In an interview with Equitymaster, Ajit shares his views on the global economy and the excitement about the emerging markets in the investment community. He also shared his thoughts on the Indian stock market and how to go about investing in stocks.Part II: Ajit on Indian markets
EQTM: How do you view the global economic environment at present? Interest rates have been raised in some economies and the US is showing an inconsistent trend in job creation. What factors need to kick in for a global economic revival, especially with regard to the big 3?
I think you have got to put things in perspective. In the early part of 2003, you had a lot of people that were speculating that there would be what they call, ‘a double dip’. That the world would go into a five-ten year depression and into what they would call as ‘the ice age’. The ice age will be an environment where no one would take risks, big finance companies would go bust and nobody would buy shares and everyone is putting money under their mattresses and world is in a deflationary spiral basically. You know that has not happened. That is the first victory of 2003. The double dip theorists have been proved wrong.
Yes, the world economy, led by the US, is slowly recovering. But the fact that it is recovering is a positive in itself and in the third quarter, the US saw an 8.4% jump in GDP. So, you know, when you have a big economy growing at 8% in a small period, it shows that even large ships can turn around pretty rapidly. In terms of job creation, I think, the one lesson of economic cycles is that you have to have patience. You have to let the cycle work itself out. And interest rates have been low for a long time in many parts of the world, including the US and Europe. In job creation, first you have got to have job shedding being stopped. So, no one is losing jobs anymore.
And as the economy recovers, consumers spend, businesses get confidence and begin to hire more factory workers or more workers just to re-stock, produce more material, and the next phase is expansion. So, I think the job shedding has stopped, which is a good sign. The job creation is continuing and as I said, cycles take time to play out and you have to wait patiently for it. In the next phase, probably by the middle of this calendar year, there will be job creation in a fairly significant manner in the US and other economies.
In terms of interest rates being raised in a few countries, primarily Australia, UK and Netherlands, Australia has had an overheated economy for some time, so has the UK led by strong housing. Those governments’ are fearful that there is a speculative bubble being build up in their economies due to cheap credit and strong housing demand and they are trying to nip that in the bud. But again, rates have risen very marginally. Even in the US, rates have fallen from 6.5% to 1%, which are 43-year lows. In the recent Fed meeting, they changed their stance that they will keep interest rates low for a ‘considerable period’ to the fact that they will have ‘patience’. But it still entails that they are not going to raise rates dramatically. I personally doubt rates in America will cross 3% in the year 2004, although I believe that they will go up and I am probably in the minority of one or two or five to say that. Even if the US ends the calendar year at 3%, which is substantially more than 1%, it is still half of 6% that was there two years ago. So, I think, one of the Fed governors made a statement in December that you should not look at the absolute rate of interest in America or for that matter in any economy. You should look at the stance of the Government. And the stance of the Federal Reserve is that they want to be accommodative. And accommodative is that rate of interest, which allows the economy to grow without inflation. Whether it is 1%, 3% or 8% is purely academic.
EQTM: There seems to be a lot of excitement in the investing community with regard to the opportunities in the emerging markets. Do you think it is justified, in the terms that emerging market growth is largely dependent on servicing the developed economies? Is this kind of optimism warranted in the long-term?
Mr. Ajit: I think in the long term, the optimism is warranted in the sense that these economies are trying to get rich. And when you try to get rich and create wealth, you create demand for products. So, at the end of the day, yes, it is good to invest in these economies based on the long-term potential. However, I guess the question you should be asking is ‘has the market run ahead of itself in terms of valuations?’ I think to that extent, the markets may have run ahead of themselves a bit. Liquidity flows into the emerging markets have been strong in 2003 and reasonably strong for the first month of 2004 from what I understand. But at the same time, you have to recognize that it all comes back to economic cycles. All these economies, whether it is China, India, Brazil and other emerging markets, also has an economic cycle. There are already press reports and indications that China is over heating, which means that the government will clap down. The last time China went into an investment binge was in 1994 and the government raised interest rates fairly sharply and cut capex, which let to a relatively slow economic growth rate. For China, 6% is relatively slow and 9% is great and for India, 5% is relatively slow and 7% or 8% is great. On the margin, economic activity in China and India will reduce in the course of 2004 and to that extent, people who are projecting continued rise in earnings per share (EPS) i.e. 20%-25% level per annum in the future, are going to be disappointed and to that extent, the markets may correct. But the long-term opportunity in terms of being an investor in these markets still holds true. There is no reason to doubt that.
EQTM: China has had a huge impact on the commodity cycle recently. So, how do you think this is going to pan out?
Mr. Ajit: My personal opinion on this is that yes, there is a secular growth in demand for copper, aluminium and steel because of the consumption patterns in economies like China, India etc. But you know, demand for these sorts of products can be met fairly easily in an 18 to 24 months investment horizon. You talk to any Indian company and they are already drawing up plans for capacity expansion. At the same time, you got economies that may slow down or may be forced to slow down because central bankers are concerned about overheating, inflation, hyperinflation and hyperactivity. So when demand falls in a margin and when supply or expectations of supply comes in chunks, it can have significant impact on commodity prices. It does not take more than a shut down 1 m barrels of oil in a day to sort of cause a spike in oil prices. In cement, just 2% or 3% swing in demand or supply can have an exceedingly high effect on prices - to the extent 20% to 30%. So, you have to keep that in mind that supply can increase and demand, on the margin, may not fall, but growth in demand can taper off. And that will have significant impact on commodity prices. So, I am not putting my personal money in buying mines and saying I should be an investor in physical assets. I am not a believer in that.