In most interviews that we do, we get an insight into what is happening in the markets. Rare is the interview where we come across simple, distilled, timeless wisdom. This is one of them. Here, Ajit Dayal, chairman, Quantum Mutual Fund, dwells on a wide range of market and economy-related subjects. Two points emerge very strongly. One, he says, if you shut out the day-to-day noise regarding what is happening in the markets and instead focus on a stock’s long-term fundamentals, it lends clarity to your investment approach. The second point that Dayal makes is that those in business must be guided by a strong moral compass. He advocates not paying bribes, fighting corruption, and highlighting the racketeering that is going on within one’s industry — even if its means paying a price. His views come like a gust of fresh air in this scam-tainted world that we live in. Read and savour them. This interview was conducted by Sanjay Kumar Singh and Anindya Bera.
What are your expectations from Q1FY12 earnings?
Well, the research and investment process used by the teams at Quantum Long Term Equity Fund are focused on the direction of long term earnings over a two- to five-year period. We ignore quarterly numbers because they tend to tell us nothing about the long-term problems or opportunities facing any company. Additionally, they are not audited. But even if they were, they would still be a fairly useless data point for a long-term investor.
Year-to-date the Sensex is down (-) 8.72 per cent. Will the second half of the calendar year see a continuation of this trend or do you expect a turnaround in the markets? On what will this depend?
As long-term investors, we tend to buy into businesses run by capable and honest management that can guide their companies through good times or through difficult times. The past movement of the index, per se, does not tell us anything about what is likely to happen tomorrow. If the earnings of companies in the Indian stock market grow, then the share prices of those companies should trend upwards over time. The pace of that increase in share prices will be a function of how quickly — or slowly — investors wish to own that share.
The Indian stock market has daily volumes of some US$ 4 billion every day. On top of that there is the futures and options market that trades some US$ 15 billion a day. My gut feel is that 90 per cent of these trades are done by some 1,00,000 investors or punters. Financial theory tells us that higher liquidity is good for the market since these many trades reflect the varied opinions that comprise any market. This high activity, theory tells us, ensures that all asset classes are correctly priced at any point in time.
Well, I have a different take on this hyperactivity. I see it as gambling with little relation to the underlying or intrinsic value of a company. Take the examples of the overpriced tech stocks like Yahoo or AOL in the year 2000, or the beaten down cement stocks in India in the year 2003, or the hyped up real estate stocks like DLF in 2007, or the India-shining stocks like Pantaloon and Suzlon in 2007. They were all actively traded. They all had high volume — and they were all mis-priced. So, volumes do not determine the “correctness” of a share price. Volumes only tell you the popularity — or lack of popularity — of a specific share or a market.
On a macro level, volumes in India are down some (-)40 per cent from their Lehman peak. That does not mean that India is an unattractive place to invest. All it means is that volumes are down — that’s all.
And I would like to link this to your question on the outlook for the second half. Well, a sensible investor will not focus on volume or popularity, but on the underlying earnings power — or lack of it — of the companies they wish to invest in. I cannot tell you with any certainty where the index will be in the next few months. Having said that, I can make a case for an index at 29,000 by July 2012 based on the assumption that earnings of Indian companies are expected to grow by some 20 per cent for the year ended March 31, 2012 and a second assumption that India will be a favoured destination for foreign investors. As an aside, I could also make a case for the BSE-30 Index to be at 10,000 next week. If every foreign investor lines up to sell their shares in India, the market could collapse by 50 per cent in five weeks just as it did in the September-October 2008 period. Investors need to live with these tremendous price risks when investing in shares — just as we are learning to live with the random acts of terrorism as we go about our daily lives. Recognising the near-term uncertainty, we focus on long-term earnings and we believe that growth in earnings will determine the direction of movement of share price.
My statement of a 29,000 BSE-30 Index by July 2012 has earned me a lot of criticism because people are focused on the number. What they need to stay focused on is the direction of the earnings. That 29,000 index level is based on assumptions of earnings that are available in the public domain and a crucial assumption of the return of the foreign investor and the local, “front-running” speculators to hyperactivity. I am not suggesting that investors should buy with that level of index as a “target” because Ajit Dayal said that will be the index. Investors should buy because over long periods of time a growing economy gives them the opportunity to participate in the ownership of companies that will benefit from this growth.
Will India see relief from high inflation and an end to rate hikes in the second half of the year?
In the near term, the prices of food products will be influenced by the monsoons and whether we can import food from other parts of the world, if we were to run into a food production shortage. We have no food shortage today and the government has allowed the export of wheat. But prices of products can also surge due to middlemen. So, we have traders who can distort the price of food for periods of time. Or we can also have powerful distributors and CEOs of mutual fund houses who distort the cost of providing advice to investors in mutual funds! Over the past five years investors have paid an artificially high cost for investing in mutual funds. Instead of bearing an expense ratio of 2 per cent, investors have ended up paying 5 per cent in many cases! Inflation can be reduced by, one, increasing the supply of goods and services; two, making distribution more efficient and affordable; and three, by reducing demand.
The interest rate hikes only address the demand side. In some sense, I view these hikes as a warning from the Reserve Bank of India (RBI) to the government — a warning to get policies in place to improve supplies and reduce the high cost of distribution for food or for real estate. And, if the government fails to address these supply side issues, the RBI will be willing to raise interest rates to the extent that demand will collapse and then prices of products will fall again. The RBI has to balance growth, inflation, and debt levels in the economy and it must never sacrifice that mandate. The Indian industrialists who clamour for lower interest rates remind me of the Wall Street firms who clamoured for a rescue. They wish to protect themselves, not reform themselves. If RBI succumbs to pressure, we will end up being like the US: generating higher debt to support consumption of higher-priced goods and even higher income inequality. The supply side tools are in the hands of the state and central governments. It is up to governments to fix the corruption and the inefficiencies that are deeply embedded in the system and for us as individuals to stop supporting such practices.
Do you see oil and commodity prices moderating further in future?
I think the global economy will slow down. There is a Lehman-like financial crisis ready to hit the world again. This would suggest that commodity prices will decline — just as they did in October 2008. But there will be some economies, like India, that will still grow and provide a base level of demand for commodities to fuel that growth. But, no, I am not in the camp that says commodity prices will sustain at these higher levels.
Read second part of this interview on October 04, 2011
This interview appeared in the August 2011 issue of Wealth Insight. Click here to subscribe to Wealth Insight.