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  • Jan 22, 2008

    "I like many stocks in India and a 20% annual rate of return is possible over the next 10 years."

    The stock markets are at their volatile best. And in our view it is an opportune time to get in a rational view on how you should deal with this situation. So, here it is - a view on the stock markets from Ajit Dayal.

    (This interview was sent to clients of Personalfn's investment solutions services and subscribers of Equitymaster and Personalfn premium subscription services before it was posted on the web site.)

    The Indian stock markets witnessed their largest ever fall in absolute terms, before staging a marginal recovery. To what do you attribute this sudden sell-off?

    Stock markets, all over the world, reflect the profitability of the companies that are listed on the stock exchanges. When companies do well and report higher earnings, one should expect share prices to increase. When companies do not report higher earnings or disappoint expectations that we have of them, then share prices will decline or stagnate.

    But the Indian share markets have quickly transformed themselves into gambling dens. Local, long term investors have been overtaken by speculators with access to trading terminals and playing in stock futures and index futures.

    People are no longer buying earnings; they are buying hope - the hope that there will be a bigger fool to buy the shares from them at a higher price. Like children addicted to their electronic games, these terminal junkies have to trade every minute to prove their existence. To add to this local cocktail, the misguided policies of allowing short term money via P-Notes has taken India to a new level of global integration - integration with the speculators in other parts of the world!

    This speculative money has no rational behaviour. It behaves irrationally when it wishes to buy and also when it chooses to sell. Since the sub-prime crisis surfaced in August 2007, the Index gained 30%! Now, this same sub-prime crisis is being blamed for the sell-off.


    For stock market investors, is it a time to wait and watch? What are the do's and don'ts you would suggest for investors?

    The risk for any investor is surrendering to his emotions. Investors are either blinded by greed at one extreme or are enveloped in fear at another extreme. The clueless investor is like a ship floating in a dark sea - with no lights, no navigation maps, and no stars to guide him. The poor fool will float with the tide and ride the waves of greed and fear. His survival is at risk. His only hope is to be rescued by a greater fool.

    A knowledgeable investor makes sure he has a map, a torch, some idea of the stars to guide him when the lights go out, and an anchor to hold on to in rough seas. When the markets fall for some irrational reason and fear grips the markets, the disciplined investor will buy into this falling market. When markets rise for silly reasons and irrationally and greed set in, the disciplined investor will sell.


    What according to you are the key risks to look out for in 2008?

    There are many risks that will dominate what happens to share prices in India in CY 2008 - and beyond. India is where it is despite pretty bad economic policies. So there is some risk that our overall growth as an economy will slow if policy making is misguided. Indiscriminate job reservations, fear of raising petrol and diesel prices, and adopting crony capitalism are some of the risks. Having said that, I think India can continue to clock a 6% rate of GDP growth, year after year, relentlessly, for the next 10 years. India has achieved a 6% average growth rate in GDP for the previous 27 years.

    Besides politics, I worry about the P-Notes and a lack of understanding about how capital flows can harm India. There is "good" money and there is "bad" money and India has still not framed policies to tap the "good" money.

    At a micro level, I think the high price of oil will continue to haunt India's trade deficits and the slow build out of infrastructure will delay the establishment of India as a manufacturing export hub - this will also hurt the trade deficit.


    Over the past few years, we have been witness to all asset classes - equities, commodities, gold and real estate - gaining significantly. Do you see this continuing going forward?

    Real estate in India is a bubble. I have said this since July 2006 and been wrong. But it does not take away from the fact that real estate prices are in bubble zone. There is no shortage of land in India. There is a shortage of zoned land. That shortage is artificial - a government induced shortage. The barrier to entry for being a real estate developer is not money. Or engineering skills. Every one can raise money for building an end product where the demand is unlimited.

    The barrier to entry for being a real estate developer is the ability to "manage" the system. To buy land at Rs 1 lakh an acre. Massage the system, get the zoning laws changed and then re-sell that land for Rs 100 lakhs an acre. This willingness to play the zoning game is the only barrier to entry. And this reduces supply of available end product for housing. And since demand is huge, prices have risen to illogical levels. But I have no idea when it will collapse.

    I like many stocks in India and a 20% annual rate of return is possible over the next 10 years. So you can make 6 times your money in 10 years by being in stocks. And I think gold is a great investment - an insurance - to buy now.


    Suppose you had Rs 100 to invest. How would you allocate the money between different asset classes in present times?

    Rs 80 in stocks, Rs 10 in liquid funds, Rs 10 in gold. Zero in real estate.


    How do you view the current global economic and financial environment in light of concerns regarding a US-led global recession? By when do you expect stability to be reinstated?

    The US economy is in recession - the numbers will not prove this for another 6 months. But the slowdown is noticeable at the street level. There will be a lot of pain for many people in the US and for many countries in the world. But I think India will not be affected in terms of the real economy. The P-Note punters may cause havoc to share prices but that will have little effect on the real economy. On a global basis, I tell my friends: buy Indian equity, buy gold, and keep money in the bank.


    Do you agree/disagree with the view that the emerging economies are decoupling from the economic performance of their developed peers (US)?

    I think this decoupling is a myth. Economies are coupled more so today than ever before in economic history. Now that the US has sneezed, the world will catch a terrible cold.

    But India stands out in the scale for being relatively less coupled because our dismal policies did not allow infrastructure to be built and, hence, we are not a major supply base for the world. In 1997, we withstood the Asian banking crises because our FERA and monetary polices forced us to be financially secluded from the rest of the world. So we have reached immunity by default, not by design.


    What is your view on the Federal Reserve's monetary stance?

    The central bankers in many parts of the world have been busy keeping the large financial companies afloat. The tax payers in many parts of the world are about to witness the largest subsidy to be given to a small number of beneficiaries.

    The American taxpayer will end up paying for the excesses of maybe fifty thousand people who lived off the fees and commissions from mis-selling financial products like sub-prime loans and the resultant financial derivatives they re-packaged and sold.

    It seems to me that the internet bubble was different in the sense that a few people gave money to fund the projects of many companies which actually created something and caused a multiplier effect of new technology and job creation.

    But where is the US today: an expensive war in Iraq, a large trade deficit, an election year, and a central bank that no longer tells you how much money they have printed. I am certain that the US economy will recover and re-invent itself - as it has done many times before. But the time horizon of this recovery is uncertain. Gold is a good place to be in uncertain times.

    Ajit Dayal is Director, Quantum Advisors Private Limited and its 100% subsidiary, Quantum Asset Management Company Private Limited. Ajit is also the Founder and Director of Quantum Information Services Pvt. Ltd., which owns Equitymaster & Personalfn.

     
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