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"There is more value at these levels than there was one month ago…" - Views on News from Equitymaster

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  • Jun 12, 2006 - "There is more value at these levels than there was one month ago…"

"There is more value at these levels than there was one month ago…"

Jun 12, 2006

In an interview with Equitymaster, Ajit Dayal, CEO & CIO of Quantum Advisors Limited, shared his views on the global interest rates, the recent stock market decline and what investors should do at the current juncture? Ajit Dayal is the co-founder of Quantum Information Services Pvt. Ltd. (owner of Personalfn and Equitymaster), CEO & CIO of Quantum Advisors Pvt. Ltd. and Director of Quantum Asset Management Company Pvt. Ltd.

Quantum: In February 2006, you said that when 10-yr US paper crosses 5% levels, emerging markets would witness selling pressure from FIIs. FIIs have turned net seller in India in the last one-month. What are your current view on the US economy, interest rates and its implications on the global economy?

Ajit: The US has had unusually low interest rates for the past 5 years. This resulted in a flood of money willing to take a small amount of risk to make unusually high returns.

The surge of hedge funds – large pools of capital looking for abnormal returns by buying or selling any assets – in some sense added fuel to the fire. Low interest rates in USA and Japan allowed these short-term pools of money to borrow at 1% or 3% rates of interest, make a quick investment and return in any asset class, and generate abnormal rates of return for the people who run hedge funds, not necessarily for their investors. But the speculative element of short-term money should not take away from the real changes in the underlying economies of many countries, including India.

Having said that, we should all remember that old adage of “when the US sneezes, the world will catch a cold” is still very true. For all the noise about India and China, the US is still the economic engine of the world. A 4% growth in GDP in USA in any one-year has the same economic impact on the world as does a 25% GDP growth rate in China or 50% rate of GDP growth in India. Which means that only when India and China can grow at those impossible rates, then they can say that USA is less relevant. The base in USA is large and what happens on the margin there is likely to influence the world for the next 5 years or so. My view is that the US economy will slow down, interest rates will increase in real terms, and the surge of liquidity will be restrained. Rationality will return to all asset pricing. Subbu and his team who manage the Quantum Long Term Equity Fund have been waiting for the world to be more rational.

Long term FII money – which India has completely failed to tap – will find its way into sensible investments within India and other emerging markets. But countries like India that did not discourage short-term investments from synthetics like Participatory Notes will also suffer this large sell-off, as we have just witnessed when the speculative money heads for the door. Please keep in mind that when you read a statistic like ‘FIIs have turned net sellers’, recognise that it is the foreign speculator who is selling.

Quantum: In the last one-year, valuations of stocks/sectors were upgraded significantly, just because it was a bull market. In the last one month however, even as the NSE Nifty is trading at around 14 times one-year forward estimates, valuations have turned reasonable! You have the experience of having seen both bull market and bear market globally and in India in the past. What is the best strategy for a retail investor who is exposed to opinions of market intermediaries?

Ajit: Buy the stock, buy the company at sensible long-term valuations. It is likely that while the NSE-50 stocks may be trading at a P/E of 14 times March 2007 earnings, there will be a slowdown in profits and many analysts – including you – may start reducing your earnings forecasts. In that case, what looks like a 14 times P/E ratio may expand to 15 times or 16 times, as the E = Earnings part of the equation becomes smaller. But clearly, there is more value, as we call it, at these levels than there was one month ago. The investment team at Quantum is clearly seeing more opportunities today than they did in May.

Quantum: With interest rates expected to increase further in India, do you see economic growth and therefore, corporate earnings slowing down going forward?

Ajit: Interest rates will have an impact on the economy and cause some slowdown, but the lack of investment in infrastructure and in people will have a larger impact, in my opinion. But we believe that India can achieve a steady 6% per annum growth rate in GDP over the next few years. These 8% numbers we have seen recently are “flukes” where cheap money and this seasonal love for India have given us a false sense of pride. We need to take the next step up and get to a planned growth rate of 8% per annum, without relying on global conditions and by investing in our roads and in our schools.

Quantum: In a rising interest rate scenario, debt gains attractiveness in relation to equities. What strategy should an investor adopt for the next three years? Has the buying opportunity in equities begun after last month’s fall?

Ajit: There is always a place for equities. Every investor must have a sensible balance of a range of investments in property, fixed income, equities and precious metals. That is something, which every advisor will say – and we will repeat it because it is true. How much to invest in equities is a personal decision. But yes, always have some minimum exposure to equities and there is clearly some value emerging.

However, share prices, like any other commodity, are a function of demand and supply. Since 2003, there was a large demand from this artificial short-term foreign money. That demand may not be as strong in the near future. And now, the supply from IPOs and rights issues may increase. Economics tells you that when supply increases faster than demand, prices will decrease. So while there is value emerging, from a timing perspective, it is possible that share prices could fall further. We are not market timers. So, we don’t understand the extent of that possible fall and tend to focus on valuations.

Quantum: In the last three years, we have been witness to all asset classes - equities, commodities, gold and real estate - gaining significantly. Do you see this continuing going forward?

Ajit: Cheap money from USA and Japan made everyone seem rich – that will change. Just as a rising tide lifts all boats, a receding tide can leave some grounded. On a global level, there has been little pricing of risk. Now there will be a more level risk-return trade-off.


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