RJ Speak

The following is an excerpt from a Rakesh Jhunjhunwala interview in the ET on the 27th of this month. Prescience?Wisdom?Wishful thinking?Motivated sound bytes?……….Time will tell.I thought it best to record the words for easy future reference.Here’s waiting for the structural and secular bull market that RJ speaks about!

During the challenging years of 2008-13, Indian corporates have restructured and become more competitive. Corporate governance has become better; and yet Indian investors have become more risk-averse and grossly underexposed to equity . We have come to believe that high interest rates, poor earnings growth and net outflows for domestic equity investors are the new normal. These factors are about to change, and for a very long time. This change is in inevitable and irreversible.

We are at the cusp of an era of strong policy frame work, business and investor friendly environment, elimination of supply-side constraints, initiation of a new capex cycle, falling interest rates, resumption of job creation, rising savings and a wall of foreign inflows combined with domestic outflows reversing into domestic inflows with a vengeance. While this is more obvious now, most of us are unable to comprehend the scale and the longevity of this change. We are at a stage where we are blinded by sudden light after being in a dark tunnel for years. We are unable to conceive the impact of a transition from the vicious cycle described above to a virtuous cycle the scale of which we have never experienced before.

Let me share some statistics with you. Corporate earnings grew at a CAGR of only 3% in 2009-14 compared to a CAGR of 19% in 2003-09. Corporate profits as a percentage of GDP has receded from 7.8% in 200708 to 4.2% in 2013-14. If corporate earnings were to normalise to their long-term average of 5.6% of GDP by 2018, that would imply a CAGR of 22% for the next four years. Interest rates in India are among the highest in the world. Greece borrows at 5% interest rate compared to 8.6% for India.

CPI inflation in India has been persistent, driven by unabated protein food inflation. In light of the stable rupee and reversal of factors pushing food inflation, and core inflation coming under control, long-term interest rates have most likely peaked.

We all know Price = EPS x PE. We have forgotten what happens when both EPS and PE expand rapidly and correct years of suppression and depression. Marc Faber said: “Bull markets are conceived in the depths of depression, and are reared on declining interest rates and increasing corporate profits.“ Any numbers on earnings, interest rates and valuations will be inadequate to describe the quantity and quality of improvement that can and will happen in every dimension impacting equity markets. The current earnings are so unrepresentative of the likely future earnings that valuation ratios predicated on current earnings will result in missing out on a structural and secular bull run. This will not be a multi-year bull run, but a multi-decade bull run.

While the recent rise appears to be “too much, too soon“, it is a preview of the structural and secular bull market that we have been deprived of. The 1991 peak was decisively overcome in 2000 but was short-circuited by the Internet bubble burst. India did have a great run from 2003-08, but that was cut short by the global financial crisis, the Euro crisis and poor governance during the UPA 2 regime.

In the structural and secular bull market that began in 2013, I expect that we will have a benign global scenario starved of growth and an unprecedented virtuous domestic cycle.

In the last few years, there has been a great polarisation of valuations between the defensive and high free cash flow (FCF) sectors of IT, pharma and consumer stocks as compared to the cyclical and leveraged plays of infrastructure, capital goods banking and real estate. There has also been a high premium for large-cap stocks as compared to small and midcap stocks. It’s my belief that these polarisations and premiums will revert to the mean.

As investors and traders, it would be a fatal mistake to extrapolate the past into the future when the biggest change is set to unfold. Remember, markets will always surprise both on the upsides and on the downsides. One must not try to quantify the move in Nifty , but try to buy right and hold tight. It is imperative that we appreciate the impact of surging foreign inflows combined with domestic investors playing catch-up on net inflows to correct the systematic underexposure to equities. Finally, we will have a favourable fund-raising environment enabling the availability of much-needed risk capital for India’s growth.

I would advise all Indians to have faith in India and its markets. We should not be under invested for the mother of all bull markets. Be prepared for the inevitable and irreversible; structural and secular bull market. I believe we will all be pleasantly surprised by the longevity and magnitude of this bull market.