Financials, Industrials And Consumer Discretionary To Lead Next Leg Of Rally: Ridham Desai

India is not trading at peak valuations, India is just trading above historical averages, if you use PE or price to book as a metric on absolute basis. Where it is trading close to peak is on a relative basis. Essentially because the EM (emerging markets) multiples have come down. To illustrate this point, in December 2007, India was trading at twice the EM multiples but then India was trading at six times more. The EM multiple was three. Today India is again trading at twice the EM multiple but India is itself trading at three times more. So it’s actually half the level of 2007. That’s because the EM multiple has gone down to 1.5 and India is still trading back to those levels. So if you look at the relative price to book chart, this is we were trading at the end of 07 and this is what happened in 2008. So that’s the clarification on that. The upside to any asset with a twelve-month view or a six-month view has to be seen in a relative context of what’s happening in other parts of the world. Because on a short term basis assets don’t do their own thing. Of course, over the long term there will be a stock that’ll give you very generous returns, and there’ll be another stock that’ll give you very poor returns, the index return will be somewhere in the middle. There will be a large spread there. But in the near term, it’s very rare to get that, especially on an index. So this index upside has to be seen in the context of what we’re saying of the emerging market as a whole. Say, the emerging market index is at a 10 percent downside so the fact that India is a 5 percent upside, it’ll represent a much better return than what we expect for EM as an asset class.So India is still our second largest overweight position in the EM portfolio. Generally speaking we are bullish. That said I think the market is getting a little bit stretched. We published yesterday evening that the factors that favour the market and that are against the market on a near term basis seem to be balanced. So, as a risk management strategy, for those who do six-month or twelve-month stuff, like a lot of my clients are concerned about the near term calls it is not a bad thing to take a little bit of money off the table and wait for the market to come down. Now this is very different from what long term investors should do. They should not bother about these things. But building a cash reserve is always a good strategy, in any market because you always want to be in a position to take advantages of opportunities that come by. if you’re fully invested all the time, then you never get that opportunity, but tactially, I feel the market looks a little bit overheated and therefore is vulnerable to a correction, so, you need to manage risk a bit more astutely. Six months ago it was the absolute opposite of this situation, as share prices were oversold and you needed to back up the truck and buy stocks. Today, I think you need to take the truck back into the garage and keep it parked there. Or, at least start moving towards the garage.

Let us first separate the India story from the global story. I think India is on a structural upward path. The next 10-15 years are likely to be a golden period for India. So anybody who doesn’t want equities will massively regret this hindsight. The younger you are, the more equities you should have. If you’re in your twenties, hundred percent or 90 percent of your portfolio should be equities. If you’re in your sixties, obviously that number will be lower, because you need cash more often. In equities, you don’t want to be a forced seller. So I think it’s a golden period. If 2003-2009 was the mother of all bull markets, I call this the grandmother of all bull markets. And we’re just at the beginning. So we’ve really not seen the movie as yet, it’s happening right now. Of course, that doesn’t mean that bull markets don’t go through corrections, sometimes there are really vicious corrections. I recall the one that happened in 2004 when markets fell 30 percent in two months. And if you’re in the middle of such a correction, it can get very unnerving. So for retail investors, the best strategy is to systematically invest money every month and not worry about the index and not worry about stocks. Institutional investors will take it a bit more actively, which is their job, which is their profession. You know there has to be a distinction here. So when I say, yeah, you have to manage risk better that is more an advisory to institutional investors rather than retail investors who are not necessarily equipped to do that. And they should not even bother, they have a day job to do, this is not their day job. Institutional investors do this as a day job, as well as I do. So, the India story, I think, is looking very strong. The global story is not looking so clear. I think it’s very muddy out there. This liquidity thing is not going to last forever and it would end a bit more poorly than what is being priced into asset classes right now. And that will act as a headwind for India at various points in time. How to time these things? We may be at such a moment right now. There is confusion about monetary policy. At some point, some policy maker makes a mistake and asset prices come down. India will bear part of that correction and then we’ll move on. But I think we are in a secure bull market and we’re at the beginning of it. So you’ve got to take a 10-15 year view on it and invest.

So the next leg may be down, so that is not going to be a rally. So the question is what time frame are we talking about.

If you take a long-term view, I think you need to invest in India as soon as you can. It is the brightest spot in the world right now, without ambiguity. The Indian consumer is sitting on a very strong balance sheet. They’re sitting on an inflection point in income and the combination is quite powerful. So let me explain that to you. India’s household debt to GDP is just 13 percent. If you take out mortgage, that is the debt to buy houses, the remaining is just 2.5 percent of GDP. For India’s per capita income, that’s the lowest in the world. This 2.5 percent can go to 25 percent in the next 10-15 years. What it’ll do is, it will produce a surprise on the consumption side because ordinarily when we make a forecast on consumption we plot the income and then match the consumption along with the income. But, if you’re leveraging your balance sheet, the consumption actually runs ahead of the income. Debt is nothing but borrowing from the future. So this current generation of Indians I feel, culturally, is set to borrow from its future. My generation did not. My father’s generation did not, I have not, which is why we are sitting on very low debt. But, the current generation is not going to be averse to borrowing from its future. Eventually, it will all end in tears but that is really far away. We are somewhere where the U.S. was in the 1970s. It took 40 years for America to end up in its current situation. Which is also not so bad, because they’ve lifted their quality of life and their living standards by borrowing from the future. Just that cycle in India is likely to go through in the next 30-40 years. So I think the consumer will lead it. Financials, therefore will be a beneficiary as well. When households are growing their balance sheets, financials will benefit. These two sectors are obvious. You can see that in the marketplace right now. There are some crazy bids out there in both these sectors. Tactically, I think these sectors look a little overdone, overbooked. So there could be a bit of a correction. You know those corrections will happen but structurally the story is very good. These are the two sectors you want to buy. I think, in part, industrials could do well, it’s a purely domestic sector. India, I think, will invest quite handsomely in infrastructure. This government is very focused about it. Already I am sensing that next year, infrastructure spending as a percentage of GDP will be four times high. We’ve done a lot of groundwork in the last two years so the infrastructure expenditure is going up quickly. So industrials will benefit. Other sectors that are globally oriented like technology, those are outside my focus right now because it depends on what happens globally. In the last six months technology has bore the brunt of the sectoral adjustments that’ve happened. Discretionaries are up, financials are up, tech is down. So, tactically you may want to rotate. But structurally I think you still want to be in discretionary, consumption and financials.

In the consumer staples, the challenge is the valuations. Stocks are not cheap and the growth to come in the future is already priced in. But if you are a really long-term investor, it would not matter. It would matter if you look at it from a 2-3 year perspective.

Keeping aside some of the business dynamics and the challenges that arise owing to disruptions that are happening there in say technology, assuming they are managed by the respective companies, from a sectoral perspective, I would be bullish in these sectors for the simple reason that when I am leveraging my balance sheet, I am borrowing from the future so I use that money to buy a house, to furnish it, to buy a car, that spares me income to buy other things. So consumption down the curve starts improving so you will find more Indians visiting restaurants, consuming media and other discretionary stocks which will gain share. There’s another way of looking at it. Twenty years ago, 65 percent of our consumption basket was food because we were really poor as a nation. Now as we get richer, the share of food will go down so it will release a lot of income. Now think about entertainment, today it is 1 percent of our consumption. Can it go to 2 percent? That is not a very tall ask. If the share of spending on entertainment doubles in the next 10 years and nominal income growth is at 10-11 percent, you are talking about 20 percent growth in that sector. So we will see a lot of sub-sectors doing that because they will gain share in the consumption part.

Are you talking about household income? Well the job creation has actually gone up and I think the error that people make is that they evaluate this from a manufacturing sector point of view and the manufacturing sector is less than 25 percent of India’s economy. Sixty percent of India’s economy is services. Look around in your office and count the number of people which have gone up in the last 6 months and you will know what I’m talking about. Anybody who is in the services sector is hiring.

When they get to their best, it will be over. So we have a long way to go.

Their structural story is playing out. Hitherto these companies were not in control of their earnings. Their earnings were determined by the government. So these companies came to know about their earnings after the quarter ended. Imagine you run a business where you are not in charge of your earnings. A third party decides how much you will earn and that is at the end of the quarter. But there is a catharsis that has happened. These companies are fully in charge of their earnings and it is not fully priced in because the market still adjusting to that. One of the inefficiencies of the market is that there is still scepticism that the government may come back and take charge of this again. So the market is still very reluctantly valuing these companies earnings because they are still not confident if these earnings are for real.

I think that is the moment to buy stocks...when people don’t like them because when everybody likes everything then there is very little upside left. I go wrong very often. I have to say that. This afternoon I was on my London sales call. They said you are making a tactical call and you know it is so hard to call bottoms and tops right? I said yes I know. The better thing for you to do is toss a coin and then decide. Tossing a coin generally beats my record so keep that in mind. But yes when a sector is beaten down and hated, it is usually a better time to buy. 80-20 I may be wrong if this is one of those 20 percent occasions when it doesn’t work.

No, investors. Traders are only faced with greed and fear. So here is a good example in tech. Everyone is fearful. There is a structural collapse coming in profits and incomes and there is greed in financials and the consumer space. In contrast, investors face envy and boredom. So there is an itchiness to act almost on a daily basis. So we’ve got to prevent that. Envy is there because the guy next door has made more money and that prompts you to do something and the lesser you do on your portfolio, the more money you make. If you act often then you lose money. See, where have all the money that investors have made, come from? It’s come from all the money that traders have lost. The more you trade, the more you lose, investors make that money.

This subject is challenging to cover in this show. But investors should be more aware of not getting carried away and not get frozen in the moment and not get envious and not get bored. If we can deal with these four emotions, then we can probably end up being more successful.

We should have closed out our underweight on materials. I was looking at it and it was the tech moment. Materials were in a ‘tech’ moment 8-9 months ago. Everything was sloshed and people were so bearish. And I just looked and looked and didn’t do anything.

Charlie Munger calls it a multi-disciplinary approach. I am a Munger fan, less of a Musk fan. All successful people have a multi-disciplinary approach to life. So we should all know a little bit about physics, history, psychology, mathematics and we will get better at whatever we do in life.

There is an element of discipline that comes from pursuing fitness which I think is very crucial in stock markets. So that’s certainly one area of application. You can be a disciplined investor and then you can use it to be a disciplined person in terms of eating and fitness habits and vice versa.

When you buy a business, if you are using that product, then it’s very easy to understand it and buy it. This is a highly misunderstood concept. Just because I do something doesn’t mean the business is good. It has to be evaluated separately and what people don’t pay attention to is the price. It is a very important ingredient. If you overpay for a business, you could go through years of zero returns. In the long run, it overcomes the disadvantage but for five years or seven years, you may just see no returns and then you have to be patient.

Micheal Mauboussin writes a lot about this subject. He delves into this to explain the differentiation. How do you judge how much luck is required in a particular role? So think about a job in which you can fail easily. Think about a carpenter who has to make a table. It’s very easy for him to fail deliberately. He’ll just cut one leg short. The table can’t stand. He has failed. So 100 percent skill. Because he’s in complete control of the failure of his job. Now think about Sachin Tendulkar batting. He wants to get out on the next ball. He can try to drop a catch, he can try to get run-out but it is not necessary that he will get out. He’s trying to get run-out, he’s stranding in the middle of the pitch but the fielder throws the ball across and it crosses the boundary. So 30 percent luck, 70 percent skill. It’s still a pretty high proportion of skill Now think about stock markets. You can do this experiment in the office. Ask people here to lose money on ten stocks in six months. You will be surprised that 90 percent of the people who were trying to lose money end up making money on those stocks. So you can’t lose deliberately. There is a very large role of luck particularly if you are looking at it from the market perspective. If you look at it from a long-term perspective, then you can take the luck factor out of it or you can reduce its effect. But in six or twelve months’ time, you are generally governed by luck because you can’t deliberately fail.