S Naren Explains How To Survive The ‘Central Bank Bull Market’ Climax
A bull statue stands outside the Frankfurt Stock Exchange, right, in Frankfurt, Germany. (Photographer: Ralph Orlowski/Bloomberg)

S Naren Explains How To Survive The ‘Central Bank Bull Market’ Climax

Central banks across the globe pumped in more than $28 trillion when debt, equity and commodities markets crashed in March after the coronavirus outbreak. That, according to S Naren, gave rise to a ‘central bank bull cycle’, something most fund managers haven’t experienced in their lifetimes. And he said it will reach a climax.

The entire amount so far has gone into assets, leading to asset inflation which makes everyone feel rich and happy, said the executive director and chief investment officer at ICICI Prudential Mutual Fund, which had average assets under management of Rs 3.6 lakh crore in the July-September period. At some point in the future, that money will seep into prices and cause price inflation, he told Bloombergquint’s Niraj Shah in an interview. “When this $28 trillion finally moves into price inflation from asset inflation, then the day of reckoning will come.”

Indian fund managers, however, are likely to be victims of the event. “That day of reckoning can’t be predicted by Indian fund managers because we are not at the apex of all this to even know what is happening,” he said. Manoeuvring the event, according to Naren, will be “complicated” for them. While the past few years have seen markets narrow, the current bull cycle will seep into the broader market, taking all stock prices higher, he said.

Individual investors can survive this using disciplined asset allocation, he said. Diversified holdings in equity, debt and gold are key in a central bank bull market and investors shouldn’t “get drunk on leverage and think this bull market will go on forever”, he said. If an investor is caught in only one asset class when the inflation turns, they will be in trouble.

No one is saying the climax will happen in the next one, two or three months because none of us in India know when it will happen and that is the reality.
S Naren, Executive Director & Chief Investment Officer, ICICI Prudential Mutual Fund

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Biden’s Victory Boon

Joe Biden’s victory in the U.S. presidential elections will bode well for emerging markets and consequently India, Naren said. He expects the dollar to continue depreciating under his government, which will lead to higher fund flows.

The president elect’s stance on clean energy, Iran and skilled immigration are all likely to be in favour of India, with the added comfort of more geopolitical stability compared to his predecessor.

Overall, the current global climate is healthy, according to Naren. Also, the bull market climax, the only major risk according to him, is not a near-term event. In the near term, “the debate and problems are only coming out of valuations, not out of trends”, he said.

Watch the full conversation here:

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Here are some edited excerpts from the conversation:

You said the market rally will broaden going forward. Will it be accompanied by economic green shoots and economic growth as well because otherwise, it’s the larger ones taking the market from the smaller ones and therefore they are growing. For the smaller ones to be able to do well have some bit of the economic growth should happen. So, do you recommend that will happen in India, in the next 6 to 12 months?

Actually, we have to look at it from an India point of view. India has not a had monetary excesses on the lines that has happened in the other parts of the world. So, when India reduced interest rates in the post-Covid environment that has given a big boost to the economy. If you look at the economic trends over the last 45 days it has been very healthy. You’ve seeing power demand go up, you’ve seen credit growth slightly pickup, you’ve seen real estate transactions go up, you’ve seen corporate numbers improve. So, I would say that India is certainly in a better position today and you’d see that economic backdrop certainly improve at this point of time.

Clearly if you look at the earning season this time it has been one of the best earning season at this point of time in years that we have watched and it’s been a very pleasant environment to see this earning season and it is of course been marked by cost cutting and indiscriminate price increases in some of the products which has led us to a very good price profits in many areas but having said that, we’ve had one of the best earning season at this point of time. So overall in India we are in the threshold maybe of an economic turnaround that should help. That’s why I would say that we are going to see clear broadening of the sectors which are going to do well. That is what we see at this point of time.

Having said that, if you look at it from the sectors which have done exceptionally well over the last 10 years, all of them are trading at 50 P/E and 60 P/E—the sectors which have done well over the last 10 years. Do they deserve to be at 50 P/E or 60 P/E or 70 P/E? That is where the jury is out but sectors which have done badly for the last 10 to 12 years. I think they have many years of a re-rating to happen because they have done badly for 10 to 12 years, so why can’t they go up for the next three four years? That is the view that we have. They have possibly only started a trend at this point of time, and I think there is a lot of scope for those sectors to improve from where they are at this point.

You play the contrarian bet very well and I’m not just using the term loosely that you play just for the heck of it. I’m sure when you play contrarian, there is a thesis that you put behind it. You just referred to the point that there are some sectors which have underperformed for 10 years and can do well. Where do you find this because I know for example over the last three years of conversations that you believed in telecom when people didn’t and they started to pay and then some of it nevertheless, because that was probably one area. From here on, where you feel that the underperformers thus far, will get rewarded because their economic scenario and the business scenario prospects are also changing?

If you look at the bulk of the sectors like in the non-consumption areas you will see that the number of players have come down. If you look at the number of players in power, look at the number of players in telecom, look at the number of players in construction, number of players in capital goods, you look at them and in all these areas, the number of players have come down and therefore the competitive intensity in many of these areas have actually come down.

So, I think banking—once the dust settles on all the moratorium and all these things settle over the next six months, if you look at the five-year view on banking, it looks very good at this point of time because many of the competition that NBFCs posed and various other things posed, they’ve also come down substantially.

So, I think there are many sectors at this point of time. If you take metals, there are no grassroot units which are likely to come up in the next three years in metals. If you look at it, you’re not going to have a situation where neither the auto industry nor the consumer durable industry can grow without metals. There are many sub sectors today, where for the last 10 to 12 years there have been no returns and no new units and consolidation. So that consolidation should lead to a situation where you’re going to see these companies and these sectors, after a 10 year zero return, they all should deliver at least decent returns over the next three years.

That is the way I look at it and because the valuations have come down, consolidation has happened, margins have come down. So, why can’t these sectors re-rate and the earnings and our margins can also go up with these sectors? So, that’s how I look at it over the next three years.

Globally also all these sectors have consolidated and many of the sectors have actually seen lower number of players and complete disinterest in these sectors over the last 10 to 12 years. So, the consolidation is not just local, it is even global. That is why I think that can happen over the next three years. If you look at aggregate market caps of many of these sectors globally, they are really low. So, for example if you go across these sectors, they’ve become a very small part of the markets globally. That is how I see it at this point of time. That is why, despite massive runs for example, despite improvement in these sectors like metals, they’re all trading at all single digit P/Es at this point of time. They’re all trading below book at this point of time. When you’re trading below book after historic low book, I mean how can you put up grassroot units unless they move to two times book or something like that, whereas many other consumptions are trading at four times to ten times book. So, I think there is a lot of scope in all these areas at this point of time.

As I said this boom ends with price inflation and they can’t end with asset inflation because of asset inflation continues forever, there can’t be new sectors. So, all these areas whether it is oil or metals a lot of them to see price inflation and it is only after that price inflation comes that the sectors will go a bit further. So that’s why I think from a cyclical point of view also they are in a good situation because finally the asset inflation will lead to price inflation. When the inflation happens like what happened between 2002 and 2007, you’re going to see a lot of profits in these sectors. That’s how I look at it at this point.

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Any implications to your mind of the change in presidency in the U.S.?

We are clearly going to see a situation where the dollar will continue to weaken which is very good for emerging markets. Emerging markets have not seen a lot of flows over a long period of time. So, we are going to see emerging market flows. We have seen a lot of problems that too, with emerging market flows and a strong dollar for a significant part of the 2008 to 2019 period.

Overall, it is a healthy development for emerging markets. While the emerging market quality stocks are not cheap, I think emerging market the value stocks and other stocks are belonging to materials, energy and various other sectors. They have got so de-rated I think there is a big boom that can happen like in 2002 to 2007 in many of these sectors which can happen. So, overall it’s a positive development and I don’t think that the global asset allocator is overweight on emerging markets. I think they are underweight emerging markets and that is the other reason why I think they can all move money into emerging markets. That will be another positive to happen in our depreciating dollar environment. So overall, it’s a reasonably healthy environment and that’s what has been seen in the last one week also.

The only challenge as I mentioned is that as and when price inflation comes global interest rates have to go up and that is the risk but that’s not a near term risk. That is as and when it plays out.

A lot of theories about Joe Biden for example brings in Iran into the global fold then it might be negative oil or he might ease restrictions on visas and that might be positive IT or he might spend on infrastructure and that will be positive for global metals. Are you trying to hypothesise on any of these because of a Joe Biden presidency?

I think overall it is positive across emerging markets for various reasons that you mentioned. There can be a clean energy trade, there can be benefit to Iran, there can be benefit due to H-1B visas, there can be benefit due to so much of geopolitical stress has also been created due to various tweets. So all these things can also happen over the next two to three years which can also lead to a lot of benefits to emerging markets. Overall, the environment is healthy at this point of time. The debate and the problems are only coming out of valuations, it is not coming out of trends. It is not coming out of trends.

The last time that we spoke you spoke about the key things that you learned which you tried to implement in your investing theory or investing sphere. Now one of them would be asset allocation and you’ve spoken about that on this show already. Anything else that strikes to you as material when we look at all that you’ve learned in your decades of learning and trying to implement them currently?

March 2020 presented such an opportunity. Let’s look at how many people made use of that opportunity in March 2020. How many people saw it as a problem and how many people saw it as an opportunity. We look at it, the reason why we started this campaign called ‘Yeh Diwali BAF Wali Campaign’ because in balanced advantage funds, we could invest over Rs 5000 crores in March and a fund which could invest Rs 5,000 crores of equity in March, and this is published data, is the kind of fund which makes a lot of sense. That is the beauty of the entire thing that our equity markets go through panics, they go through fear, they go through greed, they go through all these kinds of things. In 2013, people got consumed in real estate, in March this year people got consumed in fear in equity. The way things have shaped out today that you know on the eve of Diwali if you go across many of the places, there are people who have stopped worrying about Covid. That is the worry actually, from a government point of view, that people have stopped worrying about Covid and that is a challenge at this point of time. You can see the number of cases increasing in many of the western countries. That is the challenge in India, it’s been coming down but they’re going up in other countries.

So, I would say that everyone believes that knowledge is everything in investing, but actually knowledge is not everything. It is emotions and balance and the ability to think rationally and implement asset allocation which is interesting. So, if you look at BAF as a category, why did we create this category? Because in 2015, when China problem happened, we could buy after demonetisation when market corrected irrationally, we got an opportunity to buy. After IL&FS, the market corrected irrationally we got an opportunity to buy. When Covid happened, we got an opportunity to buy.

So, we felt that any strategy which involves buying in panic and selling when the markets keep going up, it gives investors a good investment experience and if they could do it themselves, that if they could gather the guts to buy in March, if they could gather the guts when IL&FS defaulted, they also could have made money. It’s not that they can’t do it on their own. It is just that they need that emotional balance to buy when China gets into trouble in 2015 or when Lehman is declared bankrupt or when Covid happens. That’s all that they need. So, we say that if you can do it yourself, you can do it yourself. No problem but otherwise we create a strategy which results in it. That is what everyone thinks that every data comes out of knowledge, it doesn’t come out of knowledge it comes out of your ability to handle emotions. Is real estate a superior asset class today than 2013? Certainly, because you’re at seven down years or seven flat years of real estate movement. So, on the other hand today people invest in debt, thinking they’ll get double digit returns like what people have bought by investing in 2017. Now debt is an asset classes to be invested for capital protection but to get double digit returns on debt is difficult from here. On the other end, a product like BAF can make money or the volatility, particularly when that central bank bull market climaxes and that is the advantage of that kind of strategy and that is what we tell people when SEBI says equity market carries risk, mutual funds carry risk, past is not equal to future. These are all very great statements because markets are like that. That’s the beauty and that’s what I basically believe in and that is the challenge that after an event sometimes the markets is much safer than before the event. That is the beauty for most investors.

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