Domestic Liquidity Is Real And Here To Stay, Agree Ramesh Damani, Hiren Ved
When foreign investors return is anybody’s guess but domestic investors are participating with a gusto, experts said.
Domestic flows have kept markets buoyant for the last few months as money coming in from foreign portfolio investors ebbed. This domestic liquidity is real and will drive the stock market going forward, well-known investor Ramesh Damani and Hiren Ved of Alchemy Capital, one of the country’s largest portfolio managers, said on BloombergQuint’s special show Saal Mubarak.
Here are edited excerpts from the interview,
What’s the underlying tone of the economy?
Ramesh Damani: The undertone of the economy is one of hope and optimism. Since the Modi bull market began three years ago, it has been hope, it clearly hasn’t been on earnings. But I think as Peter Drucker taught us once, culture eats strategy for breakfast. I think what we are learning is that liquidity will always trump valuations. Liquidity is the mother’s milk of a bull market. You can’t fight the feed as the old saying goes. The money that is pouring in from domestic investors has been igniting a rally. Now we are coming to a critical juncture in this market. We are going to see the base effect of demonetisation within the next two quarters or so. If earnings don’t come through, the market could be in a spell of trouble. But so far, the market is driven by liquidity and hope that things are going to get better. There are things that are getting better, not in every respect, but in some respect. There are long-term gains to have from demonetisation and the Goods and Services Tax.
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Can The Rally Sustain?
For the broader economy, there are two views. An equal number of people saying things are looking ominous and an equal number are saying things are looking rosy.
Hiren Ved: As stock market investors, we are blessed that we get to see the more organised sector, which is listed. Demonetisation, GST and the crackdown on black money has given a body blow to businesses essentially run by the cash economy, evading taxes. Those businesses are being impacted. People get confused when they look at stock market valuations.
Having said that, all recoveries are usually uneven and never broad based. It is typically one or two things that drive the economy. It’s not that all the four engines are firing together. For example, it’s consumption and government expenditure in our case, and not private spending. When these one or two things pick up and gather momentum, the rest of the economy hums together. We could have argued that part of the price-to-equity re-rating in the market was because the cost of capital fell by 200-250 basis points. When Modi came in 2014, the 10-year bond yield was 8.8 percent which is down to 6.6 percent. So you could argue that there is some lift to the PE. But the rest is liquidity and optimism that growth will come back.
One of the reasons we are seeing the selling by foreign portfolio investors in the last few months is because they have options. India had a massive premium; people were overweight by 750 basis points on Indian equities versus the benchmark which is down by 300 basis points. FPIs say that we will go elsewhere where the risk-reward is better. But the Indian retail investor is discovering the joys of investing in SIPs and in stock markets, the joy of equities.
Key Risks For India
What worries you the most about India in the global backdrop? What are the key risks that will haunt us for the next 12 months?
Ramesh Damani: Global markets are making new highs and there is a sense of fear in the marketplace among commentators. And that’s a good sign. As the market climbs the wall of worry, it is good. I don’t see people complacent anywhere. The biggest risk is that the market is complacent about geopolitical risks. What happens in North Korea, we can’t quantify. We can quantify other markets in terms of how GDP is growing or how inflation is rising. But what is happening in North Korea, we can’t quantify. Fed has already indicated it will raise rates further. The markets has discounted that.
But the thing that will keep me awake in 2017-2018 and beyond that are geopolitical risks. There is a man who is particularly unstable in America and one doesn’t know what will be launched there. If you ask me what keeps me up at night, it’s that.
And dealing with an equally unstable man in North Korea as well.
Both of them were probably twin brothers at some point in life. It’s not good for financial markets. What’s surprised me is that market has ignored this. It has totally ignored North Korea. Even the Korean market is making fresh highs as we speak. It seems that the market is sleepwalking into that crisis. If something triggers for the worse, that could not be a happy situation.
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Will Foreign Flows Make A Comeback?
Is there a chance that global flows come back to India?
Hiren Ved: Global flows came into the debt market in India as yields were very high. In the equity market, India has been always been an overweight in many FPI portfolios. Foreigners were very worried about demonetisation. They thought this will dent earnings. Post demonetisation, markets have just taken off. They took a call that we are overweight, the earnings story is not coming through, so let’s reduce our overweight stance in India for a bit.
Simultaneously, we have seen a massive rally in commodities. Countries like Brazil, Russia rose to new highs after a long time. In some of these countries, valuations were cheap and people thought there were opportunities. They [foreign investors] said we like the long-term India story but we will wait; make money elsewhere and come back at some point. India will remain a favoured market but it is just one of the places where you will stay overweight. The Modi trade started three years ago and people have been waiting. When the money will come back, I don’t know. But we are beginning to see that selling is ebbing a little bit. Whether foreigners will come back with a gusto or wait for a real correction is anybody’s call. But no one is complaining because locals have stepped in with gusto.
Ramesh Damani: There is nothing global emerging market guys are more scared of than being underinvested in rising markets. So this will continue. Trust me they will be back and that will lead to a bubble some time down the road. The domestic liquidity is not a flash in the pan event. This time it is for real.
The Emerging Themes
What do you think the story is for next 12 months? Do the expensive names continue be sought after or do you see markets start bargain hunting in pockets which so far have not delivered in a big way?
Hiren Ved: One of the reasons FMCG gave returns in the mid 80s and 90s was because HUL was compounding profits at 25-30 percent. Markets love growth with good RoCE (return on capital employed). So, if you have sectors and companies delivering constant growth, in the short to medium term at least, market overlooks valuations. People argue that HDFC Bank was always expensive, but the fact is it kept compounding at 25 percent a year.
There are very few companies with such stable compounding over a long period. So they will get a premium. What that premium is depends on interest rates and liquidity. We used to think that 4 times price-to-book is expensive. Today the dynamic has changed. Probably, 6 times price to book is the norm for high quality financials. So who is to decide? It’s the broad wisdom of the market which together decides.
On whether money will go down, there is already smart money which is going down and bargain hunting in reasonable valuations and trying to bet on turnarounds that are happening, because the economy will heal over time. Typically, what happens is that the quality [stocks] will either underperform or move sideways for a while and money will go to other end of the spectrum, what we call as the have-nots. Within the have-nots, you have to differentiate between companies which have broken balance sheets and companies which have good balance sheets. The first order will where the balance sheets are good and there was no misallocation of capital but there was no revenue momentum. But now, because of either external opportunities or because the companies themselves are doing something, you will see the revenue growth coming in and that’s where the big money is going to be made. The fact that the small and mid-cap indices continues to outperform the large-cap index, some of that could be fluff, but it’s been happening for a long time.
Portfolio Approach
Would you be chasing companies which are expensive but show promise of growth, or companies which are not showing earnings growth but could show promise?
Ramesh Damani: The biggest threat to global market is the onslaught of technology, what is happening with automation, internet, robotic intelligence. India as a consumer doesn’t understand that. Because I am a domestic focused investor, I want to make a portfolio that is somewhat insulated against technology taking jobs away from manufacturing and other businesses. The four areas I came up with:
- Real Estate: Property has some immunity from technological threat
- Airlines: I don’t think the hype will take off so soon
- Food and liquor businesses, quick service restaurants will do well
- Gaming and entertainment
People come to India for its 1 billion consumers, and not for the infrastructure or steel play. They come for the consumers. That’s the centerpiece of the portfolio I am suggesting to you. I think they are insulated technologically. And I could use the Warren Buffet test for this. If I buy a basket of these stocks and go away for ten years, I am confident it will be better as opposed to buying a steel company or an oil marketing company. I am constructing a portfolio that tries to mitigate the risk of technology over-running these businesses.
Are you looking at things that are doing well internationally and therefore could have an impact in India?
Ramesh Damani: Let’s talk about the gaming sector. Across Asia - if you look at Japan, Singapore, Malaysia, Cambodia, Philippines - gaming is big because international tourists want that industry out there. India has so far been resisting. But we are at the cusp of change. It might happen in six months or a couple of years. But the casino business will change over time in India. It’s a hugely lucrative business.
The odds always favour the house and the PE multiples are always the sexiest in the market. While I can’t time this, I am sure that over the next 5-10 years, if India wants to be an international destination, spirits and gaming sectors will do well.
Let’s look at the urban theme. We have young consumers going to work. We have women working for the first time. Cleanliness standards required, AC comfort required. Look at the quick service restaurants. These guys are selling burgers for 30 bucks or fries for 20 bucks, it's so cheap.
I can’t tell whether these themes will do well this quarter or the next. But over 5-10 years, the compounding effect will be huge. I am suggesting that if you are young and starting a portfolio, these are the stocks you could look at. Of course, you look at the FMCG and technology businesses but part of that portfolio could be done in those kinds of businesses.
Clean Energy Push
India has said that by 2050 we want to be a combustion-free country. Can you initiate investments based on that right now?
Hiren Ved: With electric vehicles, I call it version 1.0 investing. When retail in India was new, you could buy any retail stock and you would make money. Today, if you are selling EVs or supplying one small part to an EV, your stock will be up 20 percent. You can’t deny the fact that the auto industry is under pressure but it will adapt itself differently.
You still have to build out infrastructure which will take time. There are a lot of other issues. If you look at roads in India, there is hardly any discipline. So you will not have the self-driving cars. It’s something that you can’t wish away but it is several years before it becomes a reality. You can’t say what happens in California will happen in the streets of Mumbai. It is very difficult to translate that. PEs of auto companies could get compressed for a while because this fear is on top of the mind of investors. Some of these companies will adapt to the new situation.
We own an auto ancillary company which is already supplying tool parts to Tesla. Going by Tesla’s volumes today, it’s not that it will be a big money spinner; it’s more about the mindset. We are positioned such that if this opportunity were to become big, we are there to hitch that ride.
Ramesh Damani: I am on the other side of the fence from Hiren regarding this. We don’t understand the kind of changes that autonomous vehicles will bring. They will change the entire dynamic and that’s the technology threat I mentioned earlier. In the last 30 years, we have seen the incumbent always loses. If you look at BSE and NSE, NSE got market share. Look at Polaroid and Kodak which owned the instant photography market. Today they don’t even exist as listed companies. Look where Sony was 20 years ago and what Apple did to them. Typically, incumbents have their heads in the sand to protect their profit pool and are not looking ahead of these markets. I am seeing the same thing. Auto companies margins are so thin, they are not investing. Just as Tesla got market cap bigger than all the auto companies combined in America, the same will happen to Indian businesses. Incumbency rarely win the race. That is what history has told us. If anybody can do it, I salute them because that’s the example of a great management that we should bet on.
Betting On Insurance
Do you think insurance is the space which could be a money spinner for the next 5-6 years?
Hiren Ved: Yes, insurance will be a big sector. I have looked at the numbers and I don’t think that insurance penetration in India is as low as people think. The ticket sizes could increase. For health insurance, we are way behind global standards. Earlier, the way insurance was sold to people was just pushing it down their throats. With digital channels coming into insurance, you will have younger people buying insurance digitally. You could see early adoption as opposed to people buying insurance in mid 40s and 50s. Insurance will be the big sector in India.
We are just seeing the onset of financialisation. Demonetisation had a big role to play because all the deposits that went into the bank allowed the relationship manager to sell some insurance product to his customer because that was a heightened 60-day period where we had a lot of interaction with the bank branch. That will carry on for a long time. A day will come when LIC will get listed and given its size and stature, it will have to be part of the Nifty and same is the case with a few other companies as well.
Ramesh Damani: The trick in insurance companies is to find the companies with the float and who can deploy the float successfully ahead of the payoffs. That’s what I would be looking for as an analyst. Insurance will be big, without a doubt. The guys who capture the maximum float and keep investing wisely...that’s the secret of Warren Buffet’s wealth. He can invest his float wisely in stock markets with compounding returns. I think the winner will be there. So, it will be a big sector.
Big Investment Ideas
One theme that each of you believe is not necessarily new but has spent some time in the formative stage and is now ready for takeoff.
Ramesh Damani: Airlines and housing, they will be important sectors. The airline industry is just about bursting through its crackers right now. There are misinterpretations on Dalal Street about what airlines do. They are very competitive businesses. It’s a very profitable business. Given the scare of how many airlines are going bankrupt, I don’t think people will come and spoil the party. For the next 2-5 years, airline traffic will do well. And they have started to do well.
And then there is housing. The first thing we want when we graduate and start a job is a house. Housing is a nice stable sector. The market has a lot of respect for real estate. But some of the listed companies are ways to play that.
Hiren Ved: Logistics will be the one sector with GST out of the way. That sector was young and it always showed promise. Now GST has provided a trigger. If e-commerce has to succeed, you will need to have a strong logistics sector in India. Recently, a large FMCG company went in to the huddle after the BJP came in power in UP discussed its UP strategy. It’s a country by itself, how you get to every nook and corner, how do you distribute your product there. Logistics is where value can be added. The enabler is there, the size and scale is there. The mixing and matching of technologies with the logistics sector, the kind of efficiency that you can unlock this sector is just mind boggling.
Investment Mantra
What is the one key learning of yours that you’d like to leave us with?
Hiren Ved: Never say ‘no’. Stick to the basic principle but have high adaptability and learnability.
Ramesh Damani: Liquidity will triumph valuations. I learned how liquidity is important in the market. But that’s the passing lesson.
But the more enduring lesson is the value of compounding, which liberates, and makes you financially free. If your money doubles every three-four years, after 30 years you will be fairly rich. Understand compounding and the magic of compounding and that’s the greatest advice I will give.
And one tip for all the investors
Hiren Ved: It’s an intellectually stimulating and humbling exercise. Go out and explore the world. But be disciplined. Don’t get carried away. Have rational expectations of returns and think long-term.