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At a time when the rally in global markets has taken a breather and market participants are weighing their investment options, Shankar Sharma, vice chairman and joint managing director, First Global tells Puneet Wadhwa in an interview that he expects the emerging markets to significantly underperform the developed markets going ahead. In the Indian context, he doesn’t see much revival in earnings or in the capex cycle. Edited excerpts:
What is your interpretation of the economic data coming from the US, China and India? How do you see the foreign flows (to India) panning out in 2013 given this?
Data from the US has been moderately positive, but data from Emerging Markets (EMs) like China and India has been very discouraging. Growth projections for the BRIC countries, identified as the future dominators of the world, had been blown out of proportion a few years ago. The reality now is very different, wherein each country in this ‘pack’ is struggling to justify those rosy projections. I expect BRIC markets to get hurt very significantly this year, as there will growth disappointments all around. Weak commodity prices will put pressure on Brazil and Russia.
Do you think that there is a lot of pessimism getting built in to the Indian markets given the economic data, outlook for interest rates and the recent Union Budget proposals? Can the markets correct sharply from here on?
Markets had a terrible 2011, so consensus was massively bearish. And India had a super run in 2012. As was easily predictable, brokerage consensus became supremely rosy for 2013. We turned very cautious on India and EM from mid-January when a lot of indicators we look at, started flashing red.
The markets have fallen sharply after that, but I don’t think that’s the end of it. We see a big relative underperformance of emerging markets versus the developed markets, and this is just beginning to happen. The markets are at nearly the same point as where they were in September – October 2007.
So, is it all gloom and doom for the markets and economy now?
The trouble is that India and the BRIC pack are standing at the edge of a “growth cliff”. While each country has its own problems, in India, it is our independent institutions like the CAG (Comptroller and Auditor General), the Supreme Court and the Reserve Bank of India (RBI) that have in large part led us into this mess.
The CAG keeps spinning out absurd amounts to show the world how corrupt we are, which most people cannot accept. The Supreme Court dealt a body blow to FDI (foreign direct investment) confidence by sweepingly cancelling all 2G licenses. That judgement was a travesty. The net result is that we have a terrible global macro environment, within which we have stagflationary environment created by the central bank where they have successfully killed growth, while inflation reigns undefeated.
The US Federal Reserve, on the other hand, is still managing to fly the US economy, which has both engines flamed out, the ejector seat stuck, and a clueless pilot. And here in India, we had a super-jet that we have into the ground, thanks to the inability of the RBI to accept its error and alter its strategy.
What is your assessment of corporate earnings in the March 2013 quarter?
I don’t see much revival in earnings or in the capex cycle ahead. Capex requires many things to work in tandem. Of which, low interest rates is one of the most important, since in capital budgeting decisions, the hurdle rate used to value projects is directly a function of interest rates.
At a time when most airlines are finding survival difficult, India may see yet another airline (AirAsia-Tata) take to the skies. What are your views on the aviation space?
It is a terrible industry, and even more so in India, because you don’t have unlimited pricing power, and almost no possibility of durable cartelisation; Indians are too disparate and heterogeneous to form effective cartels.
That apart, the basic economics of the airline business make no sense. It is the only industry wherein every decade or two, you have to repeat your initial capex all over again, i.e. newer aircraft, etc. What this means is that by the time you build load factors and reach breakeven, the time comes to again invest in capex to modernise your fleet. This Sisyphean ordeal is unique to the airline industry, and leads to near permanent negative free cash flows.
Most information technology stocks have been on a roll. Is the worst over for this sector? What about the consumption and the metal packs?
After being bearish on IT for nearly two years, we now like the sector in light of our bearish stance on the markets. IT, pharmaceuticals and the consumer sectors are all classic bear market plays, and that’s where we think the markets are headed.
The entire metal sector is screaming short – Tata Steel, JSPL, Sterlite Industries etc. We are very bearish – and have been so for over two years now – on global commodities and see these stocks falling from here on as well. They had only China going for them since the last few years, which is over now.
What is your view on L&T that has seen a spate of bad news/developments impact the stock performance?
We liked the stock last year when it was in Rs 900 – 1000 range. It had a great run thereafter. We are now neutral on Larsen. If markets are going to be bearish, as we think they will, it is hard to see a high beta play like Larsen doing well.
How do stocks from banking and telecom sectors look given the recent newsflow?
We have liked banking for quite a while, with HDFC Bank as a favourite. We also liked the public sector (PSU) pack for a while based on our thesis that 10-year bond yields are headed down, which will lead to good profits for PSU banks on their bond portfolios.
The trouble is that lending for infrastructure (which is largely done by PSU banks) is simply not advisable. And in light of declining GDP growth, lending to individuals (the main area of focus for Private sector banks) also will slow down. On the liabilities side, deposit growth is falling sharply. Add to this clear and present competition from new entrants.
The telecom story is over, and in fact, has been over since 2007-end itself, at which point, I had turned very bearish on the entire space. Haven’t revisited that call since then!
Banking will go the telecom way when you have half a dozen new players in, which appears imminent. And even without this negative factor, these stocks look too richly valued for comfort, going into a sharply slowing economy.
