Indian Market Has Not Topped Out Yet, Says Ramesh Damani
Ramesh Damani expects stocks to recover on the back of a healthier economy and better-than-expected earnings.
The Indian stock market has not topped out yet and the ongoing selloff after the Finance Minister brought back the long-term capital gains tax on equities is a correction in a bull market.
That’s how Ramesh Damani, member of the BSE, describes the more than 3.5 percent slide in the benchmark Nifty 50 index in the last five sessions. Such corrections have historically been “short, sharp and swift” and the markets generally resume the uptrend, he said. “Since it’s hard to make money in the market, we have to remain committed for the long to truly enjoy the benefits of a bull market.”
When you add a global potpourri of events like the possibility of rising interest rates or the Dow having topped out, that gives me some pause that maybe we have to weather this storm for a little bit longer.Ramesh Damani, Member, BSE
Yet, he is optimistic of a recovery on the back of a healthier economy and better-than-expected quarterly earnings.
India’s benchmark Nifty 50 Index has fallen for five straight sessions. The slide has been particularly steep after the Feb. 1 Budget for 2018-19 introduced a 10 percent tax on gains of Rs 1 lakh or more made on sale of equities after March 31.
Market Disappointed With LTCG
If the government had reduced the securities transaction tax while imposing the much-debated long-term capital gains tax, the market would have reacted positively, said Damani.
Once the government gets its foot in the door, it opens it wider and wider and taxes it more and more.Ramesh Damani, Member, BSE
Historically, the government has never gone back on the taxes imposed by it. Minimum alternate tax was imposed at 7 percent but currently it is above 18 percent, he said. The service tax has gone up to 18 percent from 5 percent while the dividend tax too was increased to 25 percent from a single-digit number.
This definitely does not boost investors’ morale, said Damani. “But markets can live with a 10 percent long-term capital gains tax in the long run.”
Watch the full interaction here:
Here are edited excerpts from the conversation.
As of now, we have cracks in the dam. Can the cracks widen up further? How are you approaching investing currently?
Over the last three years, there were 3-4 occasions when the markets have fallen in Sensex terms 600 to 1000, 1,200 or sometimes 1,500 points. They happened on demonetisation, Brexit and when the China crack-up happened in 2015 and the market has recovered from all those nicely. This is a correction in the bull market. Corrections in bull markets are always sharp, short and swift. So, except the staunchest believer in the market, corrections shake others out and the market resumes its uptrend.
It is a reminder that it is hard to make money in the market and we have to remain committed in the long term in order to truly enjoy the benefits of a bull market.
In addition, the global potpourri of events like possibility of rising interest rates, possibility of the Dow having topped off, that gives me pause that we have to weather this storm for a little bit longer. The good news is that the Indian economy is finally starting to do well. The third quarter results have been ahead of expectations of most analysts. There are green shoots in the economy. Lot of sectors are doing well. So, in terms of earnings, there is reason to be more optimistic about the market.
How much of a dampener can this be to the overall scenario?
The two things that the global markets haven’t had to deal with in last 3-5 years or since the global financial crisis, is inflation. I think we are most worried about deflation. The data suggests that inflation may be coming back in America. The data in India suggests that because of huge expenditure on rural India and the huge increase in MSP, we will be fighting rising inflation in India over the next 6-8 months.
In the short run, inflation is not bad for the stock market because it increases profitability, costs don’t rise as prices rise at that point. So, in the short run it is okay but in the long run it is very detrimental to long-term equity values. So, the first thing we need to deal with is inflation, which wasn’t dealt with the in the past, and which implies that interest rates, whether in America or India, are headed higher. In India, we have bottomed out in the interest rate cycle.
We will probably see higher interest rates in six months to one year. Economists have suggested the same.
The other risk is that Dow has come out at extremely low volatility. But markets are rearing the head of volatility again. So, we’ll have to deal with it. Having said that, I remain optimistic on the Indian recovery. It might take a little bit longer. It takes some time for all the malaise that is built up in the system, all the excesses to be wrung out. If there is a bull market top, we need to sell the rallies. Are we seeing a correction in the bear market? On balance, if you ask me to stick my neck out, I see a strong correction in an ongoing bull market.
We have seen a metals recovery in the last 6-8 months. Does that not change your stance fundamentally for the slowing down of momentum with regards to the bull rally for this calendar year, as everything seems to be fully priced in?
We could say that about midcaps, but they don’t really count. In terms of percentage of float to market cap of India, the large caps count. If we see tech, pharma and OMC companies, they are trading at reasonable PEs with handsome dividend yields and these companies have just bought back their shares. I will not make the argument that large-cap stocks in India are grossly overvalued.
Because of domestic liquidity we had a huge run up in mid-cap stocks. Many analysts had warned against keeping on chasing those higher returns. But it is typical of a bull market that people get complacent and carried away and the multiple keeps expanding.
There is an occasional reality check, as we saw after the budget. The market is disappointed with the LTCG tax. Anytime you tax people some more, they are going to be disappointed with the additional tax. And I think we don’t like the frameework. If the government could have made an effort to reduce STT, saying we will rationalise LTCG, then markets could have perhaps reacted correctly. Look at the tax history of India. Minimum alternate tax was introduced at 7.5 percent which is above 18 percent now. The service tax which was introduced at 5 percent, it is at 18 percent. The dividend tax is up to 25 percent from a low single digit number. So, once the government gets its foot into the door, it opens it wider and wider and taxes it more and more.
We had a system that designed STT to encourage people to come into the market and encourage capital flows. And then, you’ve discouraged it by introducing LTCG tax and retaining STT. So, market was disappointed with that. The statements coming post budget too were not morale boosting for the market.
But can the market live with 10 percent LTCG tax? Yes it can. I just think the government should align incentives a bit more precisely.
Is it about the confusion on the broad economic policy? How convinced are you that we are playing with a plan and that plan is a coherent economic policy?
I have been an advocate of a more aggressive PSU privatization plan. But in the post budget confabulations with the disinvestment secretary, I don’t think it is the government plan to divest more which is unfortunate. They have taken the center piece of Air India and even if that gets through then I would be very happy. I think they will privatise 24 PSUs but they are very small, marginal, loss making PSUs.
If Ramco is getting listed in Saudi Arabia, in such a small economy with a $2 trillion market cap, then I don’t think there is any reason that why we can’t dis-invest so many things. It is the biggest government reform that the government should do. Whether to keep MTNL or BSNL on books makes increasingly less sense as it is already well connected. The fact that government has clear majority is more incentive to do it to come to power for the next term. That will be a right economic decision. If the government did that, the market will cheer it. I am disappointed that the government is not in favor of privatisation and they are sticky in it. But the economy calls for some bolder steps. We need resources for infrastructure and disinvestment is a good way to do it.
But do you think missed divestment is a missed opportunity?
I agree and one never knows how these things play out. Maybe the market will bottom out at the end of February and starts rally again or corporates earning will be better. Oil prices may come down which can be a boost to domestic markets or FI flows may resume as they are leaving their own markets and coming back to emerging markets. Any numbers can change the cocktail of things that we are facing right now.
But good economics is to bite the bullet in terms of PSUs. They have MTNL, BSNL and whole bunch of PSUs that make no sense from a strategic and governance point of view in India. Already, technology has overrun these companies.So, the government should monetise these assets, sell them like they are doing for the NCLT program, taking unviable private companies that are deeply in debt and auctioning them. Government needs to do this for their own assets. It is a very important reform, but I don’t think successive governments have had the courage in the stomach to go with it. For some reason, it is a politically no-go area.
While earnings seem to be track on to revival, there are different things in the calendar year 2017 and 2018. One is commodity prices uptick with a hit on the operational picture and the RBI being hawkish. What did these two do for the earnings picture for calendar year 2018 or financial year 2019?
The fiscal deficit which got some amount of consternation in this year’s budget because it exceeded, will come in at the government number next year because they expect fiscal buoyancy. They expect fiscal buoyancy because it seems that GST is coming through with some delay, so that could be good. Last year, even the tax collections were buoyant and ahead of budget estimates. As there is corporate earnings recovery underway, they will exceed the target set in this budget. So, the fiscal deficit number will come under control. RBI may be forced to raise the rates marginally because in the world, rates are going up, so there might be inflation. To keep that under control, they will raise interest rates at least marginally for time period of six months or one year. So, if you look at individual companies like cement, steel, we are tending to guide towards a robust year in the current year. There are companies like technology, pharma which are not exposed necessarily to the commodity price cycle. So, you have to make your bets within that area too.
We have seen that retail investors have found the stomach to tight through some difficult days, but will that momentum continue? As the money goes to small amount of stocks, how much tougher it has become for these funds to continue offering returns that will keep these investors happy?
The big worry in Dalal street is that the domestic flow which was a bulwark of the bull market for the first time in last 50 years, may now change as it is not that efficient to buy stocks. You could charge 10 percent, for short term 15 percent. There is no great difference between short term and long term. So, investors tend to take chance in fixed income as it will do better.
So, there is risk in the market. The bulwark of the market was domestic savings. So that even if foreigners sold, India could absorb it and there was no issue about it. You kind of spook that brilliant playing which has been going on in the last 3-4 years. I would be worried about domestic flow. It is too early to try and tell what will happen in this. But equities will compete with a lot of asset classes for the investor attention. So, we may see slowdown. In terms of foreign money, there is some chance as global economic recovery is continuing. Foreign money, which has been largely going to America or other countries, might come back to India. So, that would help us. In the last two days, foreigners have bought into India. May be Rs 1,000 crores in each of the last two days which helped us. The Indian economy is on a growth track. These things will happen and will continue to get derailed overtime. But there are businesses, companies which are doing well. Until proven, I am going to remain that this is a bull market, and this is a correction of the bull market.
Where do you see value in this market?
Clearly, large cap companies should be re-rated. The quadrant that we are looking at in terms of growth could be the quick service restaurant or the QSR space because I think this space is more promising in India. From unorganized to organized, women working outside the house, lack of domestic help, AC, Wi-Fi, hygiene, all these things plays into a QSR. It is a small area with few dozen stocks to actually take a look at. But if you pick and choose then these businesses will compound over a long period of time at 15-20 percent because this is a very nascent industry in India. As we move to a more prosperous economy, people will want better hygiene standards, quality of food, choices and also a better environment. So, it is a very decent area to look at.
People have been negative on the real estate sector. In terms of valuations, it is cheap. So, they will do well over the next few years as Indians want affordable housing as the push for affordable housing increases dramatically.
We like gaming stocks as across Asia, whether it is Japan, Indonesia, Philippines, Singapore, all the governments are opening and legalizing gaming industry. I think India will inevitably follow suit. There are not many choices and are expensive. But they can get expensive over the period of time. So, the gaming industry looks good.
The area that I am always excited about is the shift from service-led tech to intellectual property-led tech. We have made money on services in tech over the years. You get a contract, do the billing system, and accounts receivable, It costs you Rs 100 and you charge Rs 120. This arbitrage made the stock investors very happy. But increasingly that business became more productive and commoditised. But there are companies which are developing intellectual property. So, by definition they will have pricing power and enjoy flatter margins. For the first time, I have seen companies move out from service model to intellectual property model. Within that tech space, we can find small companies under few thousand crores which are providing algorithms and intellectual property. That will be a great area to invest for the next 3-4 years. You have to have a sharp eye for those values. I would encourage investors to look for companies which are developing intellectual property and that’s where I find a sweet spot. I think there would be huge moves in these companies in the next 3-5 years.
How do you go about identifying the right kind of companies, qualifications or attributes to invest in? Is tech more fascinating to you than Airlines?
It is harder to find but the returns are much superior. When you buy the service companies, people will be buying the older ones, but you took chance with these service companies and they became behemoths like Infosys, Wipro, TCS. IF you were buying them in the 90s, they were unloved, unnoticed and people were gradient to old economy. But the pioneers in that made very well.
The problem with the old companies is while they will do well, they are unlikely to have glamorous PEs. So, you have to be satisfied with plodding rate of growth rather than some superior rate of growth that we are used to in technology companies. Some of the younger companies might seem expensive, might be wishy-washy in terms of operational efficiency but they are doing exciting things. Companies working with Aadhaar, data or cyber security, that is the sweet spot of companies who are doing intellectual property.
In the West, Facebook, Google, Tencent, Alibaba, they are companies working on intellectual property, algorithms, negative working capital. So, it is amazing how the market is shifting to valuing companies with hard assets now only value companies with some intellectual property. A great example of company with no physical assets is Uber which has a $50 billion valuation. So, some of these companies are there for India.
I am bullish on airline industry. The big fear that everyone has with Airline industry is oil prices going down which will cap their profit or lead them to losses, but there are couple of things which have changed within the industry. They have moved from single pricing, like you pay Rs 5,000 and get everything included, to a la carte pricing. When you fly, whether you pay for baggage, meal or seat, everything is priced separately. That ensures that every time oil spikes up, this companies’ profitability will not get thoroughly quashed. Also, they have introduced fuel surcharge whenever price goes up. There is an unprecedented boom going on in the Indian travel industry. Because of the reputation that it has, you will not have a new entrant coming in. So, there could be 4-5 people in domestic market, so that will ultimately have some pricing power. The long-time prospects for the airline industry look exceedingly good. The millennials, who are the future of our country, no longer want to buy things but experiences and if you want to buy experiences you need to get there. Airlines will do well, and I am fairly bullish on that sector.
Are you nibbling into the data/mobile phone-enabled theme?
Yes, I am. I had positions and I have a security firm. I have companies that invest in routers that help data move. I have companies which provide access to them from a customer point of view. There are nuggets that you can pick up like some large cap or small cap ones but everyone is saying that data is the new oil and I believe it. So, you have to look at those kind of businesses as they are bullet proof. Anywhere you go, without Wi-Fi, things didn’t work. We need Wi-Fi and need to be connected 24/7. That’s the mantra of the millennial generation.
If you look at what happened in pattern usages, in U.S., for the first time in 50 years, people are delaying getting their drivers license because they don’t want to drive but just be connected. They order food, connect with friends on social media. They are delaying even the driver’s license, that’s how the far the movement has gone. They are staying home and connected through data. I am not sure that how it will happen in India, but data consumption will boom, and you have to find different ways to place it. Also, you have to think of all the ramifications, in terms of cyber security, social media or router networks. So, there will be a lot of opportunities for savvy investors in that area.
Do you change your investment strategies and look at markets with different eyes and put your money where it is safer?
These are questions which we ponder on every day. If I felt that this market has topped out and we are going to enter bear market, then I would be trying to raise cash. For 20-30 percent of portfolio, I would raise cash. If I feel that we are not in a bear market type of situation but more in a bull market correction, the philosophy is to find great businesses. We have to find good management running great businesses and then we are happy to hold them for a long period of time. Businesses don’t go bad because the markets goes down. So, we are ready to hold them even in economic downturn.
Entry criteria is much stronger for a business. I want to be convinced that there is a great opportunity and there is a management which has the ability to beat that opportunity and I think the opportunity should exist no matter what happens in the external environment. Even if oil prices go up or interest rates go up, these businesses should be able to perform.
We tend to look at life cycles of businesses, not necessarily in terms of markets. It may not be the best thing but we often hold through lot of very difficult periods in market. When Brexit happened or when Rajan left or Donald Trump election happened, markets where down 500-1,000 points in a single day. So, we retain those businesses. Overtime, that has been a winning strategy