‘Big bull markets are built on low land, capital costs’

Today, most factors are supportive; however, valuations remain a concern with India’s equity markets. For those investing with a three- to five-year view, now is a good time to start SIPs. Prior to the elections, we were cautious on equities, but not any more, given the fantastic mandate the government has garnered. In our entire investing careers, we have always factored in unstable coalitions but never ten years of a single-party rule with a strong majority.

We are not worried about aggregate earnings as we are in the early stages of recovery taking shape this year. We believe this year the markets will be supported by corporate earnings from domestic cyclicals and financials (larger weightages in indices), rather than consumption, which was strong over the past five years.

The answer to this lies in the reasoning for the slowdown. Pre-IL&FS, several corporates that were not credit-worthy got access to funds easily, which is not the case currently. This causes a slowdown, which is not necessarily unhealthy. The other factor was that companies were using collateral to borrow at a time when their financials were steadily deteriorating. In such circumstances, the prudent approach would be to deleverage, rather than to further add to borrowings. Therefore, non-availability of funds to such borrowers is also not a negative.

We are of the view that for the economy to do well, in the long run, lower land prices are a necessity. Despite the real estate sector being over-leveraged, land prices are yet to correct. If the government’s policy-making in the next one year results in lower land prices, we believe it could lead to a material pick-up in the economy.

Historically, in India, land and capital prices move in tandem. In 1991, liberalisation sharply brought down the capital costs. Between 1998 and 2003, both land prices and interest rates fell sharply. However, land prices and interest rates shot up sharply between 2003 and 2013. Since then, interest rates have corrected, but land prices continue to remain high.

We believe that for a healthy and strong economic growth, the cost of land and capital has to be low; labour costs in India are already reasonable. This could be one of the triggers for the next big bull market, akin to the rally between 1991 and 2003.

Till that point though, the market direction remains unclear. There could be two possible scenarios playing out - If there is near term market volatility, it could set the stage for a strong bull market later or if we have a bull run now, we may get a middling bull market with debt-style returns from equity.

One of the primary reasons was consumption stocks being too expensive along with worries around a consumption slowdown. This led to reallocation of capital from expensive consumption stocks to beaten-down cyclicals, mainly domestic cyclicals. In fact, except global cyclicals, most other cyclicals have gone up.

Currently, there has been a significant earnings downgrade in consumption stocks, but not in domestic cyclicals. Also, the earnings outlook in corporate banks or infrastructure is improving. Compared to consumption which had a bull run over the last decade, domestic cyclicals remain inexpensive.

Many of the PSU stocks are at 10-11x trailing PEs with a 5 per cent dividend yield, which is a good bottom in India. But whether these names turn out to be good value-picks or not depends on the decisions taken by the government. We can only hope that the government recognises the underlying value of these businesses.

There’s a lot of worry today about the consumption slowdown. Are there cyclical or structural factors at work there?

We were of the view that consumption cannot grow while investments stagnate. Such growth never lasts. From 2003 to 2007, we saw the opposite happening, with capex and investments growing rapidly. So, we were due for a cyclical consumption downturn given the untenable rise in valuations.

The NBFC crisis is a well-known and widely discussed problem. We are of the view that the trouble is probably smaller for the markets than the general consensus because the aggregate size of the problem is insignificant when compared to GDP.

Debt today is an attractive asset class. The more an investor is willing to move away from safe assets, the more attractive the returns are. On equities, markets are not cheap, barring certain cyclical stocks. With a good stable government in place, our outlook on equities has improved. However, the sustainability of recent outperformance seen in several mid and small-cap stocks is questionable. We were underweight on these pockets over the last two years owing to high relative valuations. Usually, foreign flows drive large-cap stocks while domestic flows drive mid and small-caps.

If the global risks were to escalate today, we believe India will emerge as a relative safe haven. In a trade-war scenario, while other Asian markets reacted negatively, India has been relatively insulted.

In fact, India stands to gain from the trade-war situation. But the same cannot be said in case there is an oil war or if oil prices shoot up. A stable oil price is critical for India. If oil prices cool off, particularly below $60 a barrel, it can be a major trigger for both bond market and stocks to rally in India.

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