Hope Modi govt has learnt its lessons and focuses on growth if re-elected: Krishna Memani
- Outlook for emerging markets for the next few years is quite good.
- The long-term growth story in India is very much intact.
- The good Indian IT companies will survive and have to reinvent themselves.
What has changed for the emerging markets in last few weeks? Why is the case for emerging markets looking so strong?
What has changed is the Fed’s positioning with respect to the US economy. In 2017 and 2018, the Fed was tightening rates and when that happens, typically flows reverse out of emerging markets and back into the US. Coming into 2019, expectations changed and as a result, people have been buyers of emerging markets and India clearly is benefiting from those general flows going out of the developed markets into emerging markets.
How serious is the global slowdown because typically if Fed is making a case that interest rate should go down, that also means the US economy will slowdown. So, should one get excited about the flow picture?
Well we are talking about slowing growth from relatively high levels and lack of inflation. Our expectation is that by the second half of this year, after going through a soft patch, 2019 growth would probably end up close to 2% and that is a relatively good environment for developed markets like the US. With no inflation and Fed not tightening policy effectively, this is an environment where equity should do reasonably well.
Given the high levels of equity valuations in developed markets, people have started investing in a reasonable way into emerging markets where valuations are significantly better and the risks associated with emerging markets getting into a recession because of the Fed’s tightening posture those risks have gone down.
How long would cycles like these last. For EMs, what is the outlook now?
Our expectation is that the current growth cycle in the US and by correlation other developed markets probably lasts a little longer, five more years is the way we are characterising it. The idea is with lack of inflation and decent amount of monetary policy support, the current cycle can extend itself. In that environment, emerging markets should do reasonably well because looking for returns, people would be focussed on where the growth is and in the current global context, the highest level of growth is really in emerging markets.
So, to the extent that Fed maintains its policy and we expect them to, the outlook for emerging markets for the next few years is quite good.
Should the outlook for EMs and the outlook on those economies move in tandem?
The outlook for emerging markets economies is a little bit more mixed. There are places like India where the underlying growth trend is relatively stable, give or take a few percentage points, depending on the policy. But then, you have places like Brazil and China where the outlook is far more suspect. Things are slowing down in China and they are trying to re-stimulate things by easing both monetary and fiscal policies. Therefore for 2019, the growth outlook is quite good. Whether that sustains in 2020 or 2021 is a very open question.
Markets are good because flows are flowing out of developed markets into emerging markets. However, whether the underlying economies grow at the fast pace that they did at the beginning of this century or even after the financial crisis, is a really open question we will be debating for quite some time.
Have you taken a relook at your stance on India recently? How are you approaching the Indian markets in the current context?
We really have not changed our India positioning in a meaningful way. We have been believers in some very specific Indian growth stories for quite some time and we are basically sticking with that. Our flows are really not that driven by near term Fed policy and things like that. We are more driven by good companies that are executing really well where we can stay for 10, 15, 20 years. That is how are operating principle has been with respect to our Indian investments which is typically not the case for most other emerging market funds.
True but what about valuations? Are you finding them attractive at these levels?
Indian equity valuations are not cheap relative to other emerging markets. Having said that, not having a decent allocation into Indian equities is something that no emerging market manager really wants to do. So, they go into these Fed driven flows as opposed to company-driven flows which is what we are part of.
The Fed driven flows into emerging markets end up in India as place holders far more than anything else in well known companies where the underperformance risk relative to the Indian benchmarks is quite modest. That’s what these “tourist flows” focus on.
What kind of companies are you focussing on in your India portfolio? Are you this long-haul guy who would take a 10-12-year timeframe?
I would clarify that a little bit. Our focus in India is really about companies that we believe will do very well because they have good management teams and which are in long-term businesses. IT sector, for example, remains a focus for us and we do not really worry too much about near term valuations in those types of things.
Banks for us are quite attractive because bank valuations are pretty good and I think financialization of Indian markets will probably continue for quite some time and banks as intermediaries should do reasonably well. Then we focus on individual banks which we think are executing pretty well. Companies like HDFC. Even occasionally a company like ICICI, which may have underperformed for some temporary reasons but the underlying core strength of the company is quite good and if we can buy them at a cheap valuation, we will surely look at it.
How do you think the NPL situation in the financial sector has moved? On one side, opportunity is coming back to corporate banks. Can the growth be a challenge because credit offtake numbers have not normalised?
I do not think it is a train-wreck. If the Reserve Bank adopts a reasonable policy, it is a very solvable problem. Having said that, I think this is something that they had to do that as the NPL position of the Indian financial sector is very problematic and finding ways of solving that problem while not throwing out the baby with the bath water, is the right way to approach things. The central government has to ensure that credit creation remains relatively stable but at the same time, coming up with policies to solve the long-term problem of NPLs and these banks being saddled with all the humongous NPAs is the right thing to do. In the short run, there is always going to be a price to pay but from a long-term perspective, it is going to pay rich dividends.
We have got a very big overhang of a very critical event -- the elections. How critical a factor do you think would elections be for the markets?
First of all, I do not think the elections are going to be market unfriendly. Modi may not get the majority that he is looking for but the chance of him not getting elected -- at least in our judgment -- is relatively modest. So that is what the markets are pricing in. We do not anticipate a meaningful underperformance of the market because of the election results.
Having said that, the long-term growth story in India is very much intact. so even if this election ends up being not too market friendly our expectation is that to fulfil the aspirations of Indians down the road at some point, and at not too distant a future, irrespective of who gets elected, policies would have to be good economic policies that support long-term growth.
We believe India is likely to remain the fastest growing long-term economy in the world and therefore if there are market opportunities like that we would certainly take advantage of that.
Some would argue that if the current administration comes back into power, nothing much could actually change because five years ago when they came into power, the general view was earnings will pick up, banking sector will revive, all the basic leakages in the economy will get plugged up India will be back on a 6-7% plus GDP growth track. But nothing has happened.
As a fellow Indian and part of the global Indian community, I am hoping that the Modi government has at least learnt some lessons out of the policies that it implemented. Demonetisation clearly was an uncalled for disaster. It did not accomplish anything and caused a great deal of commotion. GST on the other hand, has caused near-term problems. However, from a longer term perspective, it is probably the most important piece of legislation that got passed because it provides for resource mobilisation that did not exist before.
Similarly, solving the NPL problem it is short term pain but long term gain. I would say that some of the policies that they have implemented have been really good policies and some of other policies have not been as good. Hopefully, they have learnt some lessons and in the new regime they will take advantage of that and the fact that they have had a little bit of trouble of late, gets them more focussed on economic growth which is what India needs more than anything else.
Overall, what you are saying then is that due to a change in the Fed’s stand, it will mean further good news for global equities?
Mr Marks only had to go to December to see that that is absolutely not correct. From September to end of December., equity markets corrected almost anywhere from 10 to 20 percentage points.
Are you confident that this cycle can last another five years and when it comes to the drivers, which of them do you think are the strongest?
Yes indeed. Again as I mentioned before, our outlook is this cycle lasts, at least the economic cycle lasts for another five years and whether it is going to be precisely five years? I do not know. What I do know is that for any relevant investment horizon, the outlook is still quite positive and the drivers of that are relatively straight forward, supportive monetary policy, lack of inflation and no significant misallocation of resources in any part of the US and developed market economy. That is really what will probably extend the cycle more than anything else.
Markets or economies do not die natural deaths. They are driven to that either by some sort of excesses or by bad policy. The Fed pivoting and the fact that their banking system is not over levered, the fact that credit spreads are relatively stable and that credit growth has not been extraordinarily large, all together will probably support the economy for quite some time.
Let us talk about the prospects of the IT sector. What kind of stocks would you say you think can ride the cycle? Or does IT even make sense right now when the rupee is inversing?
The good Indian IT companies will survive and they will have to reinvent themselves. The point with respect to IT investment is not as a sectoral investment, as much as it is finding good companies where we believe they can revive their growth plans because they have the ability to innovate and reinvent themselves.
That is not going to be the case if you are going to be a low-end service provider, you will have to move upstream and continue to grow your product portfolio especially in areas where there is growth -- which is cloud, artificial intelligence, data sciences. If you want to remain a glorified BPO, then the outlook does not look that good. It is more company specific rather than sector specific.
Since you believe in buying companies for five to ten years, should one not shy away from buying these stocks which are trading at PE multiples of 40 times 50 times? Eventually in 10-12-year timeframe, consumer is where you should be and consumer is where even the PE multiples are elevated. They will get even out as time moves forward.
This is the biggest challenge with consumer companies. The best story in India is consumption for sure. However, if you cannot find a company that is reasonably valued, then you are basically paying somebody else for coming in and as an investor that does not really make much sense.
Our outlook for consumer sectors is really not that great. There are companies that we look at but as a sector and that is not where we are focussed. We are focussed on where the outlook is good and reasonable valuations persist and where we can come in at a good enough entry point. If some of them correct, we will look at them. But today they do not offer much value.
What about the promoters that you like in India?
I cannot talk about specific companies but I would say that there are lots of really good promoters in India. One example is HDFC. This is a company that we have been with for a very long period of time. They have delivered. They have been fair to their shareholders. It is a great company and we believe there are plenty of opportunities like that in India.