I foresee China as the next big bull bet: Shankar Sharma

Interview with Vice-chairman and joint managing director, First Global

The benchmark indices have gained around 10% in Samvat 2072. SHANKAR SHARMA, vice chairman and joint managing director at First Global tells Puneet Wadhwa he remains bullish on the emerging markets. Indian small-caps are the single best equity asset class in the world, he says. Edited excerpts:

Do you think that the global equity markets are headed higher over the next six – eight months, irrespective of the outcome of the US Presidential Elections and the possible rate hike by the US Federal Reserve (US Fed)?

Yes, I am optimistic on global equities. Fact is, the US economy is no shape to withstand hikes, no matter what the US Fed says. I have said consistently for the past one - two years that the US Fed’s standard style is to keep saying US economy is in great shape, employment data is great; but chicken out when the moment comes to hike. Frankly, it’s all classic bluster – running with hares and hunting with the hounds’ strategy. I remain unconvinced that there is will be any meaningful hikes from the Fed, and even if there are, they will be too small to dent the case for equities.

Let’s be clear, the only reason why equities have done well since the global financial crisis and look good going forward, is the almost zero return on alternate investments. So, overall cost of capital, i.e. the hurdle rate, has declined sharply, thereby making even tepid growth look great in Present Value (PV) terms. It’s as simple as that. The governments figured out the math - “We can’t do much for growth. But we can reduce the cost of capital-hurdle rate”. This is the sole reason why we have a bull market in equities despite economic gloom across most parts of the world.

How does India stack up against its emerging market peers? Do markets look over-priced at this stage?

The stupidest thing I find is everybody starts talking valuations without adjusting for interest rates. Price-to-earning (PEs) is a direct outcome of interest rates prevailing. 22x at one per cent interest rate is not the same as PE of 22x at five per cent interest rate. Nobody seems to adjust for this, and hence, keep lamenting that valuations are rich/high is utter nonsense. As long as one sees rates being low, the bull case is intact. For India, for Emerging Markets (EMs), and broadly the world, some exceptions notwithstanding. 

Can China spoil the bull-run across global markets, especially in the Asian region?

I see China as the next big bull bet. It has had a quiet time last few months, but with the attempts China is making to cool down a runaway property bull market, that money will flow into equities there. I am a bull on China from hereon, and also, on EM as an equity class.

In the Indian context, mid-and small-caps have had a good run this year. Is there more steam left? 

I remain extremely bullish on small-and mid-caps. In fact, if you see, the BSE Small-cap index is only now barely reaching its life time high set in 2008. Once it crosses that, a new journey begins. I have said this before: Indian small-caps are the single best equity asset class in the world. Go see the data; that’s exactly what they have been last couple of years. 

What are the next set of triggers for the markets, and what are the key risks one should be aware of? 

Frontline indices in India are loaded with ageing companies. The bull market in large-caps, barring a few exceptions, like autos etc, is a matured one, not a young one. Information technology (IT), Pharma, Banks, Consumers, telecoms – all bulwarks of the large-cap bull market, are showing wrinkles that no amount of makeup / cosmetic surgery can cover. It’s sad to see beauty age, but it’s inevitable. In my view, Indian large-caps will still rise but will sharply underperform small-caps, as they have, and hence, I have no interest in them, barring a few exceptions. 

What is your market outlook for the next Samvat? Which sectors and stocks, in your opinion, are likely to lead the next leg of up move?

I see a great year ahead for the small-caps, and an average year for large-caps. Autos still look great and the data is very supportive. India is still a hugely underpenetrated auto market. There is still 80 per cent of India that doesn’t own any motorised transport. Add to that a replacement cycle. Add to this the fact that autos are a branded business (unlike telecom which is a pure commodity business). I see massive growth ahead for our auto majors. I am also bullish on commodity sectors, like steel.

Do you think the monetary policy will be guided more by political compulsions rather than pure economics going ahead?

Well, the Reserve Bank of India (RBI) as an independent institution, is a thing of the past. That era of pure independence is dead and is never coming back, like it or not. In my view, rates are headed lower in India, whether conditions merit or not. It’s not for me to question that, in today’s environment. 

As an equity investor, I am clear about one thing – lower rates and moderately higher inflation are perfect recipes for a bull market. Lower rates means lower hurdle rates. Higher inflation means higher pricing power to companies. That’s all that matters for equity investors. The general public don’t matter when it comes to investing – that’s the unfortunate reality. 

Western governments have killed retirees and savers in favour of pleasing Wall Street. We will go the same way, given the unanimous support this government enjoys among the financial community. So we will have lower bond yields and that will drive markets higher, irrespective of earnings outlook (which looks terrible to say the least). Our savers don’t matter. 

Going ahead, how much importance will the markets give to corporate earnings growth and the implementation of the goods and services tax (GST) Bill? 

The GST is a long way away. Earnings are more important and they look terrible on the aggregates. How can corporate earnings grow 15 – 20 per cent when nominal gross domestic product (GDP) growth is five – seven per cent? Let’s pray that inflation comes back, if we want earnings growth to rebound. 

Calendar year 2016 has been good for the primary market. Did any initial public offer (IPO) catch your attention? Looking at the pipeline, are you looking to invest in any? 

I don’t look at IPOs for proprietary investing. It’s like chasing a needle in a haystack to find a few under-priced ones. A few do well, but vast majority are already fully priced or even over valued when they hit the market. Not my area of interest.

Talking about disruptors, Reliance Jio has been to telecom sector as Patanjali was to the consumer staples / FMCG segment. What are your thoughts on this?

Get out of telecom. As Amitabh Bachchan said in his movie ‘Deewar’ when told about his father’s death: “Mar to who bees saal pehle gaya tha. Aaj to sirf usey jalaya jar aha hai”. This sector made too much money till 2007, too high return on equity (ROE). This caught the government’s eye. Competition increased, then spectrum auctions came. Now the sector is headed down the path of no return – high capex, low return on capital employed (RoCE), commodity characteristics. A deadly combination.