Markets are at all time high again. Investors who participated by investing when market was low a couple of months back would be smiling and Investors who did not do so would be doubting the sanity of the rally. No doubt, when we are at all time high (by 21200), we might feel dizzy and jittery. Is markets really over valued. Should an investor invest now or not. What are the justifications behind the current market valuation.
Here comes Mr.Prasanth Jain - a name to recon with in the Indian Investment World. His wisdom and strong track record of successful value investing is a great asset for every investor. Managing a fund size of more than 1,00,000 Crores, with deep insight in the market cycles, his recent interview with ET NOW TV Channel is worthy read for every investor.
ET
Now: In the last three months, we have seen all textures and shades of market
action - virtual crash, fear, a comeback and a new high. So what is going on?
Prashant Jain: Markets are always volatile in the short run and that is why we always refrain from taking very short-term calls. Markets probably overreacted to the threat of QE tapering, which is more relevant for the fixed income investments into India and less for equities. If you look at the FII flows into equity markets for the last 20 years, barring two years - the year of Pokhran blast, 1998-1999, and the year of Lehman Crisis, foreigners have been net buyers. So I remain optimistic and we are of the opinion that the worst on the economic front is behind us. Markets have rallied, but I do not think they are overvalued. They are, in some sense, where they were five years back and it is only the Sensex which has recovered. The broader indices are still about 15% below where they were at.
ET Now: At a time when earnings are not expanding, margins are compressing, GDP growth is not back on the track, is there a case for an economic bottom?
Prashant Jain: Let us de-link the two - economy and earnings. Economic bottom has been formed and I will refer to the new RBI governor who recently said that the second half should be better than the first half for three reasons - a) agricultural production is doing very well; b) exports have begun to grow and we know that textile exports and even steel exports are doing quite well; c) a lot has been done in terms of resolving the bottlenecks for large projects which are under implementation in the road sector, in the mining sector and also in the power sector. So, at some point of time, even capex would start to kick in.
ET Now: Ultimately, what the economy needs is a stable currency. It has been a very volatile and choppy ride for the rupee from 55 to 60, 60 to 69, 69 to 61. Do you think the rupee has stabilised?
Prashant Jain: From 60 to 69, it was driven by sentiments and also because of a spike in gold imports of extra $10 billion in those two months and the debt sales by foreigners of another $10 billion. That $20 billion in a matter of two months was a lot for the markets and that is what has impacted that. The worst on the currency front is certainly behind us. The current account is down to very reasonable levels this year itself. So the progress on current account has been far more than on the fiscal account and our reserves are beginning to grow. The initiatives taken by the RBI are also having a very good impact. So, I would assume that the worst on the currency front is behind us.
ET Now: But can markets go up at a time when inflation is roaring again?
Prashant Jain: Earnings have been much better than what was being built in at least by many sell-side experts and the key reason is that despite the slow economic growth, the currency depreciation has a very favourable impact on the earnings. 50% of the markets directly benefits from a depreciating currency and includes software services, pharmaceuticals, metals companies, refining companies and select automobile companies. Another 40 odd per cent is neutral - banks, consumer companies, and consumer non-discretionary. So the currency depreciation is helping the earnings, and the earnings will be significantly ahead of what they were at least at the beginning of year. So despite slow economic growth, earnings are likely to grow at a reasonable pace and that is clearly supportive to the markets.
ET Now: But the good end of the market which is growing is already price to perfection, be it pharma or IT and select consumer names.
Prashant Jain: Yes, you are right and in a way, the quality premium in these markets is high and I would agree with you that in the consumer names, the room for PE multiple expansion is not there. Probably there is room for some compression there. But IT and pharma are fairly valued. They are growing sectors and they are less susceptible to a slowdown unlike the consumer sector and therefore the PE multiples can hold up. Barring these three sectors, whatever else you look at, there is room for multiples to go up as economic conditions improve and let us not forget that inflation is a pass-through for equities. So, equities give you real returns equal to real growth rates. If inflation is high, equities will take it in their stride. Companies will increase prices and you will still get your real returns equal to real growth rates over time.
ET Now: You always believe in betting big and have a long-term approach and if I look at your current portfolio, you are betting big on PSUs in general. Why is that?
Prashant Jain: I don't think it is entirely correct to say that we are betting big on PSUs, but it is correct to say that we have higher than benchmark exposure to PSUs. We appreciate that PSUs have certain limitations because of the ownership structure. But nevertheless they are sustainable businesses. They have a reasonable track record. So we like some of the PSUs despite the constraints because of the valuations and some of the businesses that we own in that space have a closer linkage to the economy and the day core economy improves, the outlook for these businesses would also improve.
ET Now: Some of your top holdings include banks, especially State Bank of India. Are you not worried about the slowdown in credit growth and the kind of NPAs some of these PSU banks could generate if the economy does not recover?
Prashant Jain: Well, we have undergone pain on that front already and as I said, the worst on the economic front to my mind is behind us and we have seen similar situations in the past as well that the Indian economy slows down. There are bottlenecks. The government takes corrective actions and over time the economy recovers. If the economy recovers, the underlying performance of these banks would improve and the markets will also appreciate that.
ET Now: So are you now aligning your portfolio for the next bull market because you are clearly not focussing on the consumer end of the market, you are focussing on the economy end of the market?
Prashant Jain: See, we had very large exposures to consumer and pharma over last two-three years....
Prashant Jain: Markets are always volatile in the short run and that is why we always refrain from taking very short-term calls. Markets probably overreacted to the threat of QE tapering, which is more relevant for the fixed income investments into India and less for equities. If you look at the FII flows into equity markets for the last 20 years, barring two years - the year of Pokhran blast, 1998-1999, and the year of Lehman Crisis, foreigners have been net buyers. So I remain optimistic and we are of the opinion that the worst on the economic front is behind us. Markets have rallied, but I do not think they are overvalued. They are, in some sense, where they were five years back and it is only the Sensex which has recovered. The broader indices are still about 15% below where they were at.
ET Now: At a time when earnings are not expanding, margins are compressing, GDP growth is not back on the track, is there a case for an economic bottom?
Prashant Jain: Let us de-link the two - economy and earnings. Economic bottom has been formed and I will refer to the new RBI governor who recently said that the second half should be better than the first half for three reasons - a) agricultural production is doing very well; b) exports have begun to grow and we know that textile exports and even steel exports are doing quite well; c) a lot has been done in terms of resolving the bottlenecks for large projects which are under implementation in the road sector, in the mining sector and also in the power sector. So, at some point of time, even capex would start to kick in.
ET Now: Ultimately, what the economy needs is a stable currency. It has been a very volatile and choppy ride for the rupee from 55 to 60, 60 to 69, 69 to 61. Do you think the rupee has stabilised?
Prashant Jain: From 60 to 69, it was driven by sentiments and also because of a spike in gold imports of extra $10 billion in those two months and the debt sales by foreigners of another $10 billion. That $20 billion in a matter of two months was a lot for the markets and that is what has impacted that. The worst on the currency front is certainly behind us. The current account is down to very reasonable levels this year itself. So the progress on current account has been far more than on the fiscal account and our reserves are beginning to grow. The initiatives taken by the RBI are also having a very good impact. So, I would assume that the worst on the currency front is behind us.
ET Now: But can markets go up at a time when inflation is roaring again?
Prashant Jain: Earnings have been much better than what was being built in at least by many sell-side experts and the key reason is that despite the slow economic growth, the currency depreciation has a very favourable impact on the earnings. 50% of the markets directly benefits from a depreciating currency and includes software services, pharmaceuticals, metals companies, refining companies and select automobile companies. Another 40 odd per cent is neutral - banks, consumer companies, and consumer non-discretionary. So the currency depreciation is helping the earnings, and the earnings will be significantly ahead of what they were at least at the beginning of year. So despite slow economic growth, earnings are likely to grow at a reasonable pace and that is clearly supportive to the markets.
ET Now: But the good end of the market which is growing is already price to perfection, be it pharma or IT and select consumer names.
Prashant Jain: Yes, you are right and in a way, the quality premium in these markets is high and I would agree with you that in the consumer names, the room for PE multiple expansion is not there. Probably there is room for some compression there. But IT and pharma are fairly valued. They are growing sectors and they are less susceptible to a slowdown unlike the consumer sector and therefore the PE multiples can hold up. Barring these three sectors, whatever else you look at, there is room for multiples to go up as economic conditions improve and let us not forget that inflation is a pass-through for equities. So, equities give you real returns equal to real growth rates. If inflation is high, equities will take it in their stride. Companies will increase prices and you will still get your real returns equal to real growth rates over time.
ET Now: You always believe in betting big and have a long-term approach and if I look at your current portfolio, you are betting big on PSUs in general. Why is that?
Prashant Jain: I don't think it is entirely correct to say that we are betting big on PSUs, but it is correct to say that we have higher than benchmark exposure to PSUs. We appreciate that PSUs have certain limitations because of the ownership structure. But nevertheless they are sustainable businesses. They have a reasonable track record. So we like some of the PSUs despite the constraints because of the valuations and some of the businesses that we own in that space have a closer linkage to the economy and the day core economy improves, the outlook for these businesses would also improve.
ET Now: Some of your top holdings include banks, especially State Bank of India. Are you not worried about the slowdown in credit growth and the kind of NPAs some of these PSU banks could generate if the economy does not recover?
Prashant Jain: Well, we have undergone pain on that front already and as I said, the worst on the economic front to my mind is behind us and we have seen similar situations in the past as well that the Indian economy slows down. There are bottlenecks. The government takes corrective actions and over time the economy recovers. If the economy recovers, the underlying performance of these banks would improve and the markets will also appreciate that.
ET Now: So are you now aligning your portfolio for the next bull market because you are clearly not focussing on the consumer end of the market, you are focussing on the economy end of the market?
Prashant Jain: See, we had very large exposures to consumer and pharma over last two-three years....
ET Now: That has changed now.
Prashant Jain: But over the last one year, I feel that with the sharp expansion in multiples in that space, the room for good returns is limited and therefore we have been reducing exposure to that space. That call has not worked very well so far, but there is merit in persisting with that view and over time it should turn out alright.
ET Now: So it that evaluation call or is that a business call because for FMCG companies volume growth also is a concern, the kind of numbers we have got from HUL, ITC, Colgate...?
Prashant Jain: Absolutely. What we have seen FY10-11, the volume growth has been way above the longer term averages and that was one reason why we were cautious on that space and we have been not so optimistic on that space. The consumer companies cannot continue to grow in isolation irrespective of how the economy is doing. So today if the economy is slowing down to 4% to 5%, it means your customer incomes have also slowed down. So your business will also slow down. But I do not think the multiples are yet suggesting that.
ET Now: You have exposure to a large oil stock. What is the logic in owning oil companies? We do not know what they will report, their balance sheet is still very opaque and to top it up we do not know the government policy which will dictate the oil sector?
Prashant Jain: I do not think their balance sheets are opaque. Yes, what profits they will achieve that is subject to variations of the government policy, that is a fair comment. But the main logic for holding on to these companies is that they are trading at a fraction of the replacement costs. They could be as low as 20% of replacement costs and these are not businesses which are going away.
ET Now: But that has been the logic for the last many years now.
Prashant Jain: Absolutely. We think the markets will appreciate the value in these businesses better when the burden of subsidy is reduced. But so far, it has not happened.
ET Now: So to your mind the big joker in the pack for Indian markets and Indian economy is not the central bank action, it is not BOJ or US Fed, it is oil?
Prashant Jain: Oil is very critical to India and we have consistently maintained that view for the last five-seven years that oil is more important to India than even the US or European GDP growth. We import oil equal to 6% of GDP. So, a 20% fall or rise impacts us far more than a 0.5% increase or slowdown in the US GDP. So it is very-very critical. At this point, again it is extremely critical because a lot has been done within. So if you look within the country, a lot of things which were not right have been set right or are being set right.
The key variable that remains now is how oil behaves and unfortunately it is not in our control. A $10 fall is oil prices will do wonders for India in terms of fiscal deficit, current account deficit, currency, interest rates and inflation. On the other hand, if oil prices were to spike up, it will postpone or put further stress on the economy. So oil prices are a key variable particularly at this point of time when we are in not a too good shape.
ET Now: India has always been known as a growth market. So to your mind in this current market, what is growing and is still reasonable?
Prashant Jain: Virtually the entire market is growing. If you look at last four decades, the gap between India's GDP decadal growth rates and oil GDP growth rates has been very steady between 3% and 3.5%. So we are a growth economy. And one year of slow growth does not mean that you cannot come back to 7-8% growth rates. We will in the not too distant future....
ET Now: That is not a pipe dream?
Prashant Jain: I do not think so. We have been in situations like these before. I have been in these markets for now more than 20 years and I have seen at least three similar situations.
The CAD was not such a big problem on those occasions, but the economy was in a similar state and we have come out of it because the underlying growth drivers are very fundamental, very basic and very sustainable and these are not going away. So we will come back to those growth rates and when the economy is growing at decent growth rates, there is nothing in this country which is not growing, which does not have long-term growth potential. Of course, if you talk today, the car market is not growing, the two-wheeler market is not growing, but these are temporary issues because income levels are under pressure. But as things improve, things should get back.
ET Now: Everyone is gung ho about IT, you also have a decent exposure to IT, your large holding there is in Infosys. How would you judge IT stocks at the current juncture...?
Prashant Jain: We have had a good move in IT. I would not say that IT stocks in general are undervalued. They represent growth. They should continue to grow. What these companies tell is that the business environment is improving. They also have the benefit of significant currency tailwinds, but at these multiples at a broad level, if you leave aside individual stocks, room for PE multiples to go up meaningfully are not there and the risk of currency appreciating, which today most people do not expect, cannot be ruled out.
ET Now: So apart from banks, where are you allocating a disproportionate amount of capital?
Prashant Jain: We have a fairly balanced portfolio at this point of time and even in banks we are not disproportionately allocating. We are in line with the benchmark. Please remember that banks are 25% of most benchmarks. So it is wrong to say that we are disproportionately allocating there. We are somewhat underweight on the consumer and the pharmaceutical sectors and any recovery in the economy should be led by investments and not by consumption. Consumption should pick up growth with the lag and any revival should be led by investments and our portfolios are geared to that thought.
ET Now: Markets could remain volatile, markets could remain choppy, but you are a table thumping bull on the economy?
Prashant Jain: Table thumping may be a strong word, but I feel in my limited understanding that the worst on the economic front is behind us. The next year should be better.
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