• FEBRUARY 4, 2004

“Don’t buy in January 2004. Wait. There will be another buying opportunity…”

Ajit Dayal is the co-founder and Chairman of Quantum Information Services Limited that owns Equitymaster.com and Personalfn.com. He is the Deputy Chief Investment Officer of Hansberger Global Investors Inc, a company that manages US$ 4.5 bn in the global markets. Ajit is one of India's best-known investment advisors; he set the stage for entry of FIIs in India. He founded India's first equity research company in 1990 (this company has evolved from that pedigree).

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 I: Ajit on global markets

    EQTM: How does India fare as an investment destination in the global environment? Do you see India becoming a preferred destination in coming years? If not, what would be the likely impediments?

    Mr. Ajit: I think India, as a destination, for multinationals to build businesses has been there for 11 to 12 years, and gets better and more visible every year. Each and every year you find more believers and that is a good sign. In terms of share market investors and portfolio investors, I think whether for India, China or Brazil or any of the emerging economies including Russia, most of the markets have risen because the foreigners have bought stocks over the last two years. My question especially in the Indian context is OK, if the foreigners begin to sell, who is going to buy? Locals are not buying. In China, locals were buying in the early part of 2003.

    If the foreigners begin to sell, particularly in India, where they own around 40% of the BSE-30 index by market cap, I have no idea who is going to buy. And the punters who have helped the markets go up, as we saw in the very sharp rally in the BSE-30 index in December 2003 when the markets jumped by 20% in one month, there is nothing to stop the markets from falling by 20% in one month on the way down. We have already seen some sort of correction from 6,100 levels down to 5,700 levels or thereabouts. If there is a whiff in the air that FIIs are selling, the punters will sell twice the amount ahead of the FIIs who will also sell, and there is no one to buy, which you know gets into a point about the stabilization fund. There has been a talk in India about setting up a stabilization fund to stabilise markets. I think that is a ridiculously silly idea. We did have a stabilization fund. It was called the Unit Trust of India and it went bankrupt because it was misused. Stabilization funds are contrary to market forces and market forces, end of the day, win.

    EQTM: What is your view on the strengthening of the rupee vis-à-vis the dollar? Will this have any effect on India’s competitiveness in the long run?

    Mr. Ajit: I think the strengthening of the rupee and other Asian currencies against the US$ is not so much really the strengthening of the rupee but the weakening of the dollar. It is not that the rupee has got fundamentally stronger, although the fact that forex reserves have increased and exports have gone up helps. But I think the long-term story for India and China is, they need huge amounts of capital to build their economies. Countries that need huge amounts of capital to build economies generally will have weaker currencies because they are creating liabilities, liabilities and liabilities, as they borrow, as they issue paper to help out in building physical infrastructure.

    But in the near term, because the US$ is hit by the same concerns i.e. that the consumption in America being financed by foreign paper, the US$ has weakened. I am of the view that the time to be bearish on the US$ was when 1 US$ bought you 1.25 Euro in October 2000 and now, one Euro is buying you 1.25 US$. So I don’t think it is time ‘now’ to be bearish on the US$. It is probably time now to be bullish on the dollar. But again, I am not a currency expert per se. But if you take a straw pole and you see this in the US immigration numbers, over the long haul, where do people want to live in? They want to live in America. And to live in America, what do they want to hold, US$. I don’t see people moving to Iraq, Germany and to India that much. Fundamentally, I look at that as one indicator and not be so bearish on the US$.

    EQTM: What is you view on the Indian economy? Over the five to ten years’ perspective, what are the challenges that we face and how do you see India performing? We are attracting lot of portfolio investments off late, but not much of FDI. So, how is it going to pan out?

    Mr. Ajit: I think FDI needs to be attracted and will be attracted. Like I said before, the skeptics in the multinational world increasingly believe in India and are coming to India. Some of the policies that the government has changed around a bit in terms of limits on how much a foreign insurer can hold in India do not allow many insurance companies that generally bring a lot of capital with them. Some of the telecom statements that have recently come out about the fact that foreigners can only buy only new shares in telecom companies also limit the takeover that may happen. In the power field, Dabhol was a failure and it showed how a badly negotiated contract just puts off investors. Companies like AES have had problems in states like Orissa and haven’t done much in terms of investing or wanting to increase their investments in this part of world. So, there has not been much success in terms of attracting foreign capital in these big-ticket investment items like telecom, power and financial services. Until the government of India changes policies on these fronts, you are not going to get big FDI flows.

    In respect of long-term economic growth or concerns that one would have, we heard a lot recently about the Goldman Sachs report on BRIC (Brazil, Russia, India and China). I think these are all very nice and glossy statements that talk about how wealthy India is going to get. And it will get wealthy. I think we like to pat ourselves on the back, as I am sure, the Brazilians, Russians and the Chinese are patting themselves on their backs. But each of these countries has got fundamental problems because they also have a darker side of their economies like poverty in Rio, poverty in India, unemployment and rural stagnation in China or whether it is increasing disparity between the rich and poor in Russia. So, each of these countries have huge social problems.

    And when you tell me that India is going to have the largest number of young people in the world in 20 to 30 years time, actually I get frightened with that statistic. Because when I see another statistic from CMIE about the number of jobs created in the organised sector in India over the last five years, it was less than 1 million. So, in the last five years, less than 1 million jobs were created and we have had a booming economy, tell me how are you going to create jobs for 100 million people over the next 20 to 30 years. If you don’t create jobs for these young, employable 100 million people, what is going to happen on the streets? We are already seeing effects of that. We are already seeing what is happening in Assam, Bihar and Maharashtra where people are saying Biharis’ go back to Bihar and Assamese go back to Assam. This is a nightmare. This thing also highlights the risk that exists not only in India but also in China. China has its own version of the risk where the rural people are leaving hometowns, going to cities and don’t find jobs. They may have some jobs now because of construction activity that is taking place. But once the construction stops, then what? And same thing is with Russia. I mean the price of power, telecom and basic food has gone up a lot and there is no new job being created there. I have never been to Brazil or Russia but from what one hears, these are problems of other kinds. So it is nice to look at the investment option and value them and it is great to put a P/E ratio on that. It is also important to look at the risks that exist and deflate the P/E ratio a bit because of those real risks.

    EQTM: Which sectors are you buoyant on, both on a global basis as well as in India in the long term?

    Mr. Ajit: I think the time to be in the early cyclical stocks was six to nine months ago because when economies are down, people do not like to buy the steel, metal and material stocks. But I think those stocks and sectors have run up quite a bit over the last six to nine months. Probably, the way to position portfolios on a global basis is, I would not say to be in the defensive names such as consumer staples and healthcare etc, but probably to be in the late cycles – the industrials, the ones based on the capital expenditure story. The fact that companies are going to invest more and they need machinery. Those are the stocks to be in for the near term and then, there will be a point in time where you have to get out of those stocks and go into the defensive stocks as the economy matures on a global basis. Because you are likely to be in a recession in two to three years time. That is the fact of the cycles.

    On the Indian economy side, there obviously is the Indian outsourcing story. I guess the way to address India is to look at the structural things in India. There are things happening at the agricultural end, which reward farmers and create wealth. When wealth is created at the farmer end, there is consumption of two-wheelers, cars and household goods. That is one story to play. There is an export story like textiles where the quotas are going away in 2005. There is export of technology and engineering goods. So there is an exporting story owing to inexpensive labour whether it is Ranbaxy with Ph.D.’s or whether it is Bharat Forge with cheaper forging engineers. And then you have got the finance story where you have got the restructuring of the financial sector, the growth in economic activity and the growth in consumer borrowing. Depending on which story sounds more exciting at a given point of time, you should be invested in any one of those three key legs.

    I think the time to be in the consumer story was last year i.e. 2003. The time to be in the export story of technology, I think it is still there. And the export story of engineering is still there. I think the time to be in the rejigging story of the finance sector is sort of over, you have already seen all that. And I think there will some bumps along the way, as consumer credit looks dangerous and may be we start seeing some defaults on the consumer side. And you will. In Korea, they are still recovering from the hangover of a credit binge on the consumer side about 12 to 18 months ago. And I spoke to someone in Korea couple of days ago and the company I spoke to, do not expect the consumer credit story to expand or to grow for all of 2004. So, you have to be careful about these sorts of binges.

    EQTM: If you look at the domestic market, the consumer base is not that significant. You have a set of people who consume. But that is not growing at a faster rate for people to come, invest in India and to grow it at a larger-scale basis. You have not seen per capita consumption increase dramatically over the last ten years. Your views…

    Mr. Ajit: I think the reason for that, as I indicated earlier, is the poverty in India. I think when you have poverty, it acts as a drag. So, you have got more than 400 m people who do not contribute to the GDP but they do contribute in terms of the denominator. I think that is the big challenge. You cannot have a very narrow pointed pyramid where 20 m people take up all the activities. It is wonderful to say ‘India Shining’. But it is shining at the top. That tip of the iceberg that you can see is glowing and is snow white. But what about the below part? It is part dark down there.

    EQTM: Both the RBI and the Finance Ministry have taken tentative steps to encourage Indians to buy global stocks. What is your view on this? What strategy should the domestic investors adopt to take advantage of this move?

    Mr. Ajit: I think one of the key investment disciplines is diversification. For an Indian, it is important to have assets in all underlying currencies and as many economies as possible, as they build their investment nest. As much as it is important for an American to have assets invested in many countries around the world, which is why see money flowing to emerging markets, including India. The American individual is putting money into a mutual fund that is investing here. In the same way, we need to invest and have money all around the world. I dare say that over the last thirty years period, in a US dollar adjusted basis, probably the rate of return that you earned from investing in the US would be the same as investing in India. So, although the BSE index has gone from 100 in 1980-81 to 5,600, it sounds like it has gone up 56 times. But the Indian rupee has gone from Rs 8 per US$ to Rs 45 per US$. So you have given up a lot of it because of the currency depreciation. Ultimately, you as an Indian or an American must be in a foreign currency and you must have the ability to buy gold or oil, which is a dollar priced commodity irrespective of what your home currency is. So, I think you need to have diversification of risk.

    In terms of how you go about doing it, the RBI is yet to come out with rules on it. There were rules announced on Jan 13th 2003, but it was a very impractical process. The Finance Minister made a speech to a group of NRIs in the first week of January 2003. And I think the excitement of allowing Indians to invest aboard was followed up in a bunch of rules that did not really follow through. But those are being looked at and I am sure there will be new guidelines on that soon. So, we have to see what the guidelines are. But there should be a clear cut message that every Indian must have assets, not only in stocks but in anything viz. currency, real estate, bonds across many economies, across many time zones.

    EQTM: While investing in stocks, which factors would you give the highest weightage? Is there any advice you would like to give to retail investors on how to go about investing in stocks?

    Mr. Ajit: I think if you are investor in equities, your key concern is whether ‘It is a fundamentally good business?’ and ‘Is it run by fundamentally good people?’ If you get the answers of those two right, there is a price that you are willing to pay for being a shareholder for the long-term in that business. I think those are the key.

    If you are an investor in a bank or a bond or a debenture, the concerns are different because you are getting a fixed rate of return. And what you need to really worry about is ‘are you really going to get the fixed rate of return?’ ‘Is it a safe company?’ What is the gearing of the company, what are the risks in the new project and whether I am going to get my money back? Those are the concerns. It is less on the management and business side and more on the financial gearing side. You have got to know the balance sheet more. But I think, for an investor in the equity side, understanding the business is the key. I can come and tell you that I am going to build a phenomenally great spaceship to go and live in Mars. You got to find what is it going to cost, whether I have the skill set to do it and am I going to compete with NASA and the European Space Agency. You got to understand what is the business, what is the barriers to entry, barriers to competition, who are the people behind it and have they proved themselves in the past or not. Then work out what you want to give as P/E ratio for that management and for that business.

    EQTM: We get to speak to a lot of retail investors and what we get to hear these days is that in a bull market the risk of investing in stocks reduces because stocks are only going to go up. So is there any discipline that an investor can practice irrespective of a bull market or a bear market?

    Mr. Ajit: I think people who make statements like stock go up in a bull market and stocks go down in a bear market don’t have a discipline. The reason you say bull is because stocks are going up and vice versa. These are descriptive words. Yes, they are right that in a bull market, stocks go up. But that does not mean that it is going to carry on forever. It can change in a minute. You won’t know about it till a few months later when you go back and look at the charts and oops, that was a bear market when I bought stocks. So, you know, there are enough people who bought technology and Internet stocks and all that stuff in 2000. When the markets started correcting in March, they kept buying in April, May, June and every single month, thinking it was an investment opportunity to enter at lower levels and lost probably, 90% of their money over the next three years.

    So, you have to be careful about that. I think the key thing is to have a discipline. If you are an investor in shares, in a variable investment alternative if you will, where there is a risk element associated with the investment, again, understand the business that you invest in because as a shareholder, you are a partner in the business and that is the way we view things. You have to have a long-term view on it. You just can’t get carried away. Unfortunately, during bull markets like now, the philosophy that we practice at Hansberger Global Investors, the value principles, actually lag market performance because while stock markets are going up, we are typically selling shares because the valuation the market is awarding, we believe and hopefully correctly, is not in tune with the underlying value of the company we are buying.

    So, we are actually selling shares and they are going up by 10% or 20% more after we sold them and we look like idiots. And we did look like idiots in 1999-2000 when we had nothing in technology. And the whole world was buying technology and we were not. Not because we did not understand it, not because we do not like it, just because we felt that valuations were crazy. We were wrong for a long time and then, we looked very smart in 2001 when we did not have anything. So, the risk of being a value investor with a discipline is that while you are following and implementing that discipline, you actually look stupid and silly, as the statistics look bad when compared to the peer group. But over the longer period of time, hopefully, we are right again this time and we believe, atleast in the Indian context, where we have sold some shares, the shares have gone up lot more after we sold them. Of course, we still hold some Indian shares and there are many companies we still like in this market. And time will tell whether we did the right thing or the wrong thing. So far, it looks as if we did the wrong thing, but time will be a judge of that.

    EQTM: Apart from stocks, what other asset classes should domestic investors look for?

    Mr. Ajit: I used to like gold. I used to like gold couple of years ago at about US$ 280. I am not a gold analyst, but I think it is important to have precious metals in the portfolio. May be 5% of the money in this asset class. I think it is very important, in the Indian context, to have real estate. Largely because, there is a change in social structure in India where the joint family system is breaking down and is giving way to the western style of independent nucleus families. That means, in a family with two kids, I should start investing in properties for my kids. Investment in properties should be a very big chunk of the portfolio of an Indian family.

    And I will buy shares. Equities, in the long haul, as we all know, give better returns than bonds, and equities give you a chance to participate in the growth of the economy and companies that grow with the Indian GDP growing in the foreseeable future. And again, keeping in mind the valuations and risks on the social side that are there. I would keep some money in banks and bonds, but not a lot of it. I believe that opportunities in other asset classes and the reason for being in other asset classes far outweigh the head in the sand attitude of an ostrich saying I am scared about the world and I want to put my money in bonds and the bank account.

    EQTM: One final question, what is different in this current stock market rally as compared to the previous ones?

    Mr. Ajit: There is a saying in investment circles that I believe was told by Sir John Templeton many many years ago that ‘This time its different’ are the four most famous words in investments. And there is a fifth word that you don’t really hear because it is whispered, is that ‘This time its different, sucker’. And I think this time what has happened in the Indian market is different to the extent that the retail investor has not participated in it so far. The fear factor that I have is that you have a government, which has done some wonderful things over the last few years. Previous governments have done some wonderful things in the last decade in India that have set the ground for phenomenal and sustainable growth rates in the future on GDP. But you have got a government that is seeking re-election and is running around with a campaign called ‘India Shining’. You have people in the government making statements about the market reflecting how well the economy is doing and that gets dangerous. Markets have to have a natural correction and when they have a natural correction as we are probably having right now as we speak, governments’ panic and they don’t want the markets to have this natural correction.

    And then, they may issue other statements that begin to encourage retail investors to come in because they perceive a one-way bet, as what you referred to earlier on as in a bull market, shares are only going up. So, I may as well buy. If the retail investor says, OK, I missed this whole rally from 3,000 to 6,000. The index is back to 5,500 now and the government is making all these noises. So, I know that till the elections are over in May-June, I have got a solid one way ticket upwards and I will start buying.

    And believe me, governments’ cannot manipulate any kind of market be it currency market, stock market or a bond market. The Japanese Central Bank has spent US$ 180 bn last year trying to keep the Japanese yen weak. But the Japanese yen strengthened. The Hong Kong government created a fund that did stabilise prices for a while. But stock prices only went up when the retail investors in the market felt that it was time to go up. So, governments’ cannot really, in my opinion, over long periods of time, influence markets. When governments’ make statements, then they begin to create a sense of false security and bring in the retail investor. So my message to the retail investors is that so far, you were not so smart because you did not buy at 3,500 levels in January 2003. But don’t buy in January 2004. Wait. There will be another buying opportunity and the buying opportunity could be two-fold. Either markets come down or the markets stay where they are and the earnings go up. Then you have another buying opportunity because valuations look more respectable.

  • Part I: Ajit on global markets

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