 "India, China will drive emerging market outperformance in 2015: Shankar Sharma")
How do you see the global markets playing out in 2015? For how long, in your opinion, will the central banks be willing to inject liquidity to support or revive growth?
Since 2009, every year has been very tricky and almost always full of surprises that defy consensus. How we pine for the
beautifully predictable 2004-07 era! The US is almost certain to raise rates, India looks certain to cut rates by a bit more, the euro zone has really no options except a huge QE (quantitative easing), Japan is failing to revive despite the yen being at 115-120 a dollar and massive QE.
By and large, central bankers globally have simply no option but to be accommodative. The world is struggling and my view since 2009 has been that the world will continue to struggle for a while, till the excesses of debt have been purged. Given this struggle, and given the threat of deflation, money will have to continue being easy in most parts.
Don’t you think equities, as a result of liquidity injection, have been artificially inflated to worrisome levels?
Equities have been inflated across the world; at multi-year highs in many markets despite economic growth being tepid. Even the US’ five per cent annual economic growth is a bit sleight of numbers. A large part of it has come from the increase in net exports, not because exports increased but because imports fell. The effect that oil at $40 a barrel will have on the US is by no means a clear positive.
Nobody living has seen a liquidity rush like what we have seen since 2009. So, all our theories of what is “fair value” have been tossed out of the window. What is real value, and how much is the froth — well, there are no deterministic answers.
The world is facing a major deflationary threat. Bond yields across the world are falling. Now, equities are supposed to be the best hedge against inflation, gold aside. So, what good are equities supposed to be in deflation? I have not figured this one out yet.
What are the key triggers and risks for the global equity markets as we head deeper into 2015? Which regions or markets could possibly weather the storm better?
Emerging Markets (EMs) have been trashed since 2011-12, well against consensus. The world is underweight on EMs and overweight on the US — the exact opposite of how it was in 2011. This could set us up for a surprise reversal trade, when EMs actually do better than the US this year, at least for a while, largely because of China and India.
We have been bullish on China since late July 2014, when it became clear the Dollar Index was going into a long-term break-out (it was 80 then, 92 now). Given this, our view on commodities became very negative, and we alerted clients about oil going to $65-70, though we never thought we might see the $40s so soon; EM currencies falling; and China, being the only dollar-neutral EM (except the UAE), doing very well.
What about India? Do you think Indian markets can continue to perform well at a time when major global economies continue to remain under pressure?
In India, we have been relative bulls since 2009 versus the rest of EMs, and have written about it many times — that India offered great advantages over the rest of the BRIC pack — and India has handily beaten its peer markets for years now.
In 2011, we wrote India was the Rolls-Royce of the BRIC pack, at a time when the whole world was trashing India, saying that the “I” (in BRIC) should be Indonesia, and not India!
India has been a standout performer among the BRIC nations since 2011. It is a model of low capital intensity growth, declining debt-to-GDP over 10 years (which is not because of high inflation, as is carelessly said), lowered interest/ Budget receipts (50% to 30% in 10 years), and a market that is well balanced, sectorally.
We see no reason to change this view. With oil at $40, the case has been strengthened massively. It is our view that India and China will this year drive EM outperformance over US equities — India should be 15% higher, and China more than that.
The surprise rate cut by the Reserve Bank of India (RBI) saw a relief rally. Do you think it will now be on a prolonged pause before it lowers the rate again? What quantum of rate cut do you expect over the 2015 calendar year?
The rate cut surprised us, not because it happened but because it happened between policy meetings. What was the rush to cut rates mid-policy? Normally, this is done in emergencies. What was the emergency here? I think (RBI Governor) Raghuram Rajan got pressured into cutting rates. Ideally, he would have liked to wait a quarter more to cut rates, especially with the fiscal deficit situation being worrisome to say the least.
But the government’s strategy (of exerting pressure on Rajan) worked, and that is all that matters. That the world is facing deflation, is manna from heaven for India, a chronic inflation sufferer. This means inflation in the country is going down for a while to come, and so, the rate has to follow the global trend. Our rate has been an outlier for too long. It should be lower by 75 basis points (bps) this year.
When we last spoke, in September 2014, you were bullish on small-caps. How has that strategy played out for you? Do you still like stocks in the mid-and small-cap segments?
We continue to be bullish on mid- and small-caps. That space has been hugely rewarding, and will continue to do well.
What are your top picks in terms of sectors and stocks in the large-cap segment?
We know the ones to avoid — oil & gas, metals, infra, power and telecom. The rest are, by and large, okay.
Do you think 2015 could belong to the defensive stocks like pharmaceuticals, fast-moving consumer goods (FMCG) and information technology (IT)?
FMCG looks good, as lower inflation should drive increase in consumption. Banks will also do well because of rate cuts, particularly PSU (public-sector) banks. IT, pharma, autos are fine, too. These sectors have been doing well since 2004 and will continue to do so through 2015.
What is the road ahead for key commodities and commodity-related stocks? Do you think the fall seen fully pencils in waning demand or have the fears been overdone?
In my view, the whole world, led by Jim Rogers and Goldman Sachs, over-intellectualised the commodity boom that started in 2002-03. The fact is commodities — from oil to gold and steel — had been in a massive, decades-long bear market (steel prices had been flat in nominal terms for 15 years prior to 2002, gold had been in a bear market since mid 1980s).
Many started calling the boom, the commodity super cycle, etc. Many predicted the world would run out of oil. In reality, there were two mundane reason for the commodity bull market — and this is something we have written about extensively. One, the fall in the dollar from 2003, which created the first impetus to the commodity boom; and two, a massive spending spree in China, which ratcheted up demand several times.
Now, both these factors are dead for a while: The US dollar is on a tear and I see no let-up this year; and I don’t see China demand ever coming back to its old levels. The case for a long commodity bear market is clear. I have always maintained that bull markets in all other asset classes — real estate, stocks or bonds — are welcome events and benefit everybody in society.
But a bull market in commodities is always a negative for large parts of the world. So, it always produces negativity. Simply put, who wants to pay more for petrol? There can never be a commodity super cycle.
How do you evaluate the government’s focus on infrastructure and related stocks as an investment theme for 2015?
Everyone who bought into the recovery theme after May 16, 2014, has been taken to the cleaners. These sectors — infra, power, metals, oil & gas — have been dogs, and their levels at present are, in fact, lower than when the new government came to power.
The paradox is that the market is 15 per cent higher since May 16 but this rise has been contributed entirely by the same sectors that drove the bull market from 2004. The sectors that were supposed to benefit because of a leadership change have been crushed. That is because the problems afflicting them cannot by solved that easily, if at all.
Infrastructure is a loss-making industry in most parts across the world. That is why governments should do the majority of this spending: The government can monetise and capture the value of infrastructure through many ways, like greater social good and better connectivity leading to higher asset turnover in the economy, improved efficiency and lower costs in the economy, etc.
A private-sector player has no such wide-ranging benefit streams: Either his road project makes money on a standalone basis or it does not.
What are your expectations from corporate earnings in this quarter and over the next few quarters?
Our expectations on corporate earnings growth are average to tepid. Lower oil prices should lead to an across-the-board reduction in prices of products; that is good for the consumer. But that will have a lag, and not immediate, effect on consumption. So, we see demand picking up in the economy about two quarters from now.
Most market participants are eyeing the next Union Budget for the government’s blueprint on reforms. What are your expectations? Will the markets severely punish any disappointment?
I never look at Union Budgets for anything useful. It is always a make-believe world of rising revenues and falling expenditure. And, it is generally forgotten three days after the event. The only thing to focus on in any Budget is the tax change fine print, since it is almost always anti-taxpayer.
Sharma can be reached on Twitter: @1shankarsharma