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Market not frothy but complacent, expensive; worried about domestic macros: Experts

Do not think it is bubble formation but it is definitely an expensive market, said Raamdeo Agrawal of Motilal Oswal.

October 03, 2017 / 07:12 PM IST

CNBC-TV18's Nimesh Shah travelled to IIM Ahmedabad with the Motilal Oswal Team where they conducted the 'think Equity, think QGLP' contest. QGLP being the Motilal Oswal Motto of quality, growth, longevity and price. Nimesh caught up with three market veterans, Raamdeo Agrawal, Ramesh Damani and Utpal Sheth of Rare Enterprises.

When asked what he thought about the over-crowded trade and if there was a risk of bubble formation now, Agrawal said he does not think it is bubble formation but it is definitely an expensive market. He also shared his rationale for thinking why market looked expensive.

Sheth said after a long time it looks like we are seeing a synchronised global growth. India used to always have a growth premium as compared to developed market and that premium seems to be shrinking, one just hopes its temporary shrinkage, he said.

According to Sheth, at this point of time looking at individual companies on their earnings prospects is most important. For the near term, there is more risk from domestic macros than global macros, he said.

When asked if thinks there is lot of froth in the midcaps and smallcaps, Damani said market is not frothy but has clearly become complacent. Market is not pricing in any geopolitical risks or global risk-off. There is complacency that market cannot go down because domestics have so much money that they will come in and save the market.


Damani said Nifty could go to 9000 levels before it goes to 11,000 levels.

Sheth is bullish on commodities and thinks metals pack is showing tremendous strength.

Damani thinks disruption because of technology could be massive in spaces like autos, oil and gas, especially if we move to electric vehicles.

However, Agrawal is of the view the disruption of OMCs if any is still few years away and so expects them to do well for now. He is still bullish on financials despite the over crowded trade.

Below is the verbatim transcript of the interview.

Q: What is your view on the market and are we headed further higher?

Damani: This market is in a bit of a squall right now. We are facing some temporary uncertainty with the economics, but these are typical of bull markets that we will tend to stumble from time to time. My sense is this is just a stumble, nothing more.

Q: In fact I was to ask you this because over the last couple of years, you have been saying this that the equity markets are going to climb the wall of worry. Now there are real worries of growth not coming up, earnings not picking up. Are they temporary to your mind or will we continue to just climb this wall of worry and go ahead?

Damani: I think this is a temporary lull in the market. It seems more and more evident that there is some real pain in the ground, particularly the medium, small section with unemployment, in those kind of numbers, so we might remain in this range for a little period of time.

Q: You look at numbers very closely and for you, number is a God. That is something you follow very diligently. Given that even the next quarter earnings are going to be a little painful, macros are not turning to the best of what could have expect, in this context do you think the upside for this year seems to be capped now?

Agrawal: One is the number, second is what is happening in the supply side. Because of the very attractive valuation for the given earnings right now, whatever is the condition, for that wonderful this 10,000 kind of Nifty. That is providing a lot of comfort to issuers, whether it is the government, whether it is a new company, whether it is foreigners.

I am not saying that they are selling only because of the valuation, but valuation is definitely one of the reasons because in all the roadshows we are doing in America and Europe and other parts of the world, we are getting this constant throwback that we love India, that we would like to be in India, but current valuations, they have a choice of going anywhere in the world.

So clearly we are getting supply from foreign institutional investors (FII), we are getting supply from government, we are getting supply from new issuers and the buoyancy is so high of domestic institutional investor (DII) flows to mutual funds and the retail participation in the new issuers and all, so domestics are buying and everybody else is selling. So my sense is that it is a nice situation to be in. Economy is kind of at an equilibrium right now. It is not giving that earnings growth across the board and yet, the demand, for whatever reason, demand flow is very high.

So we are pretty comfortable at this level and my sense is that individual companies will definitely rise. You cannot stop individual companies because once the quarterly results come or monthly numbers come, they will start moving. Market, my sense is, it will stay here till something changes or foreigners stop selling or DIIs start buying even more. Something has to change. But otherwise, for the current broad earnings, current valuations are good and you have to be stock specific.

Q: In the past as well, initial public offerings (IPO) have been a big barometer of markets peaking out or some sort of a bubble formation happening and even in the IPOs there are three sets of IPO phases come like good companies at good valuations keeping a lot of money on the table for investors to make, decent companies with decent valuations. But there are times when bad companies come with very high valuations. Are you getting a sense now that in the IPO market, you have reached a stage where bad companies are now commanding very huge premium and huge valuations?

Agrawal: No, I do not think. We have yet not started with bad companies. We are still getting good companies actually, good businesses, slightly at an elevated valuation. So what you said is right. Finally, we will go to a stage where bad companies will come at high valuations. But I think we some time right now.

Q: You track a lot of global data very closely. Looking at the global scenario, there are so much of talks about geo-political risks, talks about finally looks like the global growth seems to be picking up. How are you mapping up the global set up and what this means for India and for emerging markets?

Sheth: After a long time, we are seeing a synchronised global growth.

Q: Is that for real?

Sheth: Looks like and this is not run-away growth, but reasonably well calibrated growth. India used to always have a growth premium as compared to the developed markets and with whatever is happening here, that growth premium seems to be shrinking. It remains to be seen and we are all hopeful that it will be a temporary shrinkage of that growth premium.

Q: If the global growth is synchronised, the flipside to that would be that interest rates will go up in the US. There will be shrinkage of the balance sheets of global central banks. Will that mean squeeze of liquidity for emerging markets and that may impact India as well?

Sheth: I think the global central banks are in a relatively far more proactive role at this point of time than they were in 2007-2008. And therefore, they will calibrate in such a way that the escape velocity is in place. One can keep worrying about all those possible outcomes, but as of now, I would not worry about those. To me, looking at individual companies and their earnings prospects is most important at this point of time.

Q: When I last spoke to you, you said you are fully invested. At the same time, you are a little worried about the kind of rally you saw in the midcaps, smallcaps, some of the stocks which does not deserve that sort of a valuation premium. Are you still holding that thought that there is still a lot of froth in the midcap and smallcap which needs to be corrected over a period of time?

Damani: More than froth what worries is me is the complacency we have in the market. Almost an initial public offer (IPO) will pop up at a premium, good stocks will get even more expensive. The sense of complacency that the market cannot go down and the reason behind that is that domestics have so much money, they will pour it and save the market any given day.

But, if you look out to what is happening, say North Korea, it seems like global markets are sleepwalking to the North Korean crisis. It is a fairly dangerous situation there and markets should take cognisance of that that there is a potential conflagration there and market has not discounted that in any way yet.

Markets have discounted the fact that the Fed might tighten rates, maybe delayed after three months due to the hurricane effects. So there is a sense of complacency in the market that the market cannot go down. That typically happens 5-7 years in a bull market where people know only of markets going higher and they feel that they cannot go down. Typically, the greatest periods of volatility are after the periods of complacency. So I am a bit nervous that the market seems a bit too complacent to me regarding equities.

Q: So then what could be the downside risk to this market? I am just asking from a retail investor point of view how they should position themselves in the near-term.

Damani: I am not showing better ways to do it, but I am certainly not going out and buying the fanciest stocks at higher and higher prices. I am keeping my discipline. If I have businesses that I have bought 3-4 years ago, I am not selling them because I am scared. But discipline. Do not leverage in your position. Do not chase stocks that are touted as cannot miss stocks. Avoid those kind of rash behaviours that typically have costed investors money when there is a down drift in the market.

Q: It seems like a lot of the money is now only chasing the financials whether it is banks, non-banking finance companies (NBFC) or housing finance companies. You also have some of these large banks in your large portfolio, Focus 35. Are you getting a sense that it is getting an overcrowded trade and there is a risk of a bubble formation now?

Agrawal: We do not think it is a bubble formation, but is it a slightly expensive market? It is clearly an expensive market particularly the history, we the people, all of us, we have seen 25-30 years of the market, we have seen far lower valuations of the same companies or same quality companies. So I would think that I would be happy paying 30-40 percent lower than current prices than most of the stocks, even what we are holding. But you cannot have your wish in terms of where the market levels are.

So the whole market levels are very different. A lot of things have also changed. When we were getting the stocks cheap, that time, the interest rates were more like 14-15 percent. 15 percent non-convertible debenture from even AAA companies are almost guaranteed. Today AAA companies will get what 7, 7.5, 8 percent. It is just half, 7.5 percent. Literally half.

So if the price-earnings ratio (P/E) multiples of the same companies are double, technically speaking it is not wrong. So that is the kind of thing. In absolute numbers they look expensive, but a lot of things have changed in the backdrop.

Q: You spent the whole day at this contest looking at all the 13 participants. What have you made and what are the three winners that excited you?

Agrawal: What I enjoyed was the passion from all the campuses, all the 52 who submitted originally and then we brought it down to 13 and we have all gone through. And all the kids, they have presented with a lot of passion which was, the very idea was to sensitise all the B-schools about the opportunity in this entire money management business which is in US and all, it is almost the top or first or second choice of the kids. Here, it is no choice at all. Nobody comes from these B-schools. So that effort, I hope we are successful in that.

Second is the quality of ideas. People's understanding of the entire process, the philosophy and then pitching the ideas according to that. That was quite satisfying and we got so many new ideas out there to discuss and you will get to see the presentations.

Q: What are your thoughts?

Damani: It is actually an exciting experience to come back to campus and engage the students. As Raamdeo said, what gratified me was that the stewards of your wealth tomorrow are developing a philosophy, a process.

It is very important that the public and the students realise that it is not a matter of tips or hit and miss or inside information by which the markets operate, but on well-defined logic, well-defined processes and they were forced to present on the QGLP philosophy that Raamdeo's firm has pioneered. So they could straighten out the ideas based on a certain parameter set and the fact that they did it so well really heartened me.

Agrawal: And particularly one thing. Now we are talking about public money. Those large amounts, lakhs and lakhs of crore. Right now, Rs 7 lakh crore equity is being managed by mutual funds. We are looking at maybe Rs 25-50 lakh crore to be managed. You cannot be managing thousands and lakhs of crore the way you are managing Rs 5 crore or Rs 10 crore. There has to be a process and some sanity in the way you do the things.

Q: While there were a lot of identified stocks, so to speak, in that 13 list, likes of Page Industries, Maruti, but there were some unheard names as well, Garware Wall Ropes is not something which is quietly owned, something like Sterlite Technologies. What stood out in terms of the 13 universities that you evaluated?

Sheth: For their age, they displayed extraordinary maturity and demonstrated tremendous effort. I wish I had the same maturity and effort at their age. It was heartening to see that they went well beyond the so called blue chip list to try and find out and look for that one big insight and clearly, all of them did their best and we were quite impressed.

Q: One thing on the commodities side because that is where lot of money is being made over the last 12 months. China has surprising been on the good side, so to speak, for a lot of the Indian companies as well. What are you mapping up the Chinese data and to that extent, what are your views on the commodities?

Sheth: All the commodities seem to be in a fine fettle right now and it is not just the economic stimulus by various countries. It is also to do with a lot of shut down of economic capacity. The whole metals pack is showing tremendous strength.

Q: You have always been a believer that every bull market will have different sets of leadership. We are seeing some sort of leadership in the financials but that looks like an overcrowded trade. What, to your mind are going to be the next levers of growth if this indeed, bull market continues?

Damani: This has been a story of India entering the middleclass. So the consumption will be a large driver, but you slice it in different ways. We are looking, for example, at fast-food restaurants because we feel they will be not exposed to technological risks that a lot of other sectors like auto, auto ancillary might be exposed to. But it is harder, nothing is very cheap.

So, you just have to either forego one or two years of earnings or you just have to wait till the market corrects to the point that you are comfortable buying this. But having said that, I am already 97 percent invested, so there is very little latitude to go out and buy a completely new idea or a new sector.

Q: You look at disruptions quite closely because of your global understanding and all. In fact you have raised some queries as well with the kids who presented on certain sectors. To your mind, which are the big sectors where you are going to see a massive disruption because of technology?

Damani: Clearly the one that worries me or keeps me up at night is the end of oil. If, for example, we are going to move to electric vehicles, the entire complex after World War II built on oil, oil refining, auto, auto ancillaries is a threat. Insurance is a threat, infrastructure is a threat. So, there have been lots of changes. Once when the rupee depreciated, once when India rose in technology.

So this is a very major shift coming in how we invest globally in the world. So that is what keeps me up at night. I really believe that the days of the internal combustion engine are waning and the days of the electric vehicle and the autonomous vehicle are rising and investors probably need to start thinking about aligning the portfolios with that trend.

Q: You have been riding this good rally in the oil marketing companies (OMC) for the last couple of years. With the kind of risk coming up from electric vehicles, are you going to change your view on the OMCs?

Agrawal: One of the things what happens is that yes, this innovation is one our head. It might be 5, 7, 10 years ahead and what happens is that a lot of investments in the old economy that gets deferred or gets completely killed, say upstream investment, exploration or the entire refining and petchem and all, people will say that oil is dead so I will not invest.

But, if by chance the mass customisation of innovation takes 15 years, what will you do between now and 15 years? So, my sense is that is an opportunity right now and say oil companies like HPCL, BPCL, IOC or a lot of these, even component companies, ancillary companies. I think we reading too early. The innovation is going to hit us, but I think it is too early. There is a lot of, 10-15 years ahead for the conventional technologies.

And the current leaders of the conventional technologies, they would also be coming back with the newer products with new innovation. So it is not that they are not aware of what is happening.

Damani: Typically does not happen, I will tell you because these guys get all the profit from the conventional technologies and they do not have the heart to put it in new technologies. Look what happened to Kodak. It is not they did not understand instant photography, but they never moved into that ph0otography that Nokia and Apple moved into. So, typically the old guys have ostrich like attitude towards that. There will be exciting opportunities, right. Of course, it takes time. I am not saying it is going to happen tomorrow. It will take time out there. But clearly you start. If you want to build a portfolio in the next 10 years, you have to start thinking about these things.

Q: To your mind, what could be the big disruptor over the next few years which can hit a lot of the Indian companies?

Sheth: There are multiple disruptions that are taking place across multiple sectors. What I would like to focus on is the fact that – Joseph Schumpeter said theory of creative destruction – we are all focused on where is the next creation. We should be equally focused on where is the next destruction. And the terminal value gets compromised much earlier than earnings get compromised. So, when Raamdeo was saying, we will still take 15 years and that is an opportunity, I am sure he is right about that, but maybe the terminal value of those companies will get compromised much earlier and the earnings will still continue.

Q: One thing that worries a lot of investors is the whole banking issue, the non-performing asset (NPA) issue within the banks. In fact, SEBI actually withdrew that instruction of one day, one rupee, default. What is your view on the banking sector and do you think there are real options available to resolve this whole NPA crisis?

Sheth: There are real options available but all of them are tough and painful and we, as a country, have to decide on that. It can be a matter of slow displacement like how the BSNL and MTNLs of the world got displaced by the private telecom sector, we could have something similar. Or we could have a one-time large correction and that is the decision to be taken by the government. But it is a serious concern for the economy as a whole.

Q: 11,000 on the Nifty first or 9,000 on the Nifty first?

Damani: Probably 9,000.

Q: Banking sector or non-banking sector right now to invest?

Agrawal: Banking sector.

Q: Bigger risk coming from global markets or bigger risk coming from domestic markets at least in the near-term?

Sheth: Domestic markets in the near-term.
first published: Oct 3, 2017 12:41 pm