‘We are not decoupled from the rest of the world’

In an exclusive interview with Moneylife, Vetri Subramaniam, Equity Head, Religare AMC, gives his perspective on the current market rally and where the markets are headed. We present to you the first part in a three-part series of the interview.

ML: Are we witnessing the start of a new bull market?

Vetri Subramaniam: It's like asking somebody in 2003 that whether they thought they were in a multi-year bull market. I don't think anybody knew at that time and it's the same this time. The one parallel is that at the lows in 2003, the Sensex was trading almost at 10 times one-year forward earnings. At the lows of March this year or October last year, the market was in a similar kind of trough valuation. So that would suggest that in some ways those lows were significant but whether that is necessarily the start of the new bull market is a million dollar question. I say this in hindsight but not with foresight.

The only thing that I believe is actually comparable is the fact that valuations in March this year or October last year on the forward basis were similar to where the previous bull market started. Now whether you want to interpret that as a new bull market, or the last 18 months was a fall in the bull run that started in 2003, is hard to say. But the important point to keep in mind is that the valuations were at the trough levels that we have seen historically and in a way the price levels were suggesting that all the macro bad news had been discounted. I don't think you answer that conclusively unless you answer with hindsight.

ML: How different is the current rally from 2004-06 or 2006-08 periods?
The beauty of 2003-2008 period was that you had all cylinders firing. Will we get all those cylinders firing all over again? I have my doubts.

The only piece that is in place now is the local piece. The global piece is not really there. But about 40% of our earnings are not driven by the India story. It's driven by what is happening at the global level. Reliance's refining margins are not determined in India, they are determined globally. Steel prices for SAIL or TISCO are determined globally and not locally. The software sector is dependent on the US situation. So 40% of your earnings are affected in one way or the other by global environment and global growth.

Let's face it, at the end of the day there is nothing in the last six years which tells you that we are anywhere decoupled from the rest of the world. It seemed that we were decoupled from the world during 2003-2008 but as somebody pointed out that even sub-Saharan Africa recorded a stellar growth till 2007. There is no data indicating that we have decoupled very significantly from the world in terms of growth rate or in terms of the way asset prices behave. And given the fact that the global scenario remains gloomy, at some point it even clouds the visibility of going back to 9% GDP growth. Can India go back to a 9% growth rate in the absence of a conducive global environment both in terms of growth and capital flows? That's pretty much impossible. In that case, the current forces are very different from what fuelled the previous bull run.

In general, global cues remain very important because if the last five years have been correlated, last 18 months have been even more correlated and the last six months have been incredibly correlated in terms of the way prices are moving across all risky asset classes. That poses its own challenge. At the end of the day while you look at the macro factor and feel positive, you are not seeing the kind of lack of correlation that you would like to see in the behaviour of asset prices and that suggests to me that there is some level of risk and therefore global cues can create downside risk as much as they can create upside reward.

I think what the events in the last 18 months have shown me is that India's secular growth story has been reinforced, given the way growth has come back so strongly. But it is very difficult to extrapolate that economic trend into a conclusion that the market concerns are off to the races again, as they were in the previous stretches of the bull run.

ML: Is there too much of complacency not only about global growth but also about the domestic growth situation?
Let's look at what goes into the 9% growth. The very first year when we had 9% growth RBI slammed the brakes in July 2006 saying that the growth is too fast; we don't have enough productive capacity to support this growth level. They started tightening in 2006 and we got two years of 9% growth despite that because the capital flow was strong and because exports were strong. Today we are in an environment where the exports are not strong. Capital flows have picked up but going back to those levels I think is a bit of a stretch. Have we actually solved any of these so called supply constraints that YV Reddy so famously talked about three years ago? I am not sure. I haven't seen any data indicating that the constraints have changed. Therefore 9% is a nice number to talk about. But is it a practical number? I don't know. Presuming that the global environment continues to be difficult, the more practical number is 8% in the first year out of the slump and then settle back at 7.5% sort of a growth rate.{break}

‘Industrial recovery was stronger than expected’
Moneylife presents the second part in a three-part series of the interview with Vetri Subramaniam, Equity Head, Religare AMC.

ML: Why has the market so quickly discounted the impact of the monsoon?
I think the monsoon is not a significant factor. When you look at data like monsoon is 20% less, how much does it affect the GDP growth? I am not an expert in this issue but it suggests to me that there is some kind of downside pressure on the economy coming through from agriculture. But I think the reason why the market has looked beyond is actually something else and that is essentially the fact that the industrial recovery has been far stronger then what we had anticipated. I mean six months ago our baseline view was that we would grow at a 6%-6.5% and while my baseline view has still not changed, that number frankly should be revised upwards given the strength in the industrial production. The only reason that it has not been revised upwards is only because of the weakness that we can eventually see from a poor monsoon. 
ML: Domestic investors have poured more funds into the markets. Have we finally shrugged off our huge dependence on FIIs? If so, what are the long-term implications?
Well, the rally was started more by foreign money. You can argue that the paper that was floating around was actually sucked out in the first place by domestic investors during late 2008 and early 2009. I think the bigger issue is that pretty much since 2007, the total domestic institutional buying—whether it is insurance, banks, mutual funds put together—has actually been more than what the foreigners have done. I think this is an important trend and it’s a trend that will at some level eventually sustain because at the end of the day the economy is growing in nominal terms at 10%-12% and incomes are growing and when incomes are growing investible surpluses are growing. They have to go somewhere. Obviously the asset class of choice much to our chagrin has been ULIPs over the last three-four years. Maybe it will be the New Pension Scheme in the next three-four years. Eventually this money has to find a home somewhere. If you say this money won’t go into the equities because the Indian investors are very risk-averse, I would argue it would equally end up creating an asset bubble, because the money would then flow into bank fixed deposits. Then we should not be discussing rate tightness; we should be discussing 5% rate for FDs. Eventually something has to balance out the equation and I think the pure fact that you are continuing to grow at nominal terms 12-14% GDP means that incomes are growing and disposable savings are growing and equities are bound to benefit.
ML: What are your expectations regarding corporate performance and which sectors do you see outperforming?
I think the resilience has been more on the economic numbers rather than necessarily in earnings and particularly balance sheets. A lot of the pain which was not felt in the economy was recorded in the earnings and lot of the pain that was not recorded on the earnings was recorded in the balance sheet. Companies have done all sorts of accounting jugglery; they used the rules to their advantage to not take into account what they should have had on their P&L and all of that. Maybe the true extent of non-performing loans has also not been recorded in the system because the RBI gave a time-window to the banks. I don’t think the true extent of earnings damage has been captured fully in all the reported numbers. Having said that, in terms of a trend, the June quarter numbers were clearly a little bit of a surprise, but more because of cost-related issue rather than top-line. My sense is that the second quarter will be more of the same. Maybe the top-line is still going to look uneven but the bottom line will look much better, but by the time you get to the end of the year, the cost pressures are going to start catching up again. We already started having pressure on most cost items whether raw materials, salaries, fixed overheads all of them have started to inch back up again. It’s interesting that you actually saw some of the best operating margins that companies have ever recorded in the last eight years being reported in the June quarter, when we were just coming out of a recovery. I think at some level they will have to give out some of their margins back either because of the pressure of raw materials or because of competitive pressures. Margins cannot stay at these elevated levels for so long. But hopefully it may get replaced by some element of top-line growth by the time you get into the fourth quarter and that should be possible because on a year-on-year basis obviously your volume numbers should grow as per your expectations.
Our key preference remains for domestic consumption themes like consumer staples and consumer discretionary items. Not that they are absent of valuation issues but the valuation issues are across the market. Banking and finance companies too feel that credit growth is starting to recover. We are far more cautious about sectors that are more globally interconnected like the commodity space. We have been positive about IT but now valuations have gone up. But on a two-three year perspective, the IT business model will weather this downturn because the downturn in the western economy in this time is more consumer led rather than business led. The health of corporate balance sheets in the developed world is reasonably good. The financial system had a problem but that also has been largely put behind so I don’t think spending trends will really get badly affected. {break}

‘RBI will have to gradually start to hike rates’
Moneylife presents the last instalment in a three-part series of the interview with Vetri Subramaniam, Equity Head, Religare AMC.

ML: At what stage would inflation and higher interest rates be worrying factors given the higher high liquidity in the system, rising prices and huge government borrowing?
On inflation the RBI has already started to move the coin around. When he spoke in July, the governor talked about how the primary agenda is growth and we (the RBI) will not do anything until we are sure that growth is well-entrenched. Now he says that we might have to exit our accommodation ahead of the rest of the world because there could be inflationary pressures mainly because we remain supply-constrained. RBI will have to gradually start to hike rates and it could be as early as the current quarter. There could be some non-interest related measures of tightening in this quarter and then the more classic bank rate, repo rate in the first quarter of calendar year 2010.

ML: On the other hand, there could be a lot of money coming from PSU disinvestment and maybe there would be no need to raise rates?
It certainly helps to ease the problem but what I hear we will take the middle-of-the-road approach of raising $4billion-$5 billion a year. But the government can do what China has done in the last five years, which is to think big and act big. I would actually recommend that if you want to raise a big chunk of money, disinvest stakes in Coal India and LIC. When you do that you will be surprised with the kind of appetite. Local retail has always had a strong following of all these PSU offerings as long as they are reasonably priced. But it would be a significant matter for foreign money as well. Forget $4billion-5 billion, we could raise $10 billion or $15 billion in one very large size disinvestment. If we do it in big chunks, we would be surprised with the kind of money flows.

ML: With the markets back in full swing, IPOs are back in vogue. A big burst of IPOs is usually is a contrarian indicator. What is your sense?
Going by the number of pre-IPO research reports which have been flooding into the office in the last one month, it obviously signifies that the trend is picking up. Lot of these are the usual suspects who got left out in the fund-raising last time around are coming now. Most of them are real estate companies who couldn't raise the money in 2007-08. I think they might find it a little challenging. We don't lack diversity in terms of the number of listed real estate companies. Now you have got 10 more real estate companies wanting to raise money. I don't think it is going to be so easy. The PSU offerings, if they are large-sized and reasonably priced will have a large following because there have been reasonably large number of people over the years who have made money by investing in these government offerings. I think there will be an active calendar of offering from the government, which the market can absorb. If we see a lot of these real estate IPOs meet with an extravagant response, then I would start to think about it in terms of being a contrarian indicator.

ML: What is the direction of the market over the short-term, medium-term and long-term?
I think from a medium-long term point of view we are definitely positive. The only issue I see is that the scope for returns have been reduced by the fact that the valuations have already run up quite a bit. Historically, Indian market returns on a rolling basis is 15-16%, which are a shade above the kind of nominal growth rates that we have in line with profit growth. But when you have already run up to a PE multiple of close to 20, you need not just a 15% profit growth, but you also need the PE multiple to remain unchanged over the medium term to realise that 15% CAGR. My sense is that the medium-long term prospects are still good but medium term returns are being compromised by this level of valuation. In the short term our sense is that the market is outside our comfort zone in terms of valuation. It is vulnerable. What will cause it to come down is hard to say. For example, we have seen China fall off almost 20-25% from the peak in August and September for a variety of factors. So it could be anything that could cause a significant pullback.




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