What Shankar Sharma Expects From India’s ‘Upside-Down’ Market
“You buy expensive, you make money. You buy cheap, you go bust.”
That’s how Shankar Sharma sums up India’s equity markets today. “Most things are upside down most of the time in India, and stock valuations more so,” said the veteran investor in an interview with BloombergQuint. He doesn’t see that changing anytime soon.
India’s benchmark indices have been scaling new records in the last year as investors piled into heavyweights amid uncertainty and a slowing economy. Broader markets, however, bled for most of 2019 before picking up towards the end of the year.
Yet, Sharma doesn’t see all doom and gloom. Finding new investment ideas, however, will require a lot more effort. That done well, he said, investors will be able to find stocks which can return three to four times the benchmarks.
“A broad bull market is when anyone can go to the office and come home richer at the end of the day,” Sharma said. “This is not that situation. It is going to be narrower and narrower, and will require hard work.”
India will at best perform in line with global equities, and at worse, lag marginally. It will be difficult for the market to show stellar returns, especially in the absence of any major fiscal measures to spur growth, he said, adding that returns will track growth. According to him, it might be prudent to get used to a “slowish” growth forecast for India for the foreseeable future.
Sharma doesn’t expect companies investing in capex the monies saved through last year’s tax cuts and removal of dividend distribution tax in the budget at a time demand is absent and companies have capacity. He sees India Inc. using the savings to reward shareholders through buybacks and dividends.
And he called the government’s mega divestment plan of Rs 2.1 lakh crore, as retrograde. But if it’s the only option to tide over the fiscal stress, he said, then it’s fine.
Watch the full show here...
Here are the edited excerpts from the interview...
I was looking at your Twitter handle Shankar and it said, that among other things if you are disappointed with the budget, blame it on yourselves and don’t blame it on the budget. Now that the market has digested the disappointment and moved slightly ahead, how would you think the mood of the investors would be?
There are several takeaways from the budget which the market should sometimes start to think positively about it. In my view, while it may not be considered positive from a liberalisation sense, but the raising of custom duties across several items in my view is positive. My view is that, India has been too liberal with its import regime, leading to flooding of goods from overseas into India, and that in turn had a major impact on the MSME sector, which has now gone into a huge tailspin. Domestic policies hurt them, but also the sheer flood share of imports. So, I think raising import duties across a wide variety of items will help domestic industries. I think that’s positive the market will start to factor in. It probably has factored in, to some extent already, but I think that was a significant positive coming out of the budget.
To be fair, a lot of policy decisions are being taken outside the budget as the last six months have shown. Almost every Friday was an event in itself for a few months ago. Would it be fair to say that markets shouldn’t rely on the budget to be this big annual bonanza played throughout the year?
Yes, I agree. I mean I think that’s been the pattern over the last budget or two, wherein the major policies have been announced between budgets rather than during the budget. I think that’s not a bad thing at all. Markets do need a drip-feed of positive news flow coming in because it’s sometimes impossible to digest all the positive news flow coming in a couple of hours. I think spreading it out is a smart move. So, I think it’s a sensible thing that the government has decided to follow as a matter of dissemination of economic measures and policies.
Just one more on the budget, but that one question that has got the market divided is this divestment move. Now, some people who spoke to us immediately after the budget said that instead of being on this piecemeal divestment, we would have hoped for a full-fledged divestment and even though the number is impressive, some of it may not necessarily come into the capital markets as well. How do you view this move and the targets that have been set out, as a process?
Philosophically, I am opposed to divestment. I think it’s a retrograde and regressive move on the part of any government. I am not singling out this government because previous governments have also done divestments or at least attempted to do so. If I were the Prime Minister of India, that would be the last thing I would do. I would in fact make sure that they run better, they are run better and run professionally. Within the same businesses, you have the private sector companies making hand over fist profits. Why should that not be the case in the case of the public sector? They have good managers and down the line, I think it’s just good leadership that they need and less interference from the politicians. Why should that be so difficult to get? I mean you have just a handful of good PSUs anyway maybe 10 or 20 of them. Why can you not run them better? Why can we not run them well? So, I think selling PSUs is a complete cop-out, it’s an admission of failure on part of any government—whether UPA or NDA or the United Front Government. I think it is an admission of failure that you cannot even run 10 or 15 companies and on what basis should you even lay claim to be running as country as complicated as India?
So, I belong to the camp that PSUs should be in fact grown, the role of PSUs should increase—just as it’s in the case in countries like Thailand and China. In China, the company called Moutai—which is like the United Spirits of China. It is a state-owned company like the Indian PSUs are. The last time I checked, it was a $50-80-billion dollar market cap company. Why can you not create massive PSUs all over again in a country like India which is blessed with managerial talent? I belong to the camp that selling anything is ridiculous. See one more thing, what’s going to happen is, you are going to be able to sell only the ones that are saleable. So, the good ones will go, the bad ones—no one wants to buy—so, they will remain with you. So, you will have an adverse selection. A couple of years down the road, we will have a portfolio with all the dogs, while all the stars would have been sold to foreigners. Is that what you want?
Your point is well-taken, but in which case if indeed the divestment target would not have been so stiff—which means selling family silver out—how do you reckon the government with the limited fiscal space and the limited revenues that it anyways has, would sail through the next 12 to 18 odd months? The problem of immediacy I mean.
So, it is accepted that divestment is not being done with some grand vision of liberalisation. It is being done to basically meet a cash-flow problem, right? As long as we accept that then if it’s got to be done, it’s got to be done. So, let’s not confuse the motive or divestment. If the motive is to fill a cash flow hole, by all means, do it because that’s the only thing you have left. If the objective is to couch it in the whole shroud of being a very great policy for India, I don’t think that somehow adds up. We are very clear. So, I think there is obviously as you mentioned—as everybody who has studied economics at any point in time from kindergarten onwards, knows that there is a problem in terms of the government fiscal. You need to sell stuff to make both ends meet, apart from taking dividends from various counters or places, you still need to do some fire sales and otherwise. I think if that’s the objective, that’s the only way out.
So, let’s then move back to what the markets do. I mean, almost everybody is of the opinion and maybe rightly so that we are back to being subservient to global cues. How do you view the globe right now? Yes, there’s this coronavirus scare that’s prevalent right now, but that and beyond that, the next 10-11 or 12 months; how do you see the world, how do you see India within that?
I think India has been a laggard in the last several months. If you look at the relative chart of India versus emerging markets or India versus the globe, I don’t see that trend changing. I think India will at best perform with global equities. At worse, it will lack global equities. The macro picture in India is a tad more worrisome than it is in other parts of the world. Because the trend has been down, we are all hoping that the four to four-and-a-half percent GDP we saw is at the bottom, but the other message that budget gave out which we must not ignore is that the general consensus is that there would be a breaching of 3.5-3.8 percent fiscal deficit and the government would basically say that we are going to go to 4.5 percent and the extra percent—around Rs 2 lakh crore would be used to pump around the economy.
That did not happen—and dwell a little bit deeper on why it didn’t happen because the government, again in one sense is right. It said that if we do that, then we are risking a rating downgrade which can get them further with downstream effects. So, the message is, get used to a slow-ish growth forecast for India. Unless you put in large amounts of capital to work, you are not going to move this needle from 4-4.5 percent. In reality, it is a lot lower than that because remember the new series and adjust it for the old series, etc. It is a percent, or two lower and plus high-frequency data is also pointing to a lower number than the GDP print.
Be that as it may, you should get used to a slow-ish GDP growth profile coming from India. That’s the message the budget has given out and you have to take it, you can’t fight it. As in, the government has said that we cannot put in the amount of capital needed to take you to 7 or 8 percent. I mean implicitly, that is what this budget has conveyed and if you take that, then India’s earnings growth will be no more than 4-5 percent because earnings growth typically lags nominal GDP growth which has been 7 to 9 percent. It actually lags a bit. It will be four-five percent earnings growth at best. That’s the highest, you don’t expect the market to give you 20 percent returns and that’s simply not going to happen. Select stocks will, but on an aggregate basis, markets will not—which is why if you see the last four-five year returns from India has been around 6-7 percent compounded, in rupee terms. Remember, in dollar terms, it’s a lot lower than that. In rupee terms, you’re talking around 6-7 percent CAGR which is about the same return as what a government bond will give you.
So, equities in India generally have been disappointing over the last several years. In the last I think, five or six years, I don’t see that changing dramatically in the future, especially in light of the absence of any major fiscal stimulus coming from the budget. In that situation, India will at best perform and probably lag the global markets.
The belief is also that with the corporate tax cut done in September and DDT, there is some money in the hands of corporate India. Therefore, should it find favour to invest and revive the capex cycle. Do you agree?
I think whoever is thinking that is completely off his rocker. Capacity in India is not the problem. Supply is not the problem. Demand is the problem. How is putting more money in the hands of a few select corporates, which I think are about 30 or 25, going to revive the capex cycle? Most of them, by the way, are capex-light companies. So, you have tech companies, services companies, the banks and FMCG companies who are anyway either zero capex or minimal capex because that’s not their business model. So, the guys who require capex are the guys who are not going to get any benefit from this tax cut. So, I don’t know how people come up with these kinds of ludicrous leaps of faith. These companies are already cash-rich, they already have enough capacity, there is enough slack in the economy in terms of capacities. Why on Earth will you take that money that the government has helpfully given you and put up capacity? You will distribute it as dividends and that too, is a problem as we now know. So, that is in the light of the budget, that itself is another question. You will either sit on the cash or dividend it out or do a buyback instead of putting it to a real capex intensive use.
In which case, your first global handle speaks about how different January was. No surprise, but it also speaks about let’s be prepared for maybe some different months in the ensuing period as well. Would you believe that more of the same which is the last 12 months would continue in the next 12 months, too?
So, understand this. You correctly mentioned the first global handle, you correctly mentioned the January performance at 9 percent, which in a month is phenomenal. So, the market indices were flat to down. Those things cannot be replicated month after month and you will get months where everything works out okay. So, that’s a different conversation. I doubt if we’ll replicate that in a hurry in the next 2 or 3- or 5-months’ time. What it is telling you is something important. That done right, you can still make money in India. I’m not saying it’s all bad, all I’m saying is headline indices will not deliver you returns which will be your cost of living. But if you pick right, if you construct portfolios right, if you do a lot of hard work you can potentially make returns which are 3 or 4 times the market returns, at least to a pretty large extent. So, it’s not doom and gloom, it’s just that it’s going to require a lot more effort to make money. See, a broad bull market is where any idiot can go to the office and come home richer at the end of 3:30 or 4:00 PM. This is not that situation anymore. It’s going to be narrower and narrower, smaller and smaller list of stocks. So, you have to work harder and harder to get to them. So, it’s great for people who can make that happen. It is not so great for multitudes of people who basically track the index. The index is not going to be spectacular by any stretch of imagination.
So, it was asset-light, quality, defensives all of which did well in 2019. Do you see that changing? Because that will change if the growth cycle will turn, and I presume your belief is that, the growth cycle is not turning.
My view so far is that the theme doesn’t seem to be changing at all because there’s not enough quality on the other side or at least, buyable stocks on the other side of the seesaw which is capex-heavy, betting on domestic economic revival. I mean that kind of domestic consumption, industrial story, there is not enough for us to be brave and go out and pick stocks there. So, all of us have sought the comfort of the same handful of stocks. Interestingly, in India is that valuations don’t matter.
They have not mattered for now for several years and you can keep buying in Asian Paints or Hindustan Unilever or Nestle etc. at nosebleed valuations. Yet, they will keep beating the market. While if you buy something cheap, then go and buy an ONGC at 3-3.5 times the earnings, you are going to be taken to the cleaners. So, it’s just completely upside down. In India, most of the things are upside down most of the time but in valuation, it is completely upside down. You buy expensive, you make money you buy cheap, you will go bust.
From the looks of things, it’s a politically light calendar. Do you think economic or other announcements which in the past couple of years have seen some alignment to the political calendar will cease to be a factor in 2020?
Are you asking that because of the light political calendar, there will not be that many announcements?
I’m asking that will the market not worry about all these announcements happening in tandem with the political calendar because in the past, people have given that thought a lot of credits.
I don’t think in India politics and economics collide at all. I mean that’s a completely different India. The India that is interested in economics is basically 2-square-mile India: Fort, Nariman Point, BKC etc. For the rest of India, it’s more politics first. So, you are getting plenty of that, irrespective of elections or otherwise because there are many events which happened even without elections as we all know. So, I don’t think we should get too worried about a light political calendar.
I think there will be enough coming to keep all of us very busy looking at news and using Twitter. As far as the economic headlines are concerned, I do believe, and it is a hope that they will tweak the capital gains tax. I think they have just held it back for a more opportune time. During the year sometime, because it’s a free reform. Nobody has got capital gains anyway.
The government is not making any money from it, so why not just give it? At least tweak it like instead of one year making it two years or whatever. So, I think they understand it. I think they didn’t want to sort of give out too many things in the budget itself. They wanted to keep it back as a bullet to be fired in case the markets tank. Remember, the corporate tax bullet was fired when the markets had really crashed and crashed badly in the month July and the aftermath of the previous budget. If you look at the pattern, they have held a couple of very market-sensitive announcements back. I think people will get it during the year for sure.
What is the early Amazon and Apple investor doing when it comes to the Indian landscape? Listed, do you find any early themes? I’m not asking about stocks but themes which are attractive in the unlisted space too. So, what is it when you look at the Indian landscape currently?
I think the Indian landscape for unlisted space requires guts of a level that I, at my age, am simply unable to command. So, it just requires the ability to buy companies with Rs 2 crore of revenue and Rs 250 crore of losses. So, that only people from Japan and some people from Silicon Valley can do. For us Indians, we have made money in the old-fashioned way. We have bought good companies or half-decent companies and made a bit of money riding them. Even Amazon and Apple were nowhere, in terms of earnings profile or cash flow profile, as bad as the numbers you see in the startup ecosystem today.
So, yes unlisted is for very brave people and we don’t belong to them. But I think it listed alone you had terrific companies again. I’m not making a recommendation here but with IndiaMart which was listed last year, these are all factual things. Today, it has doubled in a years’ time or in a few months’ time. There are enough companies even in the listed space. The headline indices haven’t done anything but below that, I can look at 20-30-40 decent companies. That’s enough to fill up a decent-sized portfolio that has delivered exceptional numbers, exceptional stock price performance. So, we are very busy, to be honest, we are not sitting and moping. We’re hungry, we’re looking at stuff, we’re finding stuff for sure.
We have seen in the last 12 to 18 months while the broader markets may have stayed subdued, creation of small sub-sectors of sorts which are making money. It coincides with what you just said, right? There are enough and more things happening wherein serious entrepreneurs are doing the right work in order to create wealth for the companies and thereby for the shareholders too.
Absolutely. I mean I think we are awash in a place across the market cap spectrum. I mean you have a company like HDFC AMC, which is not a small-cap, come in and virtually triple in a year’s time. That’s a serious-sized gain right there, in a prominent group. Large-cap, in a large industry just coming in and tripling your wealth. So, I don’t think we have any reason to be feeling cheated. People who are investing in mutual funds, index hugging, I think that’s where the problem lies. But, if you are prepared to be a little creative, I think there is more than enough money to be made and you can beat the market handily without any doubt.