We saw a massive selloff in April, May and June. After that, we have seen a monster rally. Do you think it was crushed on both the sides – first the decline and now the rise?
Let me just start with the perspective of how we look at where we are in this whole market cycle. We believe that in March 2020, we reached a point of real maximum pessimism when Nifty was falling 1000 points a day when the shutdown was announced. Actually we made a bottom a day after that but that was the time when it was complete chaos and people had no idea how the economy was going to pan out.
Since then, because of the structural and cyclical factors, we have started a new bull market and in my opinion, whatever happened in the last 9 to 12 months is more of a cyclical or a corrective phase rather than bear markets starting. If one has to have that view, then it was only a matter of time before we resume the uptrend again and we have pretty much started on that uptrend.
Your birthday comes once in a year but correction can come more than once in a year!
Yes, yes. A 5% market fall is a dip; a 10% to 20% is a correction and more than 20% is not a bear market in my opinion. There were genuine headwinds, there was war, there was inflation, there was interest rate rising so enough reason to be concerned and some amount of valuation correction was required.
At the same time all these macro headwinds are going to lead to some kind of a margin impact, some kind of profit impact but nothing is going to really impact the balance sheets of Indian corporate or the Indian government’s balance sheet. So the balance sheets are strong and if that was to be the case, once these headwinds recede whether it is the inflation or whether it is margin impact due to this inflation, the growth trend will start again.
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We have yet to witness an up cycle. The housing cycle is just beginning. It is probably 12-18 months that we are into a housing cycle. Credit growth cycle is just beginning. None of the corporates are really leveraged. So leverage is at an all low. If that is the case, then how can we possibly enter into a recession or any kind of a downturn which can last for a long period of time? That is where I am coming from. This was a correction, we have corrected, we have shown fantastic resilience in that correction.
We are almost flat for the year. Now whatever could go wrong has gone wrong this year – inflation, war, crude, central bank, FII selling.
I had told you earlier also that in October last year or midyear if one had the foresight to know that all this is going to happen, one would have still been wrong on the market. I mean you have got all the macro factors right and yet be wrong on the market. So market is telling us something – that these factors are temporary hiccups. Anything that could have gone wrong, has gone wrong and we are where we are. So just to put things in perspective, we had $35 billion of FII outflows. $35 billion is almost 2.5 times what the selling was and the global financial crisis.
When the world was melting…
When the world was melting when we really were staring into an abyss and we had no idea tomorrow which country will survive, which central bank is going to say okay you know we do not know what is happening? Those were the times where you really could not foresee what is happening. So that kind of a phase and that $15 billion led to 65-70% fall in the Indian market. This time around, a $35 billion selloff led to 17-18% at its peak in terms of FII selling. In terms of their own holding, we were close to 5%. In terms of India’s market cap selling, it was 1%.
So, in all parameters, we could see that FIIs had taken the money off the table as much as they could if not more and despite that, the strong domestic flows absorbed everything. The domestic story continues to be strong even right now. Of course, in the quarterly numbers, there is a margin impact but I do not think there is such a big growth scare; in fact just the opposite. Growth remains strong and there is a lot of possibility of operating leverage kicking in and taking care of some of the margin impact along the way.
The headwinds are real and some are structural. Some of the headwinds are so strong unlike anything ever seen before. The US inflation is at 40-year high, war in Ukraine, commodity prices, mean reversion happening in other asset classes, we cannot be dismissive about them?
I do not think we should be dismissive but at the same time we should be a little bit more nuanced. What is probably structural for the US might not be structural for India. For example, the inflation that you mentioned, a lot of it is driven by home prices and wages in the US while over here it is driven by food and commodities. Already we have seen that the commodities have cooled off more than 30% from the peak, even fuel for that matter is coming down.
In my opinion, the inflation over here is far less structural than it is in the US. Also, most of the time, we have to look at the point from which the whole factor is panning out. In the US, the corporate profit to GDP has gone to 11-12% and that is an all-time high. When valuations are based on profitability which cannot sustain, then obviously the valuations will correct far more.
For us, the corporate profit to GDP cycle has just turned in the last 18 months. The profits are at a high since the last 18 months but the capex cycle has not yet picked up. So companies are making profits, generating cash flows, capex is at a low and capacity utilisations are rising. Now the companies are going to be spending money to do capex to enhance their capacity because they have the comfort of sustaining demand. I would say that these structural factors are more so for the developed markets or maybe US and Europe specifically and not so much for Indian markets. That is why India has shown this kind of resilience.
Anti Fragile India in a Fragile World, it is available on your website?
Yes, of course, it is available.
The last time when we were at 17,500 was the end of 2021. The lay of the land was different, it was all about digital; fintech companies were going public, metal stocks were at a record high. We are back at 17,500 but the market setting is very different. It is banks, autos, cyclicals. What are markets telling you?
We have also changed our portfolio accordingly. We have also changed away from IT, IT platforms, pharma, chemicals, sectors.
You are saying you have sold pharma?
No, we are underweight. We still continue to hold pharma. But what I was trying to say is that those were beneficiaries of a short term cycle. We realised that along the way. Covid led to a lot of sugar rush. There was a period when most businesses could not fulfill the demand and so they went on an overdrive and stocked up more and now those demand drivers are gone and suddenly they are seeing themselves stuck with an inventory.
In IT also, a lot of it was driven by the US digital boom, now obviously there is a real slowdown happening over there. There are layoffs happening, there is some amount of slowdown in the spend and that is going to have its second order effect on Indian IT. These were the areas where valuations were on a high and so the market was assigning high valuation multiple to profits that possibly could not sustain at least in the next one, two years. Maybe a structural theme can again come back a couple of years down the line but at this point, it is not clear whether the structural demand will sustain and hence those areas are now out of favour.
Obviously with the market cycle, fund managers tend to over allocate to performing sectors. That is why they are going to be underperforming in my opinion for the next one, two years. While on the other hand, spaces like auto, engineering, capital goods, financials were the ones where suddenly the market realised that everybody is underweight and things are changing for the better, the domestic cyclical economy is picking up and is resilient in the face of this macro headwind.
Hence this initial set of reallocation towards this sector has happened, some amount of rally has happened but I do not think the cycle has completely panned out. We are looking at a good two, three years of up cycle in these sectors.
Post Covid, if 70% of your allocation was global, now is it the other way around?
Yes, I mean I do not know the percentages exactly but yes broadly we have…
Heart of the portfolio is now domestic?
Pharma I understand that generic prices are under pressure. The US FDA audits are stringent plus there are inventory losses. It is a business cycle which has gone haywire. But why IT? These companies are still committing to double digit growth? They still have attrition issues which obviously mean demand is there
I disagree over one thing that IT is a very predictable business. IT is not a predictable business. IT is the only sector that gives quarterly guidance, no other sector gives quarterly guidance. Even sometimes IT companies come mid quarter and revise their guidance down.
QSQT like I call it, quarter se quarter tak…
And that just tells you that they do not know what their next quarter is going to be. While IT is a great sector and eventually I expect it to do well, there had come a point where the valuation has gone from rock bottom in 2018 to a high of 25-30 times multiple. It is a sector that still struggles to grow beyond 15% and where we have no idea what the next quarter’s growth is going to be and, of course, which is facing margin pressure due to 25-30% attrition. Those are the reasons why we have stayed away from IT.
Has consumer tech or fintech or the new tech become attractive again? management yesterday used the word path to profitability at least five times in five minutes!
So that realisation has dawned on all these tech companies that funding is not going to be easy going forward and they have to move to a business model that is sustainable. The days of land grab in terms of just take as much market share as you can on investors’ money and then figure out along the way how you are going to get profitable are probably over or maybe the beginning of that phase is over.
Going forward, I would still be keen on getting in with a five-year view in companies where the unit economics are in place and where capital requirement is on the lower side.
Have you added anything there?
No we have not, valuations have become attractive but not so attractive yes in our opinion.
Define your attractive, Zomato’s market cap is gone. The stock has gone from Rs 160 to Rs 40. What is attractive then?
If stock price goes from Rs 40 to Rs 20, it can still be expensive. The path to profitability needs to be demonstrated. There has to be a sense that there will only going to be two players and there will not be any further competition coming in, the margin pressure will ease and it is going to be focus on profitability. It has to be demonstrated.
So price might have fallen but previously in these companies the benchmark for prices were essentially the rounds done by previous private equity players. But that is not an exact science. You can be wrong. Most of the people are realising that now that IPO prices happen at very high valuations and one needs to be very careful in assigning valuation. I would say things are not yet very clear and so I will hold back on adding to these names. Overall I am not bearish on this space any more. I will look for opportunities.
You look at companies with three- to five-year timeframe, companies which are on inflection point, market share gain or the business inflection. Where are those points?
Auto and auto ancillaries is one such space…
What do you like within auto and auto ancillaries?
So whether it is PV, two-wheeler or commercial vehicles. Our order of preference is commercial vehicles, PV and then two-wheelers in auto. We believe that the last four-five years have been really bad for commercial vehicle cycles and right now the numbers are rock bottom. So the leading indicators are pointing to the fact that the CV cycle is going to revive.