Consolidation healthy for markets: Rakesh Jhunjhunwala
PART I
Rakesh Jhunjhunwala shares his perspective on what has happened over last four months and what the road looks like from here for the next three-four quarters and the next three-four years. He says that it would be healthy for the markets to consolidate at this range, which will prepare the ground for a dramatic rise.
He also thinks interest rates have peaked off and he doesn't see a further rise in rates.
Excerpts from an exclusive interview with Rakesh Jhunjhunwala:
Q: We will talk about the fundamentals, but you spent a lot of time watching the screen. What is the screen telling you for the moment?
A: Surely in the last two-three days, the market has exhibited weakness, but I am not sure that we are going to see a major movement, either way. Maybe in the next one-two months we are going to see range bound markets with some amount of consolidation rather than a major move, either way.
Q: How would you classify that - a major move? You are saying that more then a 10% Index move is unlikely over the next one-two months?
A: I would think so.
Q: Either way?
A: Either way.
Q: So essentially are we going through a consolidation phase?
A: I would think so.
Q: But are you a bit surprised that the Sensex has not gone on to make new highs or the Nifty did not stick at new highs for a very long time?
A: I am not surprised, because in the last four years, we have had a path-breaking rise from 3,000 to nearly 15,000. As a long-term investor, I would be happier if the market consolidates at this range and makes the ground for real dramatic rise. We have had fantastic returns over the last four years. As long as the market doesn’t lose much, I am not concerned at all.
Q: But you think this consolidation phase will be short-lived or could it be an extended one?
A: I think it could extend to six to nine months to a year and I would think that’s healthy for the market.
Q: But what are global markets telling you now, because almost every market has rallied so significantly?
A: Economic growth in Europe has surprised positively, there is a lot of positive news out of Japan, economies in Asia are doing well. Not only is economy doing well, but the percentage of profits that corporates are getting out of GDP, are at all time highs. Now the worry could be that these percentages may not be maintained, but the fact remains that today the percentage of corporate profit of GDPs is that it stays high. Interest rates worldwide are not at very high levels, but inflation is surely a matter of concern, which is why markets are doing what they are doing. But to my mind, the uniform increase in asset value of all classes is something that could be troubling.
Q: What troubles you the most about the extent of the breadth of the rallies that you have seen in commodities, bond, stocks, gold, oil, everything?
A: Sometimes I feel that too much wealth has been made very easily. But maybe out of prejudice, I have all my assets in Indian equity. I feel India equity, as an asset class, will standout.
Q: Do interest rates bother you, because that’s been the fear for the last few days globally that they might start inching up and denting the case for equities?
A: The markets are not discounting the fact that interest rates will inch up. There were expectations that interest rates in America will come down and in the last four-five days, after the economic news and Mr. Bernanke’s statement. The feeling now is that interest rates may not decline in America. As far as India goes, liquidity is abundant; inflation is below 5%, it's not expected to go above the 5% figure. You have seen some slowdown in the auto industry, so the monetary authorities can feel that they have achieved partly what they set out to do by easing interest rates. I see no reason why in India interest rate should not come down.
Q: Do you think they will go up before they come down?
A: I do not think so.
Q: It's completely peaked off you think?
A: I think so, absolutely.
Q: You do not think because of the ample liquidity right now the Reserve Bank may make another tightening move?
A: I do not think the government is necessarily interested in hurting growth. Government is interested that you have growth with controled inflation and I think, it's very difficult for inflation to go above 5% in the next five-six months. In India, we don't have more then 2% owned houses, we are at an initial stage of consumption; why should any government want to limit consumption?
I personally feel interest rates should come down and industry will be lobbying now that inflation is under control. If you do not have elevated inflation, next four-five weeks, we can expect some softening in the July policy.
Q: As early as that?
A: Why not? Whether the Reserve Bank softens or not, if liquidity is what it is now, it will soften by itself.
Q: So you wouldn’t be terribly pessimistic about some of the rate sensitive sectors any more?
A: Not at all.
Q: That would include public sector banks?
A: Yes, I would think so.
Q: Did you get bearish on public sector banks when rates were going up?
A: I have no investment in public sector banks and as far as my investment in the banking sector goes, I do not go by quarters because they don’t affect my investment over a period of time. Especially, State Bank of India is 30% of Indian banking; I think if State Bank can get its act together, it can be a really fine investment.
Q: Why do you steer clear of public sector banks? You do not like their business morals?
A: I get a secular return in my investments on a multiple return if there is a secular profit growth, but no public sector bank in India produces secular profit growth. There are fundamental problems like ratio of cost to income. These banks income can explode, if the ratio of cost does not increase in proportion to income and I think that could happen in State Bank now.
Q: You are more optimistic on some of the private sector banking space?
A: Yes because I think, there is going to be consolidation in Indian banking, it's not more then three-four years away. Most old private sector banks today quote between 1-1.5 times book and I think, consolidation will not take place at less than 2.5-3 times book and their profits are growing at about 20-25%. In fact, I have an investment in Karur Vysya Bank which I made in around 1993. I never sold that investment until today and if I am not wrong, Rs 150 investment today - one share became 10, 10 became 30, 30 became 90, 90 became 270 - so Rs 150 investment is Rs 80,000 today. I have never sold that investment and there is a natural growth in banking.
Q: Do you think these are the banks, which will go first. The Karur Vysya Bank, the regional older private sector bank or the new ones like Yes Bank and DCB?
A: I don't know. I think, you are already pricing in into DCB and Yes Bank the prices at they will be consolidated. So whether they will go or not, nothing's left on the investor’s plate. I don't think there the return can exceed profit growth, while in the other banks, there is going to be a valuation kicker plus there is a profit growth.
Q: You said three-four years - you don't think it will happen as soon as the doors are open in 2009?
A: The doors may open in 2009 or it may take two to five years.
Q: What’s your call on how the rupee has been moving? How do you see the technology space panning out?
A: I have very little exposure to technology.
Q: Aptech must be one of your significant investments?
A: Aptech is in the training space. I don't think, it’s as much a rupee appreciation as it's a dollar depreciation. I do not know much about the currencies, but I am not of the view that rupee can gain more than 2-3% a year. We might have seen the best of the software industry, as far as investors are concerned. At least for the next two-three years, because surely there is going to be wage inflation and if the currency doesn’t appreciate, it will be a double whammy to the balance sheets.
Historically, margins of 30-32% have not been maintained. If there is a slowdown in the US, the first sector which will have a hit in India is the software industry. Now there is a double opinion about that; lot of people say more work will come in, but in the slowdown in 2000-2001 not only work was a challenge, but also the rates were a challenge.
Q: You have not taken any contrarian position in technology after the rupee’s recent rise?
A: No and I don't think you should also, because their PEs today are well priced. So there maybe growth, but if their margins don't expand, then PEs could contract.
Q: The other sector I remember you telling me a few Diwalis back, which you were circumspect about, was telecom. Another sector that has done extremely well. How do you look at valuations and growth in that sector now?
A: Growth will be good and valuations are also good. In a bull market you can always be wrong as long as you don’t go short. So if you don’t buy, everything goes off. So what’s important is you should remain committed.
Q: In the last few weeks since that February fall happened, at any point, where were you significantly short because we have this phenomenon people going short and then the market moving up foreseeing them to cover up. Have you had any such experiences in the last 4-5 months?
A: I don’t think I have made any short positions significant in the last 4 years. I don’t get the feeling internally that markets are going to dip in a big way or markets are valued at such levels that just sell-sell-sell and sell.
Q: Even when the market fell to about 12,000 odd levels, you didn’t consider, because that was a sharp fall?
A: I was caught on the wrong foot in the Budget, I was long on the Budget day and I exited and I did not short anything. I hope I had, but I did not.
Q: How do you read the global cues right now and do you subscribe to that view that the shape of the Indian market in the near term is very tight to what’s happening globally or not quite so?
A: It’s difficult to say. But I don’t think it’s so much tight as people are apprehending because lot of domestic money is going to come. The Indian economy has got one of the lowest international exposures because I don’t think that any international slowdown is really going to affect any exposure of India, other than software. Also, if there is also going to be an international slowdown, commodity prices will come down which for a net importer of commodities like India, it’s going to be a very good factor; interest rates worldwide will come down.
We have a very large domestic economy, which is largely going to remain unaffected by what happens internationally. So even if things internationally slow down in the first leg, India is surely going to be hit both in terms of sentiment and maybe economically. But over a period of time, we will find that India is the economy that will be the most resilient and may therefore attract the largest investments.
Q: How much of this rally in the last few months is being fuelled by pure liquidity because that’s what people keep talking about?
A: I don’t understand what is liquidity/ what’s not liquidity, because I don’t know who is to decide what is value. I think it’s the most transitive word in the English language. History has never been a guide really because history has always been made afresh. So I look upon PE and valuation as an economic performance and the amount of money, which is available to buy that performance. I don’t agree with all that there is liquidity chasing. Do you think analysts know what value and valuations are? They would be the richest people in the world.
Q: You don’t agree that valuations are expensive in India right now?
A: We can’t generalize. Surely there could be pockets of valuations where I won’t buy as an investor or I would exit as an investor, if I have a holding. There are pockets where there is opportunity.
But in general, I don’t think; one of my biggest learning as an investor is that good stocks always remain expensive. So if India is going to perform as a market, we are always going to feel it’s expensive. They (stocks) are not expensive, because expensive, I don’t I think it’s not going to be expressed in terms of valuations until and unless valuations are way-whack out of any reality.
Again ’92, you had SBI Magnum - it was a closed-ended equity fund. At the NSE, it was Rs 50 and the quoted price was Rs 150. Valuations are really expensive when people just want to participate, leverage and markets are rising 10% everyday, and everybody is participating. So it’s more a psychological manner and matter rather than the absolute number.
Q: You don’t sense that euphoria at all right now?
A: I don’t know what you were doing in ’92 - you have not seen ’92. I think we are going to have another ’92 in India and we are going to have in next 3-5 years. That will be the time to sell stocks; like 2001-02 was the time to buy stocks.
Q: Do you see any extreme over-valuation pockets right now in the market like we saw in the hay days of the technology boom, some speak about real estate being one of those examples: do you agree with that?
A: I won’t equate it with the technology bubble. That was not a boom - that was a bubble. I don’t think real estate is valued as the technology stocks were valued. So I don’t see that kind of extreme overvaluation.
Q: Have you invested in the real estate sector at all?
A: I don’t have any investments in real estate.
Q: How is that possible, last one-one and half years they have been some of the biggest multi-baggers? You must have had reasons to look at those opportunities and let them pass?
A: It’s a very dicey subject. None of the real estate companies pay tax. I don’t know how they get their profits. Second thing I also feel that anything, which can be valued as one plus one is equal to eleven; is not what ultimately gives you returns in markets. I don’t know, I have never been into real estate bull in my life and wrongly so.
Q: But you have bought a lot of real estate yourself; how come you don’t buy those stocks?
A: I have not bought any real estate. I bought a house and office.
Q: Commercial real estate you have dabbled in the past, haven’t you?
A: Not at all. That’s not my cup of tea.
Q: So you would not be queuing to buy DLF, would you?
A: No I wouldn’t.
Q: Why - valuations or innate distrust of the business?
A: I would say valuations, more than anything else.
Q: So you have had a look at it?
A: Yes.
Q: You don’t agree with those - slight premium to land bank - those kinds of valuation models at all?
A: Why should I go and buy DLF, I will buy the land only.
Q: Do you think this will have any kind of material impact on the market - the fact that some serious amount of paper is hitting the market over the next 2-3 months?
A: Lot of that paper will be bought by the strategic buyers. ICICI Bank's 10% will be bought by the Government of Singapore. In the international context, this kind of paper is not much, in the Indian context surely, it will have some effect on the market. It's not coming at a valuation, which is very cheap. So nobody is going to today dump markets and buy those issues. There maybe a new class of investors, there are a lot of first time investors. I foresee, by 2010-11, we should have USD 45-50 billion of domestic money coming in. If you have that kind of money coming in, surely USD 15-20 billion of local issues will be easily absorbed.
Q: Why is that money still not coming in? We've had a fantastic run, everybody can see that equities is the place to be, but aside of some mutual funds, NFOs, we are not seeing great participation coming in locally.
A: I beg to differ. Lot of this money is coming into the insurance sector. I am told, last year the investment made by the insurance sector in Indian equities was higher than the investment made by the Indian mutual fund industry.
Q: You are talking about unit-linked plans?
A: Mainly unit-linked plans. In India, pension fund money is not allowed. Only 13% of the Indian labour today has pension and out of that pension, not one paisa comes into equity. All that has to be allowed ultimately. As time passes, market should not lose. If markets gain and don’t lose much, then I think money will flow in. If there is going to earnings growth in India, even if you get 15% return, a lot of money will flow into Indian equity. I am confident that we have ssen nothing yet, as far as domestic flow goes.
Q: Why not directly? Why are we not seeing direct equity participation?
A: The general participation is through insurance and through mutual funds. Maybe we require more penetration into smaller towns and now I am told, lot of money in the mutual funds, insurance companies is coming from smaller towns. Also there is a distrust in equity, because people lost money in ’92, people lost money in 2000. But I am confident that lot of money is going to flow from the domestic side.
Q: You made an interesting point that volatility and sharp falls drive people away. You don’t see the prospect of that later in 2007, because when the market falls 20% in a small period, people don’t come in for 6-7 months?
A: You have to see corrections from not only what value it corrects, but what time period it corrects. If we do not have earnings damage, which we cannot rule out, I don’t see any way by which we should go below 11,500-12,000. But if the index is to earn Rs 840-850 next year, at 12,000 you are 13-14 times earnings. The index has historically never traded below those levels even in bear markets.
Q: That to your mind, is the flow for valuation?
A: If the earnings are 850, I think 11,500-12,000 would be the flow.
Q: You are reasonably certain of delivering Rs 840-850 this year?
A: It should come through; I don’t see any reasons why it should not, at least not of now.
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