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High Interest Rate Problems

Shankar Sharma, VC & Joint MD, First Global, says that high interest rates are hitting corporate India’s profitability…

How worrying is the fiscal deficit?
The fiscal deficit is always something to worry about but I don’t think it is a make-or-break issue. The real worry is the external situation - the current account deficit, the BoP. That might become a problem, I think the internal deficit is not too worrisome right now.

A while back you gave an interview in the media on why you believe the India growth story has gone down the drain. You seemed to have changed your view.
Let me be clear. My view on the GDP number is negative. What this means is that I am negative on growth prospects which translates into corporate profitability. But if you ask me about the government policies, whether they are good or bad, I am saying that I find no fault with them.

What do you feel is the biggest problem facing corporate India today?
High interest rates. The high interest rates are killing demand and hitting profitability. Lack of fund raising. These are the issues. But then again, corporates have grown substantially in the past 7-8 years. So there is a cyclical angle to this entire slowdown in corporate profitability. No company can keep expanding profits by 20 per cent for 20 consecutive years. No company has done it before barring Microsoft. So it has to slow down. There could be many reasons but the core reason is that cyclically it is due for a slowdown. Which is what we are experiencing.

Where demand is concerned, do you see a drop in volumes?
There will always be a lag effect. You raise rates today, demand will not fall tomorrow. It will take a while for that impact to manifest. There is some growth momentum which continues. But when it is done continuously over a year it will hit profitability.

What is your view on earnings in the next few quarters?
Going by this quarter, I do not see any hope of a revival. Commodity prices softening will help certain parts of the industry for sure. But on the hand that softening will hurt the suppliers of commodities. Overall, corporate profitability won’t see a rise.

Around a month ago, you had made a statement saying that it will not be smart to invest in large caps.
That would have not been a blanket statement, there would have been a context to that. But broadly, large caps appeared expensive while mid and small caps were absolutely decimated at 1x PE. So that is where I would rather go. Hunt for mid- and small-cap companies that would survive the downturn. Large caps in that sense have no value. But of course such picks need a lot of work in terms of analysis and understanding of the business etc. And then one can find some gems that will turn out to be multi-baggers.

You have said that you do not look at valuations but you look at momentum. Can you be more explicit?
Valuations are vague. What is cheap? What is expensive? It is hard to define. Typically I look at momentum because when there is momentum of earnings then a so-called expensive stock will also do well. If there is momentum in the stock price, that has a life of its own. But just buying a cheap stock will not tell me whether the stock is going to go up or not. So I find this entire theory of value investing to be slightly misplaced. If there is value plus momentum, then it is a good trade. Value without momentum is not a necessarily a good trade. The momentum will tell you that others also believe there is value in that stock. If I am the only one believing that there is value in a stock but the rest of the market ignores it, what is the point of such a trade?

How do you define a bear market and going by your definition, are we in one?
We most certainly are in one. I define one as when the market falls 50 per cent off the peak.

You see more pain?
A lot, lot more pain.

So is it a good time to get into the market now and hold?
No.

The coming year won’t see any market revival?
I don’t see any money to be made now. And I really doubt there will be money to be made next year too. Occasional trading moves will take place where a trader can make money, but not an investor. Twelve months down the road, we should be lower than where we are right now. The trend is down though there will be the occasional sharp rallies where the market will go up by, say, 10 or 20 per cent. Someone smart enough to play this will make some trading money. But buy-and-hold investors have a long wait.

Are you invested in the market right now?
I don’t have a single rupee in equity right now.

In that case, where do you advise investors to invest?
I would advise them not to. At least in a fixed deposit they will get their money back. The focus is now on return of capital, not return on capital.

When do feel is a good time to get into the market?
I think a sell off of another 25 per cent off the index will be a good time to get in which means in stocks, the fall could be another 35-40 per cent.

If an investor told you that he had to compulsorily get into the market right now - what would you suggest?
There are just around 10 stocks that look good right now. For instance, Tata Motors and Mahindra & Mahindra. Some consumer companies look good from a defensive perspective such as Unilever and ITC. I don’t know how much more room they have to run on the upside, but on the downside they look good. Some pharma companies look good. Banks don’t look good.

Over the long term, would you still bet on India?
In the short term and medium term, it will be tough. There is no easy way out of the situation we are in. Next year this time I see the market even lower than what it is now. But from a long-term perspective I am happy to be invested in India. We will be the only guys left standing. On a 10-year basis, India will be the country to take a bet on for sure.