Market has rallied a lot from February lows and it is normal to see a correction of 7-8 percent after a big run feels Shankar Sharma of First Global speaking to CNBC-TV18 on a day when the Nifty slipped below the key resistance level of 8,750.
Market has rallied a lot from February lows and it is normal to see a correction of 7-8 percent after a big run feels Shankar Sharma, Vice-Chairman and Joint MD of First Global. He was speaking to CNBC-TV18 on a day when the Nifty slipped below the key resistance level of 8,750.
Sharma believes the emerging markets down cycle bottomed out in February and the next few years look very good for these markets on a relative basis.
While growth for large caps look tepid, he expects mid caps and small caps to outperform as they typically grow lot faster than large caps.
He also shared his expectations on the Reserve Bank of India’s likely policy stance as the new Governor presents his first monetary policy in October. He also shared his outlook on non-banking finance companies and information technology stocks.
Below is the transcript of Shankar Sharma’s interview to Anuj Singhal and Sonia Shenoy on CNBC-TV18.
Anuj: What is your sense? We have had a big global bull market. Are you sensing some kind of speed breaks or is this just profit taking or do you expect things to turn a bit more volatile from here on?
A: Markets from February lows have rallied a lot. If you look at emerging markets in dollar terms, they are up 35-40 percent from the lows February. So, when you have that kind of rally in 4-5 month period then it is a normal glitch that a 3-5 percent even a 7-8 percent kind of correction. I do not think we have achieved even that much so far. We have seen probably a 4 percent correction in the last one month or so which is not a lot when you have rallied 40 percent. I do not think we should get too worried about seeing these small bouts of the downtrend in markets which have rallied quite sharply.
Sonia: The benchmark emerging market index has seen almost a 15 percent growth year-to-date and the numbers look exceptionally good, more than USD 9 billion pumped in recently. Do you see substantial scope for further emerging market inflows?
A: Yes, my view is that the emerging market, bear market started in 2010 or thereabouts and the US, the relative bear market ended then. So, if you see the last five years from 2010, US has been an absolute massive outperformer, while emerging markets have been absolute disasters. That cycle, in my view, bottomed in February, 2016, just 4-5 months back.
From that point, my belief changed that the emerging market bottoms have been made on a relative basis and that the next few years look very good for emerging markets on a relative basis.
At that point again, oil was about USD 27-28 per barrel, so commodity cycle also bottomed out in February. The emerging market cycle which is closely co-related to the commodity cycle also bottomed out and from there you see emerging markets have been steadily outperforming the global indices. So, my call is that the bottoming of emerging markets happened January-February this year and for the next 1-2 years I see sustained upmove on a relative basis in emerging markets. So, the bear market for emerging markets ended earlier this year.
Anuj: One of your big calls has been that we are in for a big bull market in the Indian midcap and smallcaps. That started as a stealth bull market, but as we discussed, even in our unplugged show, you said that it is now getting more prominent. Do you see more midcap outperformance and smallcap out performance for Indian stocks as we move into 2017?
A: I have said this in the last two years that the single best equity class in the world is Indian smallcaps and so far that view has been vindicated. Even if you see a day like today, mainline indices are down 1-2 percent, while midcaps are down about half a percent and quite a few of them are actually up. We are seeing this pattern consistently for the last two years. Even when markets fall, when typically midcaps or smallcaps should fall more because they are supposedly more volatile, they actually do not fall as much. So, that is itself telling you the inherent strength in this class that they fall a lot less and then they bounce back a lot quicker than the largecaps do. So, my belief is in that, smallcaps in India are just a terrific area to be in and across sectors they have done phenomenally well.
I know there is a lot of scepticism generally about smallcaps and if you talk to big asset managers in India, it has changed a little bit now, but for the last two years I have only heard that it is a bubble and valuations are too high and unsustainable. I think that is a very shallow way of looking at midcaps and smallcaps.
The number of them have had big balance sheet restructurings or big cost restructurings. Their return on equities (ROE) are decidedly superior to that of the larger cap companies. Also because they are smaller, by very definition they are able to grow a lot faster than the largecaps. So, while largecaps have been struggling for growth on a broad basis because the economy has been very tepid, smallcaps have been finding growth in their niches whether it is in a regional niche or an export niche or whatever it might be. So, I see no reason why midcaps or smallcaps in particular should not trade at a premium to largecaps. I am very optimistic on the smallcap space.
Sonia: I wanted to complete the argument on the emerging market view. Another key theme that is playing out globally in emerging markets is the cyclical improvement supported by monetary and fiscal stimulus. We saw it with China, we saw it with Indonesia with a cutting of rates. In that context, how important is the first RBI policy by the new governor on October 4 and do you expect a dovish stance. If there is a rate cut, do you think the market could rally further or it does not make a difference because this market is rallying purely on liquidity?
A: This market is rallying on two factors. Number one factor is, as I just mentioned a minute back, it is running on the back of very strong performance by the small and midcap companies which is kind of providing a floor to the largecaps who are not looking very good in my view, they are looking tepid. But, just because the underlying bedrock of the market, the smallcaps have been generally very buoyant.
It is hard to see that largecaps will be negative when smallcaps are that much positive. So, it could only be that if smallcaps are up 15 percent, largecaps might be up 5 percent but they will not be down 15 percent. Small caps are actually driving, in some sense, the performance of the largecaps, that is one. The larger reason why India has been okay, has been good is and I have made this case repeatedly in the last two years is basically, India has a cost of capital. Our cost of capital is measured through the lens of bond yields, and they have been too high. When the world is looking at zero percent yields and negative yields, India was at 8 percent which is a huge outlier and the currency being stable, that is too much of an arbitrage and that arbitrage has to be closed.
So now bond yields are down to about 7 percent or even lower. That itself is providing a floor to this market. So I do not think earnings growth numbers will be anywhere close to what the market experts or other brokers expect. For the last three years we have seen every year starting with a 17 percent forecast and ending with anything between zero percent and 5 percent in reality.
I don't think it is will be very markedly different this year. But market still does not reflect that missing of estimates consistently because bond yields are headed lower. So, there are only two reasons why market goes up. One is that growth is good, second is that the cost of capital declines.
In India growth is tepid, cost of capital measured through 10-year bond yields has declined to 7 or below 7 percent and that is the reason why India has been looking very good. In fact that is the reason why global equities has done well since the crisis of 2008.
It is not as though great gross domestic product (GDP) growth or great earnings growth will materialise anywhere in the world. But yes, fine there was no growth but on the other hand, central banks ensured that cost of capital or the discount rate themselves came down so low that even small growth looks very good in present value terms because the discount rate has actually come down. India is coming out in something of that fashion where growth is tepid but the discount rate has now come down or is now coming down consistently which is making even moderate earnings growth look good in present value terms.
Anuj: We have the new RBI governor in place now and indications are that a couple of brokerage houses have already called for a 50-100 bps rate cut. Do you see that playing out and do you see that being the next trigger for the bull market. In the past you have been a big critic of RBI keeping rates at higher levels. But if we have a series of rate cuts do you see that as a big trigger for equity markets?
A: Obviously, if you cut rates you will have strong equity markets. It is clear equilibrium in a seesaw in which one end you have interest rates and other side you have stock markets.
My view on the RBI's policy in the past has been simply that they are making policy without data. So, they are making rate policies which is monetary policy based on an assumption that by doing you are going to affect inflation. But if you looked at the inflation basket and see the interest rate sensitivity of each of the component of inflation basket I find no correlation. We have done this exercise, I find nothing.
Broadly on the basis that if I tighten rates or if I tighten monetary policy inflation will come down, that is what the US works on and maybe the developed economies work on but we are nowhere even close to that in terms of interest rates affecting your inflation basket. So, I don't know on what basis the past two RBI governors have made rate policy decision, right from Mr Subbarao to Mr Raghuram Rajan and I have argued this publically that I have to make decisions based on data and that data definitely doesn't support any kind of rate tightening of the kind that we have seen in the past.
I don't know how the new governor will look at it. My sense is that while the public persona is that he is hawkish, I don't think he got the job because of that. He got the job because there is a classic understanding that look, you will not follow the same policy that the previous RBI governors followed. If one were to read between that, my view is that I don't know whether you will get 100 bps but you will definitely get to see rate cuts in the course of next 12 months time.
Bear in mind one simple thing also that the only time in the last 16 years we had a really rock solid bull market was between 2004 and 2007 and look at where bond yields were then. They were at about 4.5 percent if I have not mistaken. The market compounded was 60 percent in three years, something like that. That is the central point, that if your yields come down to 5 percent or thereabout this market is going to go through the roof, without any doubt.
What is going to prevent that sharp rate cut would have been not just inflation outlook or whatever but also the fact that a large part of India depends on fixed income for their daily living. So, pensioners or retirees or even salaried people, therefore they put money in banks and earn a 6-9 percent rather than speculate in stock markets. That is a problem, that if you cut rates too much then that affects your saving potential and people's income that comes out of the saving. So, unlike the west where they have taken it to zero and people have no option but to speculate in stock markets. I don't think India should go that far out and cut it to a level when you are just unable to take any reasonable return on fixed income portfolios in India. That is going to be a policy challenge in my view.
Sonia: You said that you are bullish on midcaps and small caps and the spaces to be in this year, have undoubtedly been the agri stocks, the tractor makers, the auto ancillaries, the NBFCs in the mid and small cap brackets. Are these spaces that you would still back?
A: Yes, as I said midcaps are of variety of use and they are hard to kind of categorise within a particular sector many of them but NBFCs I have always believed that NBFC boom keeps coming every few years and the previous players have been wiped out. New set of players come and for the first two three years of your loan book you look very good because you are lending at high rates and people who are borrowing at high rates, almost inevitably can't pay but for first three years your earnings look good because nobody takes a loan today and defaults tomorrow. It will be three years before they start to go bad. So, for those 2-3 years it was exactly like that in sub-prime. The first 2-3 years of a sub-prime loan they all looked good because you had booked a large part of the income upfront in your books. So, you are stretched for the next 12-14 quarters. When they started to turn bad is four years later. At that time you have got your bonus, you got your market cap, you sold some stock and you are home and dry.
NBFC boom - individual companies here or there will do well but at an aggregate I find this business to be clearly something which is not a sensible business. But it is a boon right now and I find marginal players also now jumping into the game. Corporate groups keep jumping into the game every 5-6 years. It started in 1984 with the leasing boom and it has continued every four-five years. People wipe out their net worth, the next set of guys come and they say that I will do it differently. So, it is a good short term play, I don't think it is a five year or ten year play. Within that you will find some good companies here and there. If you want to take that risk by all means do it.
Anuj: Your big call which worked out beautifully this year was IT is going through a problem that it will not be able to overcome. We have Infosys now at 52 week low, TCS practically there. There is one way of looking at these stocks now in terms of valuation parameters is that they have now become attractive, would you avoid that temptation even at these levels, would you still completely avoid the Indian IT stocks?
A: I am not a big fan of valuations, I am a big fan of momentum. I look at valuations only at extreme points, when something looks extremely cheap and extremely expensive. I think the existing stocks are somewhere in kind of a twilight zone, you can argue both sides whether they are expensive or cheap. My view is that the momentum is totally against them.
There is nothing unusual about our IT pack seeing where they are. It is nothing to do with them per se. They are terrific performers, terrific companies but every company gets disrupted. I think they are getting disrupted whether they like it or not. It is unfortunate but that is the order of nature, it is nothing to do with individual managements. It is just that technology being what it is, it can disrupt anybody. Right now it has chosen to disrupt our IT players. I am not too optimistic on the outlook for these companies.