/Want to make outsized returns? Buy despair: Ganeshram Jayaraman

Want to make outsized returns? Buy despair: Ganeshram Jayaraman

Keep in mind that the current account deficit is almost zero. It is a balance of payment surplus quarter and as a result, liquidity is surplus. There is money in people’s hands and they are spending a lot less on imports, on electronics, on gold, on fuel, says MD – Institutional Equities, Spark Capital Advisors.

You are not as gloomy as perhaps the consensus on the Street. In fact you are seeing some early signs of recovery and growth and hence you believe growth recovery could surprise many. What are those indicators that you are spotting which is giving you that conviction?
Since March, we have been trying to predict what will be the impact on earnings, how long this pandemic will impact us and what will be the impact to the overall economy. Till then we were underweight banks, cement and autos. We changed our stance in March in the same week as the correction because of our ability to say that the recovery will be stronger after the lockdown ends.

It is still a work in progress. There are still ifs and buts — how long the lockdown will last etc– but the basic point for us is that the confidence comes from four-five aspects. One, we believe that the NPA fears will be a lot less than what Street fears. There are a lot of checks on the ground. We believe the banks are doing something which funds do which is a bit like averaging. They are lending to borrowers where they are confident that the borrowers will be back on their feet. The pain which they are going through is temporary and they are making a call that in 18 months, this guy will be back on track, either because credit guarantees are common for SMEs or because for non-SMEs fresh loans are being given.

In some form, new loans are being given to pay back the old dues. And there will be a lot less NPAs in the moratorium book which will be on a falling curve. That will give confidence to the banks by next three to six months. I know they have equity. Many of them will be raising or have raised equity and excess liquidity at lower levels of deposit rates. If there is an improvement in the NPA curve, that will give them the confidence to go then start lending again which will help us grow.

Second, interest rates are at almost 20-year low, maybe even more. I find it very intriguing that for an economy which has been in a contracting mode in the last four months, how is money supply at a three-year high? How is the money multiplier effect going up? As banks’ results come, we are watching savings bank data and we see overall current account has gone down and savings accounts have gone up. I am talking of collective bank balances. Term deposits in absolute terms have gone up. How this is happening in a phase where people think there are job cuts, pay cuts and whether this will have an effect on retail loans has to be seen.

Keep in mind that the current account deficit is almost zero. It is a BOP surplus quarter and as a result, liquidity is surplus. There is money in peoples hands but they are spending a lot less on imports, on electronics, on gold, on fuel.

Benefit is coming to the government in the form of higher fuel prices, in the form of lower interest rates to consumers. Also, it is manifesting itself in the form of lower gold consumption, lower electronics consumption and so in some form, this is helping us weather this problem a lot better. Also keep in mind that the gold price is up 70% in the last two years and as a result, gold loans are growing 25%. That is a shock absorber, an inbuilt insurance which the society has built. It is a savings pattern built over centuries and that is helping the rural economy which is holding pretty well.

In fact, we believe that over the next six to 12 months, even the residential real estate market can start picking up because of non-resident Indian demand. That is a little underestimated industry for eight years now. Property rates are flat, rupee has depreciated from 47 in 2012 to 75 against the dollar. Interest rates are down about 1.50 to 2.00 bps. So, the same house is about 45% cheaper vis-à-vis 2012 and that will in some form help recovery as well. Lower commodity prices are helping gross margins and not showing up in EBITDA margins.

Let us talk about the interest rate sensitives — financials and realty. How are you recommending those two sectors should be played right now?
We are overweight banks, autos, some durables. Realty will show up with a lag. We need to be very selective about the companies there. There is not a wide choice available in good quality names. There are a handful. We are also looking to play cement.

Across banks, auto, cement, pockets of realty and some durables as well, we should be able to play out this recovery with a certain degree of confidence. All this would not take shape in just the next few months. This is built with almost an 18-month view, 6 or 4 months back. We are just in the initial stages of this. It will take time but we believe that our confidence on the recovery direction is pretty strong. It will take time though for all of this to play out.

Is the market sensing it because it has been pretty resilient in the face of so much caution? How is the market cycle playing out in terms of factoring this recovery in?
Go back to the last 12 years. Investors have got outsized returns only when they have bought into despair. March 2009 was as gloomy a picture as you could have asked for. Investors who bought into that despair, made money in the first one month and even though the subsequent two years were muted on returns, the first 12 months returns helped them. Again in late 2013, there were the taper tantrums and India was called part of the fragile five. Everything was negative around it and if you bought into it, you made outsized returns in year one. Then year two and three were moderate. By the time we get into year three, the negative return starts coming. Again it happened around demonisation. Again it started around mid March of 2020. The broader point I am telling is if you want to look at the three-year return horizon, the year one outsized return gives a lot of comfort and that comes only when you buy into despair.

Why is this repeatedly happening in the last 12 years? The central bank or the central government has propped up the economy and markets. In the initial 6-9 months, it appears that liquidity is driving markets, then that liquidity starts percolating into the economy and starts showing up in earnings and recovery. Once that plays out, the policy makers tend to step back and then within 9-12 months, the growth falters because we see the policymakers stepping back and that starting to hurt demand.

So, on year one, recovery will appear ahead of markets, on year two earnings catch up and year three is kind of moderating earnings because the policymakers step back. This has been playing out for the third or fourth time in the last 12 years. We do not see that changing in the next three years.

This was not the case the previous 10 years or in the 90s but that is because once the policy action comes in, somebody else takes over the baton. But now we are not seeing anyone else stepping in to take over. When policymakers want to step off, there is nobody to drive subsequent growth and that is why this cycle appears shrinking every three years, which means you need to buy despair otherwise you are not making outsized returns.

What would be the risks to this hypothesis which investors should also keep in mind?
The key risk is how long this whole lockdown lasts, whether there will be another wave, if we will see more states having these partial lockdowns. Will the consumer behaviour change sustain for long after this? Will risk aversion of either consumers or banks continue beyond the horizon? These are all the key questions which we will see.

Have you seen permanent destruction of wealth, of incomes of businesses that will have a lingering effect beyond horizon? There are risks, but when we weigh the two in balance, we think that our ability to get growth is something which we have confidence in and we also believe that earnings will revive.

We also look at certain things as lead indicators. For example, we study the cash flows of companies both for the March quarter and when we see the June quarter results as well, What we have seen picking up when earnings are down is the cash flows which are improving because working capital requirements have come down. The supply chain, the dealers, the distributor level inventory have come down.

When we see how life can be post lockdown and when we see some auto numbers coming up even for the month of July, how is it that in an economy like this some companies are reporting year-on-year growth in volumes? It is possible because there is a double reason; one, the supply chain is restocking. They were in a destocking mode till March, even in the lead up to Covid because of BS-VI transition.

There has been abnormally low levels of inventory and hence there will be restocking. Demand apart, from end consumer demand, due to either rural demand, interest rates, liquidity, the savings account balances trend means that there is money in bank accounts. Speaking to banks, we are realising that the average savings account balances are trending up which is confounding in a contracting economy.

It is a current account surplus, a BOP surplus quarter. So there are elements which we cannot ignore and that is why we believe recovery will be strong and when we weigh the two, we believe that it is not the time to go and hide in defensives. We do not take these one month, two month, three month kind of calls. Our view is at least for 18 months and we think the concurrence of how 2021 can take shape gives us confidence for some of these to play out.

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