In India, if you can offer something aspirational yet affordable, you have hit the sweet spot: Gautam Baid
Higher for longer – ever since this commentary has come from the US Fed, all the portfolio managers are on a back foot. The environment may remain full of turmoil for a long period of time. What are your thoughts on this matter?
More than the interest rates being higher for longer, the more concerning part for the market is the quantitative tightening by the Federal Reserve and by central banks globally because as we all know liquidity is like mother’s milk for a bull market and without very high liquidity, one cannot really have a global rally going on.
The entire markets globally will tend to become very narrow and this is why after active investing underperforming for more than a decade, passive investing is all set to make a very big come back and bottom up stock picking is going to be more relevant than ever because the broad indices may be range-bound because of high interest rates and tight liquidity, but bottom up stock pickers will be handsomely rewarded.
Another very important point to note here is that BAAP or Buy At Any Price investing strategy which was in vogue during the low interest rate environment, may underperform in a high interest rate environment because most of these companies have got their cash flows a distant way into the future and as interest rates go up, their intrinsic value is very sensitive to changes in interest rates. So buying at any price or just ignoring valuations will not work. One has to be conscious of the value that you pay.
You are spending a lot of time in the US and also travelling across the world. How deep is this issue of slowdown in your view because it was an engineered slowdown by the US Fed to calm down inflation but some believe that it is actually overdoing it by stalling growth. How serious is the issue in the US?
The Federal Reserve has a tendency to overshoot both on the downside as well as the upside. When they are easing, they ease too much and when they tighten they tighten too much. Right now, the demand is still pretty strong in the US and that is why the Federal Reserve wants to curtail the wealth effect.
As long as people feel right and asset inflation is in vogue, they will try to keep increasing interest rates and tightening liquidity and that is why the US which is resilient so far, may enter into a recession next year. Europe is already facing a very sharp slowdown and companies which export to Europe will be the first ones to get affected, followed by companies which export to the US. So Europe first, the US later and the market is very efficient.
Already we are seeing a sharp derating of many IT stocks in India over the last few months. Many of the stocks are around 40-50% and the market has been very efficient in bifurcating the winners and the losers in this environment. So, domestic facing companies and domestic-oriented companies will outperform going forward.
Last two weeks, you have been touring friends, families and relatives in various parts of the country. How do you see the buzz here in India? The G20 presidency, superior quality earnings, on ground wedding season – how are things?
The biggest observation has been that urban India and discretionary branded consumption is doing very well but there is a clear slowdown in the rural parts of the country. But again, that is why India is getting cheap valuations in the rural facing stocks as well. In the stock markets, you pay a very high price for a cheery consensus. So if you feel that this is a short term problem, then this is a good time to buy into those rural facing stocks. Otherwise you can stay with the tried and tested branded consumption names which have always done well in India over the long term.
When you meet people from all income strata, are they spending well, are they optimistic about their future? How is the consumer confidence here in India which you are picking up in your interactions across the country?
The biggest observation here again is that there is a lot of pent up demand which is still in vogue. Let us take the example of Goa. Over the next two months, if you see more than 99% of all hotels are basically booked, that is the kind of demand traction that we are seeing in India right now.
So discretionary consumption is really booming now. Tthere is a lot of revenge spending happening post Covid and whatever long-term durable items people have to buy, they have bought earlier like all the home renovation items and residential real estate. Now people are spending more on experiences and that is where the real spending is happening. So experiences, branded apparel, branded discretionary consumption, but lower tickets. In India, if you can offer something which is aspirational yet affordable, you have hit the sweet spot and that is the area which is doing exceptionally well in India right now.
You may have also met some managements or people who are working with corporations. What is the visibility on earnings growth for companies in the supply chain of various companies you have in your portfolio? Is the worst of the margin issues behind them?
Most of the managements are now of the view that the worst of the raw material pressures are behind them. Many raw materials are basically linked to the crude oil prices and crude right now is trading below where it was at the start of the year.
So bulk of the raw material pressure is basically behind us and one should experience margin expansion. But this margin expansion will not be enjoyed by all the companies. Only companies which have pricing power, which are able to hold on to their prices even amid falling raw material prices are the ones that will make disproportionate money. One has to pick the spots very carefully.
Do you also feel this conundrum of valuation versus superior earnings because where there are superior earnings, valuations are not very cheap or around the fair value zone. How do you dabble between the two?
One big learning from investing journey over the last 15 years is that the great investors are active seekers of truth and the truth is that the supply of high quality equities in the largecap and midcap space is very limited. The stock price at any point of time is simply a function of supply and demand.
Demand is high but the supply of quality equities in India is very limited and that is why comparing the valuations of stocks here with valuations of quality equities in the US is futile because in India, the supply of quality equity is so limited. That is why I think high quality largecap and midcap stocks in India will always trade expensive. You may get them less expensive in a bear market. I do not think you will ever get them cheap per se.
But how are you really looking at flows because in the year gone by, the flows from the retail investors were almost like a renaissance moment but FIIs are big sellers do you see a case building that in 2023 while the domestic investors may not abandon the market, FIIs on the margin may start coming back and hence like a good situation or you think because of the global turmoil FIIs may not hurry to come in?
See what I have observed from operating India Fund and the US is that lot of these FIIs lot of them act based on their short term forecast of where the rupee is headed, where the flows are headed so once the Federal Reserve is through with its interest rate tightening cycle I think emerging markets are all set to make a comeback after and India may be the disproportionate beneficiary of that EM up cycle in the future. Domestic flows are anyways very resilient in October I believe we had 13000 crore of inflows in the domestic mutual funds so domestic investors has been very resilient even among all the volatility and when the emerging market start receiving flows again from next year once the interest rate hikes are done with I think India may be the single biggest outperformer in the emerging markets pack from next year.
Let us talk about how you are constructing your portfolio right now or looking at opportunities or hunting for opportunity does anything in the primary market excite you or have you looked at or you analyse it but not making a move on any of them?
So there is an affordable housing finance company which I am evaluating right now which has got more than a 20-year track record of maintaining very good asset quality across cycles. It is a recently listed company in the primary market so that is one opportunity which I am looking at actively but generally majority of the primary market or the IPOs as we call them generally are very overpriced so generally I tend to stay away but sometimes when they undergo price correction or the when the initial investors or the anchor investors start booking out and the stock prices correct those are the times to actually start looking at them. I think we should not really chase those exuberant listing pops but we should just wait for the prices to come into our desired valuation range.
You are also a student of behavioural finance to a large extent and Buffett and Charlie Munger’s prophecies on how investors behave at any point in time. If you look at that data some of the listed tech brokerages are sharing, the F&O related work volumes are shooting through the roof but the delivery base is just stagnant or showing slow growth. How do you see this phenomena?
I would rather go by hard facts and empirical data. If you look at what the Zerodha founder just said recently in a tweet, less than 1% of all traders in India have made less than the FD return and that basically says it all to me. Good investing is at the end of the day all about respecting base rates or what is the probability of success in a particular strategy. If less than 1% of all traders are making less than the fixed deposit return, this shows you how difficult it is to make money on a sustained basis.
You may make a lot of money once or twice but the third time you may blow up and then at the end of the day, the key to compounding is endurance and survival. If you cannot survive, then you could not be really big in the stock market.
CRAMS, China plus one, Europe plus one theme apply to two-three sectors. How are you looking at it and how big is this theme?
This theme is here to stay easily for the next decade. Low cost contract manufacturing is in India’s DNA and we should basically play games where we have the right to win. I think India has got the right to win in CRAMs, electronics manufacturing outsourcing. Domestic manufacturing is also a very promising theme driven by revival of the capex cycle and PLI.
The domestic lenders, NBFCs, housing finance companies, banks all are entering a fresh up cycle because most of the banking system has been cleaned up post IBC and also in domestic manufacturing, capacity utilisation has inched up across corporate India to a very high level now and that is why many companies are embarking on a fresh round of capex.
History teaches us that one of the key drivers for a sustained bull market in any country is a revival of the capex cycle and that is where India stands today. People are still underestimating the kind of returns which people can make from participating in this bull market and that is how typically a bull market behaves. We have a lot of disbelievers in the beginning but then it tends to surprise most of us on the upside.
What about lenders? How are you playing the lenders, banks, NBFC? This entire pocket or some of the insurers or AMCs what kind of cherry-picking are you doing there?
More than insurance and AMC I am more bullish on the lenders per se and banks and the private banks I am very bullish on companies which have cleaned up their balance sheet. A lot of people over the last few months have made a lot of money in the public sector banks, they are good for trade you can make your 1x-2x in a short span of time but you cannot really retain that wealth which you make from those PSU stocks because at the end of the day the majority owner is the government which works for societal good not for minority shareholder wealth creation so be very careful to exit on time otherwise you may again end up with permanent loss of capital in all those companies.
You also like the auto and auto ancillary space which is coming back after almost a decade of underperformance. How are you playing that side of the pocket?
Again two-wheelers is a space which I am looking at now because there are some initial green shoots of recovery in the rural cycle. I have a branded very strong company in the two-wheeler space which has got pricing power and along with that, Auto ancillaries generally tend to outperform the auto OEMs during an auto up cycle. I also have exposure to some auto ancillary names in my India Fund portfolio.
Just want to understand, for this mix of stocks which you have in your portfolio, what is the earnings growth trajectory if we take a two to three year view?
As we all know, over the long run, stock prices follow earnings and for the current portfolio construct as a whole over the next three to five years, I am expecting a blended overall earnings growth expectation of 20%.
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