Shankar Sharma: India will likely lag its EM peers

Same government coming back, does not mean much for the market; another government coming back for temporary period might mean a bad thing but market might then end up thinking that new thinking might not be such a bad thing. So we will wait and see, said Shankar Sharma, VC & Joint MD, First Global, in an interview with Nikunj Dalmia of ET Now. 68196059 66931376 66918133 Edited excerpts: What is happening to the world? 2018 was a shaky year. It took everything on the chin. In 2019, has world made a comeback? World is fine. I do not think world has any problem. We can see how China has performed over the last few days. It has put behind trade tensions, trade wars. The world is a very peaceful place. I do not see any problems and I am talking about the world at large, not necessarily in our backyard. Rest of the world seems to be talking progress and economy and rates and jobs and I think the world is in a good place. US is doing very well. Russia and Brazil have performed dramatically well. China, which was a laggard, has in my view now broken out and now you will see a lot of outperformance from China. The world seems to be a great place to put money into equities. Even the US had a very ugly December but do you even remember that now? It has gained back pretty much everything. Even a stock laggard like Apple is now at a three-month high. So things are looking good globally. If things are looking good globally, why is India underperforming? Global trends in 2018 were negative, but we stood tall. Now they are better, but India has to align with global reality? As long as we are going to do all that we are doing, I do not see why India should be bucking the trend that it has seen in the last few months. It is just that stock markets like peace, calm, harmony, progress, discussions around economic issues, discussions around employment, not the stuff that we are largely discussing these days because that is a path to nowhere. Nobody got rich or prosperous discussing war and temples and stuff like that. So I am little worried about the discourse that we have right now, taking us away from what really the country needs and obviously we need to grow a lot faster than we are. We need to have more people coming into the employment net. We need to have companies declaring much better numbers. So we need to focus on the good things but somehow the discussion and discourse in India is a little different. If you were to question that, then obviously you yourself questioned as to why are you taking us away from what we love discussing these days which is border and tension and Pakistan and stuff like that. So, it is okay. We both know that good news and good prices do not come together. Right now news is not very market friendly whether it is geopolitical, earnings, or the promoter front. But do you think it is time to start shopping? My view is that some of the stocks are still fine, some are dodgy. Many corporate groups look extremely dodgy. So there is a mixed bag of players out there. Several of them have corrected which I think is great and if you are brave, you can go and buy them. But I am not prepared to make a big market call and say the worst is over. I could be very wrong on that but that is okay. I am invested. I will be happy if the market rallies and rally sharply from here on. It is just that I do not want to stick my neck out and say that worst is over and blood is on the Street and so let us go and buy some stocks! Like I said, we do not know how the stuff that is currently dominating the chatter, plays out. We do not know how all this affects the elections. There are many imponderables out there. I recognise the fact that sometimes market can work very differently from what people generally anticipate. I am prepared to take that risk and I would rather not stick my neck out and make a big call on where the markets are headed. But there are many stocks that look very attractive and we will stick to that. Let us look at all the scenarios, to understand what the markets are pricing in. Scenario number one – the current government comes back into power in the current avatar. Scenario number two – the current government comes back with outside majority and third is that we see a change of guard and a new government takes over, backed by a different political party. What do you think markets are betting on? So, let us assume the same government comes back. I do not see why that itself should mean a big upmove in the market because if the same government comes back, you will have the same policies, good or bad. I am not making a judgement on that but it will be basically more of the same. In that case, the markets will just replicate or keep going down the path they have gone for the last few years which has been not very bad, but not very good either. So it has been a mixed kind of thing. India has not been a huge outperformer or a huge underperformer barring of course the last couple of months. If the same government comes back, I do not see any cause for the markets to suddenly go up 20% a day because it will be the same thing being repeated all over again. On the other hand, if another government comes to power, the market is now left with a whole new set of things to figure out. Let us say the UPA comes back in some form, in which case the markets might say okay for a minute it is very bad news because we love the current government and any stable government or any existing government going out is generally considered to be a bad thing, but then we had 10 best years of stock market growth and the 10 best years of economic growth under the UPA. So, maybe then it is not so bad. Remember, in the first phase, which was the best phase of the UPA -- UPA-1 -- they had the Left to contend with and despite that we had terrific numbers. The markets in my view will sit and take a deep breath once the numbers are out and in either event, I do not think you are looking at a very substantial up move. If the same government comes back, I think it will be more of the same so it will just continue around the path. Other government sort of comes, it might have a down day but the markets will then sit back and re-examine past data and say it is not that bad and India’s policies for whatever they are worth will still continue and a fresh government might give you some fresh thinking. So it is a complicated question and there are no clear answers, but my sense is that the same government coming back, does not mean much for the market; another government coming back for temporary period might mean a bad thing but market might then end up thinking that maybe new thinking might not be such a bad thing. So we will wait and see. So you are of the view that markets are unlikely to move higher in the short term, the underperformance in India is here to stay. There is a case for anxiety because of geopolitical events and because of election. What kind of picture do you think could emerge in the runup to the election? Is a 10-15% fall likely? Of course. If you are talking 10-15%, I do not think there is anything to discuss. If you are talking a 10-15% decline in markets and you are going to put 10-15-20% of your capital, that is a pretty good area. But I do not think markets are going to decline 10-15% and that is going to be a huge fall if that were to happen! I do not think we are set up for that kind of fall unless something very drastically wrong happens at the border and you do not know how things can happen in such volatile situations. Leaving that aside, I do not think the markets are set for 10-15% decline. If they were to happen, there will be many stocks which will fall 30% and they have already fallen 30-40%. That means you are looking at incrementally 50-60% from the peaks. As long as you are confident of the companies’ numbers and they do not have leverage, you can put money to work in those kind of situations. You have been a big votary of small and midcap stocks. When there is such a negative wave of selling of mid and smallcaps, how would you safeguard your small and midcap portfolio?If anything, I am even more bullish because there are newer companies that I have seen look very good and numbers are very strong. We had stocks falling 30-40% and I have always said that this is a volatile category. If you do not have the stomach to withstand 30-40% fall on your portfolio, then you should not be in this category at all. Rather, you should not be in equities at all! Forget about smallcaps because even largecaps will take a 20% knock. I see any number of very good companies’ numbers for the next 12 months. After even two years in the bag, stocks are down 40-50%. I think you are going to do very well buying a number of them.You have liked the chemical space in the past. There were a lot of chemical stocks in smallcap space which became part of the midcap space. But after the market correction, they have gone back to the smallcap space. Why do you like chemical companies, the so-called old economy B2B businesses which some would say do not have the pricing power?The entire chemical space is very good even now. Look at companies like Vinati Organics or Aarti. These companies have been stellar performers over decades and there are many around. There is a very tiny company which I cannot name, which just in last 12 months went up 20 times. There are so many names like that. If you pick them right, it is a sector which obviously has been very volatile over the last 10-15 years because of chemical prices moving all over the place, but there has been some kind of solidity coming in.You have to figure out these companies. I am figuring out one new company right now as we speak. It is a good overall space and that apart, there are a number of smallcap companies which do not fall into any category. I am looking at a number of them. I mean, I am very optimistic on this space.Should one not get tempted by the price fall in NBFCs? NBFCs now have a balance sheet issue. Never ever say where is the bottom in financials. People keep talking about this was four times book, this is now only two times book or this was two time book and now 0.5 book. You do not have a clue what the book is! Long and short of the whole story is that off balance sheet, there are all kinds of structured transactions. It is a whole black box in terms of balance sheets of financials, not just in India, but across the world and we are probably a little better. In such a ,situation the book is frankly just simply calculable. When you cannot calculate the book, then why waste time calculating price to book? As for NBFCs, I have been very clear even in the boom period that they enjoyed for the last couple of years, that this is not a sector I want to put even one rupee of my capital into and nor would I advise other people to. But of course, it is up to the people to take their chances. It is a sector in which your cost of funds is higher than that of banks and therefore you need to find higher cost borrowers in order to make a reasonable spread. As a result, you go out there lending to people who generally have dodgy credits. That is why the real estate or promoter funding and structured transactions work well when you have a rising market. The moment you have a bear market -- and we have seen a 12 month- 13 month bear market -- the tide recedes and that is when the quality of collaterals is exposed. That is when you start demanding more cash or more collateral and that is when promoters or your borrowers simply do not have additional cash or collateral to give you. Result: your stock prices start to take hits and that is why you have seen all of them collapse. I was looking at the valuations of NBFCs. How can financials trade at seven times book and six times book and eight times book? This is absurd and even after correction they are like three, four times book value! I just do not think it adds up. This sector should trade at book, 1.2 book or 0.8 book. That is pretty much the range it should trade at given the risk in their core business models. But in an euphoria you will find these kind of companies running up a lot. They are just cooling off but I am not sure whether you have seen the bottom here.What to your mind could be the second derivative impact of the slowdown in NBFCs? They were lending to the consumer space, retail space, the Bajaj Finances and some would argue the Cholas of the world. They have created very big consumer retail businesses. Are we in for a sizable slowdown if not in the infrastructure space, but in the consumer/consumption space?Of course, the NBFCs were not really lending to the infra and all those sectors unless it is at the promoter level. But they have lent a lot to real estate and that we all know is in deep strife and a reasonably large part of the consumer boom in India that we have seen in the last three, four years, has been funded by NBFCs. People are not extending credit anymore because whatever the inflows are is simply going to pay off the liability. No net new credit is being created by NBFCs in aggregate. That will have a knock-off effect on consumption for sure. You will see that happen and the stock market did what it did because of the consumption story and not because of any other part of the story. If that slows down, we have a little bit of a pickle on the earnings momentum part.Is India in a Jekyll and Hyde kind of a situation where the good news is that we have corrected, valuations are looking reasonable but the negative part is that we have got elections, we do not have a proper earnings recovery to keep the consumption engine going while the investment engine will keep us dragging down?India has been a very confusing market. In the last six months, there have been equal number of times when I have thought that India is breaking out and is putting all the problems behind it. Just when I start to get a little confident, it just kind of reverses, including as recently this morning, from where we started to then what it did during the day, it has been just impossible to get a very clear line of sight into where India is going. On the balance, it does look that it will lag its peers in the emerging market space, that is at least my reading so far. The tape is telling you that. But like I said, it has been all over the place in the last few months time and it is very hard to say that India is an outperformer or India is an underperformer.You always say a bull market is on somewhere in the world. Where do you think the bull market is on and what should be the right asset allocation?Emerging markets look very good. They have underperformed quite a bit but they are coming back. US looks very, very good. By and large, equity looks good and is not in trouble at all. You would see the periodic corrections of the kind we saw in December in the US but I am very optimistic on global equities and within that, the EMs look the best because they have lagged a lot of and with China now sort of coming back, EMs look very good. I am very optimistic on emerging markets equities. You are a great tape reader, you do not look at valuations or pricing but you look at the screen and the tape. What is the screen telling you?Well that is what the tape is saying. I mean, do not take my word for it, you just have to go and see. The tape and data is pretty clear that -- and that’s a little bit of a concern and disappointment -- because usually India is a very robust market in good times and in bad times. The world is going along pretty okay. In that situation, India should have been blowing out the lights. That we are not, is a matter of disappointment for me both as an Indian and as an investor.Which is the one big regret you have about your investing career? Which is that one big asset allocation or stock purchase or stock transaction you would like to reverse? Hand on your heart. you would say oh I did a mistake otherwise I would have been a billionaire?It is very straightforward, I should have bought all the MNCs in India in the 90s which were trading at 60 times earnings onwards to 150 times earnings. Gillette Shaving Products was trading at a 150 times earnings and Lever was the cheapest, trading at 60 times earnings. Everything else -- Nestle and the others were trading between 60 and 150. I thought they were very expensive and never bought them. In hindsight I should have-- that was a big mistake. We should have loaded up on them believing that India will always be expensive towards so- called higher quality companies. I somehow could not ever believe that even for quality you should be paying 60 or 150 times earnings, but I was clearly wrong.

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