In an interview with CNBC-TV18 Consulting Editor Udayan Mukherjee, Sharma, however, made it clear that he is not forecasting a crack of a similar magnitude (in percentage terms) that was witnessed globally during the financial crisis of 2008.
“I am not making a case for a 50 percent fall in market,” he told CNBC-TV18’s Consulting Editor Udayan Mukherjee. “All I am saying is: directionally, and the speed of [an expected down] move will be very similar to what we saw in 2008.”
In the interview, Sharma also discussed how he expects Indian equities to fare in such an environment and outlined his view on various sectors.
Below is the transcript of Shankar Sharma’s interview with Udayan Mukherjee on CNBC-TV18.
Q: How have you been reading the turn of events, because suddenly, there seems to be complete mayhem in global markets, did you see it coming?
A: Even at the risk of sounding immodest, for our clients, particularly their global funds, we got very light on equities right from November onwards. And my view has been that if you are talking in the globe, the US market was heading nowhere, but down. And that had been grinding from January last year.
So, if you just simply saw the market action, it was just unable to continue the way it had continued from March 2009 bottom, so it had lost complete momentum. There was no steam left in the market, it was just treading water.
So, everything was pointing towards a pretty bad 2015. 2015 turned out to be an average year, tepid, flattish year for most markets. India was down 6-7 percent, most markets were down around that or flattish. But, that did not mean that 2015, what one was seeing in 2015 was over and that 2016 would be a markedly different year.
My view was that, I really thought that this crack would happen sometime in 2015 itself. It did, particularly China, but for the global markets to crack, it obviously took a little bit longer because remember, this has been a good market, or sort of a bull market. I do not believe it has been a bull market globally anyway, but most people tend to believe that from 2009, we have had a bull market, but that is still an overall a trading range for global markets, not a secular bull market.
But, be that as it may, it took a while for global markets to roll over. And now, January 2016 has eerily started resembling the January of 2008. If you recall, again, the first fortnight of 2008 was really ugly and this is kind of shaping up that way.
Q: Are you saying that you are seeing shades of 2008 in how his year has begun? I mean, that was a 50 percent drop in the market. You are not suggesting that it could that ugly this year, are you?
A: I am not saying it is going to be exactly in terms of market percentage move like 2008. I am not even for a moment suggesting that, but of course, one market has seen something like that which is China. So, it is not that no market has done bad, but I am not making a case for a 50 percent fall in market. All I am saying is that percentage moves are all debatable, but directionally and the speed of that move will be very similar to what we saw in 2008, because the data out there, the Fed hiking rates, trying to convince itself more than anybody else that things are fine with the US economy, while nobody seems to be convinced that it is indeed the case.
In my view, China can still fall a lot more than what it has already done, because it has just kind of come back to where it was about 18 months back. It is not really fallen on a two year basis. If you look around Asia, you look around Australia, you look around emerging markets, Brazil, where do you make case for even a moderate bull market or even a flat market? There is just completely, no sign of hope for large parts of the equity world.
So, I am of the opinion that this year, particularly in the first half is going to resemble in some sense, a second half of 2008.
Q: Almost a bear market like situation?
A: Well, that is the kind of debate that I have had with many people for a while now, that actually, we have been in a bear market globally for a long time. I recall in 1999 or 2000, Warren Buffet had said that he does not believe that equity returns incrementally. That was I think he was talking in 1999 end or early 2000. Incrementally, the returns would be matching the returns of the previous 15-20 years. And guess what, he has turned out to be absolutely right that the Standard and Poor’s (S&P) 500 was 1,500-1,600 at its peak in 1999 and today, it is 1,900. So, over a period of 16 years, all you have got is a couple of percent a year kind of move, I you include dividends, maybe that is another 1.5 percent.
So, in my mind, that is still a bear market. Over 16 years, if you have delivered virtually no returns, that is a bear market, right? Japan has been in a bear market for two and a half decades. Europe, again, reasonably strong bear market barring small markets here or there. Asia, emerging markets have been in a bull market or were in a bull market till 2007 end. After that, it has just been a grinding market for most of the markets. India being a little bit of an outlier. But, if you adjust for the currency, then even India has not taken out its highs of 2007. The dollar highs of 2007, the peak of the market has still not been taken out. I think we are good 10-20 percent away from those highs. So, for a foreign investor, India still remains and has remained for the last 7-9 years, in a bear market.
So, what we are seeing now is a more stronger manifestation of a bear market, but it is already been there. It has been there on a stealth basis. We have had a bear market globally in equities for quite a while now.
Q: Do you subscribe to the theory that the way China is moving and the way some of the data in other parts of the world are coming out, we could be headed towards a global recession triggered off by China?
A: Again, think about it, and this is something I have said many times that first look at the equity markets. Despite these kind of low interest rates, markets had delivered virtually no returns for years on end. Despite such low interest rates, the globe has, the world has delivered almost no real meaningful economic growth. So, the fact of the matter is that if you adjust for interest rates, or if you adjust for normal interest rates and then look at equity markets, and then you look at actual macro economic growth, there has been a recession, for years globally.
So, remember this zero interest rate policy has kind of tapered over or masked what has been in reality a bear market in equity markets, and a recessionary condition almost across most major economies in the world. So, again, things reach a point when it becomes very apparent to the world that there is a bear market or there is a recession. But, if you are a close observer of data, a close observer of rates, you would have definitely seen this coming. I do not think it is any great science on my part to say that I say this, but if you are looking at data properly and you are looking at market action properly, what is happening is not a surprise.
Q: What do you see falling more from here? Do you see this continuing to be an emerging market problem or do you see 2016 being a year where developed markets and emerging markets fall in tandem?
A: If you go back 2008 for any kind of reference, I think both of them did almost equally badly. In fact in the first half, emerging markets did relatively better because oil had rallied to USD 150 and generally commodities were relatively strong, so markets like Brazil, etc. were still quite resilient in the first half. Really that crack happened in the second half, but the US market was in absolute disaster. So, my view is that we can say that developed markets will underperform emerging markets and which I do believe can happen because that is the area where the outperformance has been quite remarkable over the last few years. They have beaten emerging markets handily.
So, when things turn bad, then obviously, people want to take money off the table on their winners rather than on their losers, because the losers have already tanked and just to give you another piece of data. The emerging market exchange traded fund ( ETF ), the most liquid ETF for emerging markets, which is EEM is now USD 31 and it was USD 31 in 2006. 10 years, zero returns. So, that is something that people now, probably it is like conventional wisdom that look, this asset class is not looking good, so let us take money off the asset class which does not look good which is primarily developed and within that the US. So, it is very likely that the US might actually get hit more than emerging markets, at least for a few months in all this year.
But, directionally both of them are down and that is unfortunately the reality.
Q: It is an interesting point because locally everybody has been scratching their heads about this foreign institutional investors (FII) outflow problem that we have seen in the second half of this year and it has been a bigger problem across other emerging markets, and the general view seems to have been that it is because sovereign funds are selling because of the oil problem. You are saying that you cannot just wish it away, it is just an oil related problem. There is general disenchantment with the emerging market equity class.
A: Exactly right. Again, looking at data, looking at history helps. Emerging markets had been an absolute dog, equity asset class till 2003. Throughout the 1990s, for instance India, our dear old India, did not take out its highs of 1992 till the late 1999 tech boom and that too it was very centred around the technology and the market which drove the Sensex to 6,000 odd. But the old economic companies remained flat for nearly 10 years. Larsen and Toubro actually had put that as a slide in presentations to investors that guess what the returns Larsen and Toubro delivered over the 10 years was in the 1990s. It was precisely zero.
So, the fact of the matter is emerging markets had been a terrible asset class through the 1980s and the 1990s and for a brief while in the tech boom, markets like Taiwan and India did briefly well, but that was very short-lived as we all know, that fizzled out within a matter of a year or so.
The real bull market in emerging markets started in 2003 and by 2007, it was all over and after the 2008 crisis, the emerging markets have gone nowhere but down. Again, China coming out of the blue, delivering a cameo innings of 100-150 percent, but then we know how that is ending. I mean, that is not a bet any sensible fund manager can take the way the China markets have behaved. So, rationally, emerging markets have done nothing for investors. For decades on end, barring a brief period of four years.
And now, people are going back and saying that guess what, if you look at the ETF data, ten years, zero returns, why are we even looking at this set of equity markets? Why can we not simply focus on what is well understood? Because, remember, again, most of the money is anyway coming from the West and within that the US where tech has been doing reasonably well. There are enough pockets of growth within the US economy. Even in consumers or in technology. So, why do we even need to go and waste time looking at these kind of markets which have promised a lot but delivered very little.
So, it is not about sovereign wealth funds alone, there is a general problem when you look at emerging market long-term returns shorn of these four years between 2003 and 2007.
Q: What about India? A lot of people make the point that yes emerging markets might be in a spot of bother but more than a spot of bother, but India is much better and it should stand out as a almost a separate asset class? Do you buy that story?
A: First of all, India is not an asset class. It is another equity market. This is just too much of self glorification when we Indians start saying this. And I used to hear this story back in 2006 and 2007 when again the same case or a similar case was made when India belongs to a different planet because it is a different asset class. Yes, it is a good market and I believe that for decades now, that given the structure of our markets, given the quality of our company’s in general, given that we have commodity companies, but we also have branded companies, we have consumer companies, auto companies, fast-moving consumer goods (FMCG) companies, IT companies, pharmaceutical companies, so, this composition is unavailable in any other emerging market. This is more like a developed market, market structure.
So, within that context, in times of crises, India does end up behaving in most periods, in 2008 of course, we fell 60-65 percent, but forget that for a minute. But if you look at most crisis, India does almost similarly to what a developed market might do because of inherent structure of India or the Indian equity markets being very good. But, my view again, for the last 18 months or so, I have said this openly that there has been a stealth bear market in largecaps, that is not where you are going to make any money at all, but on the other hand, there has been a big stealth, not even stealth, not it has been a big bull market in midcaps and smallcaps. And that is the area that I have been most interested in because I have seen nothing that excites me about GDP numbers in India. And therefore, if you are not looking at big topline growth for the economy which is a GDP number, then it stands to reason that that will not then translate down into big topline numbers for the large companies in the economy.
And more so now, while the real GDP growth, nobody seems to believe the government numbers and that is rational not to believe these numbers, but the 7-7.5 percent is like 5 percent if you look at the nominal numbers which is roughly a 10 percent cut from the 14-15 percent we have gotten used to over years and years.
And all corporate date is always looked at in nominal terms. So, when we look at topline growth and obviously, following from that, bottomline growth, that is all nominal data. We do not sip out the effective inflation when we are making these workouts. So, when your economy is growing 5 percent, how on earth, can your companies, the large companies who eventually will become mirrors of the economy, grow 15-20 percent. And , which is why I have always found this bizarre thing about Indian analysts that they start the year, every year, go back several years, they start the year projecting 17-20 percent growth and when you disaggregate the numbers, this is all like living in la-la-land and by the time March or February comes around, it is down to 5-7 percent. Exactly what has happened in this year. And that is the kind of forecast you are looking at for 2016-2017.
So, largecaps cannot have directions or trajectories which are very different from the nominal GDP growth or the economy and that is running at 5 percent or whatever, 5.5 percent. You cannot expect largecaps, so that was my basic case that with the collapse in commodity markets, obviously, inflation comes down, wholesale price index (WPI) comes down and because of that nominal GDP comes down. And hence, that 5 percent is simply not enough to propel a bull market in largecaps.
But, in my view, that 5 percent is adequate to propel growth in smallcaps or midcaps, because those kinds of companies can derive growth out of very localised markets. There can be very regional plays, there can be very segmented on a certain kind of, if you are looking at infrastructure, certain kinds of infrastructure. So, for them to grow their revenues 40-50 percent, even 100 percent, is something that is believable and that is plausible. So, hence my shift away from looking at largecaps as a viable investment option to smallcaps or midcaps over the last 18 months. That was the central rationale underpinning that move. And if you look back, think about it. Last year, 2015 they have blown out the lights and on a relative basis, it is like 14-15 percent point relative gain for midcaps and smallcaps, just on the index alone and if you look at individual stocks and looking at many 40-50, 100 percenters.
Again, bear in mind, that is a minefield and for investors or professional investors like us, to find one good company can take months and months of work. It is very simple to make a big call on the banks or on autos or FMCGs in the largecaps because those are largely macros trades. But, to make out a case for a single group of smallcap stocks, it is extremely labour intensive.
But, if you are prepared to do that, then that is the area where you have made most money in the markets in the last 12-18 months. And I do believe incrementally in India, there is still a bull market on for small and midcap companies.
So, it is a completely Jekyll and Hyde market that we have. Largecaps, I think are going nowhere but down. I think midcaps and smallcaps are going flattish to up. That is the broad call that I have on India.
Q: So, how much absolute downside do you see in the largecaps? Do you think that the index can go back and retest its previous highs, that the Sensex of around 21,000 and the Nifty of around 6,300? Do you think it is conceivable that we can retest that in 2016?
A: That is possible. I cannot rule that out, I mean that is like 15-18 percent move or thereabouts which we have seen worse, if you just get that, we should be happy. We will take that. And obviously, a big part of that move will come because of the banks because again, banks literally are a mirror to the economy and when you have nominal GDP growth at 5 percent or 5.5 percent, then to expect banks to do well and to grow assets and to grow assets with the right quality, beyond a point, I do not think they can walk on water. They have walked on condensed milk, but I do not think they can walk on water. So, that is the area of the maximum risk in the market that exists right now, because commodities have been crushed anyway and I do not think consumer companies can fall because of the inherent nature of the business.
So, when you have a market down-drift then it is obviously the leveraged plays that get hurt the most and what can be more leveraged than a bank?