in the interiors.

If you would have looked at consumer products you would have thought Marico , Dabur are addressing segment two of Indian society rather than segment one. If you had thought of two-wheelers you would have thought of Bajaj and Hero Honda addressing segment two rather than the car segment and so on.

Even in media its not the people who are looking at the English channels which are dominant but its the Hindi and the regional language and you will get businesses coming out of these places which do not have that level of competitive intensity. Therefore their margins and returns are better than lot of the national champions because over the last four-five years one has observed that the RoE for India is been trending down from 22-23 to close to 17 today. Whereas one goes on to the smaller companies which are still emerging.

One finds that the RoEs are still north of 25-26 and the PEs perversely are in the 10-12 range and that's probably the bit of the adjustment which is going on in the markets as we speak today.

Q: When you look forward into the next couple of years do you see a high volatility phase because we just came out of a very high volatility phase and went into one year of extremely low volatility. Are we going to see a big spike in volatility whichever way over the next 12-18 months?

A: It's a truism to say that something big has to happen in rest of the world. It cannot be life is usual that you blow-up, you put more of the same spirit into the patient or you are doing chemotherapy and nothing is going to happen. So something has to give away in the West.

In India one worries about a number of things on the long-term perspective that while it's easy to pull the spreadsheets out and say 9% growth and therefore a 14% nominal growth is kind of given by god to us. There have been countries in the world which had the same demographic dividend as we did and which didn't tackle and one doesn't see despite the money going into the villages through National Rural Employment Guarantee Act (NREGA) and so on so, there is no intent in our country.

 If we are planning to be from a trillion dollar to a USD 4 trillion economy, the number of large issues there which frankly the government needs to address and it is going to be about leadership and governance in this phase. If India disappoints it will be on those access that we do not have a plan for educating people to make them job ready, we don't have a plan for how will 20-30 million people come into the job market every year and where will they get absorbed.

We don't have a plan for our energy security so we are happy to get a nuclear bull pass but what is going to happen to India's oil demand in the next five-ten years or its power demands. We do not have a plan for what is going to happen to exports because one cannot perennially be running a 3% current account deficit, one doesn't have a plant to counter what China is already doing on water. If we are going to get richer do we have a plan for what is going to happen to food because our consumption not just in volume but quality of food that we will eat will also go up.

What is happening with country in strive from Kashmir to all the way to the red corridor. So these are now all governance issues, urban infrastructure; there is just no one looking at the governance and the government. While from a fiscal deficit side I am very excited about the changes which are happening that the government is managing to monetise its PSU, its managing to monetise - now also they are talking of mines and land, they have done the 3G, they are going to do the NELP the next round and so on.

From a balance sheet perspective the government is getting its act very well together but from a delivery point of view to the average consumer and therefore also the average businessman and the average investor. I think that's the challenge in the country.