S Naren Picks A Key Positive In Government's Approach To Consumption
The government does not want to create an out-of-control consumption boom, says S Naren.
While the capex push in Budget 2022 is commendable, what's even better is that the government does not want to create an out-of-control consumption boom, which leads to trouble, according to S Naren.
"If you look at the 2009-2013 phase, we had a current account deficit and oil subsidies going out of control," the executive director and chief investment officer at ICICI Prudential Asset Management Co., India's second-largest asset manager, told BloombergQuint's Niraj Shah.
"If you look at what has been done successfully now is that you don't have current account deficits going out of control or oil subsidies going out of control," he said. "You're being careful in ensuring that you're not creating a consumption boom going out of control."
That means, he said, that automatically the government recognises that capex is superior than consumption. "Whether the numbers are 24% or 23% or 16% — the fact that you're not taking current account deficit to record highs and you're not creating oil subsidies like what you did at one point of time, that itself is a big positive."
Finance Minister Nirmala Sitharaman announce a 35% increase in capex spending in Budget 2022. Economists, however, see actual growth in lower and a large part is routed as interest-free loans to states.
Watch the full interview here:
Read edited excerpts from the interview:
What do you make of the Union Budget 2022, and its pros and cons?
S Naren: It is too much to expect now that the budget is a big event. First of all, we must accept that the bulk of the work has already been done over a period of time.
The GST Act has ensured that a lot of what has to happen in indirect taxes has been pushed out of the budget. So, for the budget to be a very big event is something that we all want to believe, but it can't be such a big event. So, that is the reality that we have to accept.
What really transpired from the equity market side was that it was a good budget. So, in my dual hat of what I look at in fixed income, and that is where the markets got a bit spooked, because at the end of the day, a borrowing program of Rs 15 lakh crore is not a small amount.
What it means is that somewhere every week, the government has to borrow something. If I assume 52 weeks, you're talking about Rs 25,000 to Rs 30,000 crore every week. That is really the challenge which has come out of the budget.
From an equity market point of view, you have a buoyant economy, a buoyant corporate sector, buoyant retail sentiment, and you have everything going for it with the exception of valuations. So, there's nothing in the budget to say that there's something which has been stopped. Everything is going smoothly. Virtually, there are very few taxation changes. So, what has changed? (There is) Nothing negative. So, nothing negative is equal to something positive.
There was nothing wrong with the equity market from the budget point of view. But Rs 25,000 to Rs 30,000 crore having to be raised every week in debt by the government is not a small figure.
You have told me in the past as well that over a slightly normalised period of time, equity markets tend to follow the bond markets. They get a large portion of the cues from what the bond markets are doing. It seems to be a bit of a challenging year for the bond markets, never mind the possible inclusion in MSCI. How do you see the challenges that lie ahead from RBI’s perspective — in terms of policy-making and the cues that the equity markets and other asset classes derived from the bond market?
S Naren: I think that is where the challenge is. In India, we're not used to thinking of cost of equity and various other things for any retail investor.
But if you look at it, that challenge is going to shape up at some point of time. How did the retail equity bull market start in 2020? It started off with the fact that fixed deposit rate came down sharply. So, then many investors asked the question, 'Should I invest in fixed deposits, or should I put money in retail? Should I start trading on my own in equities?' That is how this entire bull market started, and then investors made good money, and they continued with it.
Today with interest rates going up, they have all got used to the fact that they are trading equities. Should they now invest in fixed deposits, or should they trade in equities? This is a question that many investors have to think about, and this is where the big challenge is.
Do they come out of equity markets before they lose money or do they come out when things are good and invest in fixed deposits and debt mutual funds and asset allocation-oriented products?
This is going to be a very interesting thing because in my 32 years of investing, I have seen people come out after making losses and do these things. But if they did it when they were making money, like they are today in a very big way, then it will be very interesting. But will they do it before losing money or will they do it only after losing money?
I have been a stock broker between 1994 and 2004. I saw two times in 1998 where they said, 'Now I'm going to move into fixed deposits' and then in 2002, they said, 'I'm going to move into fixed deposits'. Both times, they did it after losing money.
That is the most interesting challenge retail investors have because today everyone is sitting on a pot of profit across stocks, companies, everything.
Do you reckon that there is a fair probability that the markets could have either a price or time correction or both because of the factors that you have outlined?
S Naren: I watched the U.S. equity markets for some period. There were several loss-making companies in the U.S., and those loss-making companies kept going up. They kept going up and suddenly in the last four months, they just collapsed. They kept going up and went down suddenly.
So, there is a situation where there has to be a price and time correction. But from what level and from what time point? Those are all very complicated questions and it's difficult to say when it will happen. There are no guarantees that it needs to happen from February 2022 or it needs to happen from February 2023. All we can say is that the big thesis that we had in 2020, where June, July, August and September, we were bearish, and we went wrong.
In October 2020, we realised that we were wrong because we were in a Central Bank Bull Market. We were not fighting valuations or fundamentals; we realised we were fighting the global central banks. So, then we told everyone that you are in a Central Bank-led Bull Market.
As an AMC, we launched new fund offers like the ESG Business Cycle Flexi Cap because we said we are in a Central Bank Bull Market. We feel that the Central Bank Bull Market was over in November 2021. The day Jerome Powell of the U.S. Fed said he no longer believes that inflation is transitory, and is going to taper and increase the interest rate, the Central Bank Bull Market was over.
Now, once you move out of the Central Bank Bull Market, it means that you're going to have respect for cash flows, respect valuations, etc. So, which means that you're in a period of volatility. That period of volatility does not mean that markets will just keep going down. Definitely not. Periods of volatility means that there'll be periods where markets go down, there'll be periods where the market goes up.
And the task of making money is not going to be as easy as it was between March 2020 and November 2021. The day, the Fed Chairman again comes and says they are going to start printing money in a big way, then the task of making money in the equity markets in India will again become very easy.
So, the task of making money in India will become much tougher and that does not mean you're going to have one-way down markets. You're going to have down markets, you're going to have up markets, and it makes the task of making money much more interesting and tough.
Your peers on the global front have been consistently selling Indian equities while you and your Indian colleagues have been buying. A couple of people who are bullish raise the point that, as much as there are headwinds for Indian equities in terms of valuations and other factors, India promises to be the only major economy having some meaningful, large growth at a point of time when both the U.S. and China, among others, will not be able to show growth. And that should drive the comfort in the Indian story and people might be okay with the higher valuations as well. Do you believe in this argument or are there challenges to this argument?
S Naren: India is a structural growth market simply because the demographics are superb. You have working age populations which will keep going up for the next two decades. So, India is a structural growth market. The kind of growth that we talk about in most products in India is much higher than the growth that we talk about in most products in other parts of the world.
But just because we are a structural growth market, people believe that stocks will keep going up, and for valuations, you can give any amount. That part is not true.
Just because we are a structural growth market doesn't mean you're not going to have bouts of volatility. And when you have more than $600 billion of foreign money in India, you are going to have bouts of volatility
If you take the last few months, you have had a situation where the interest rates have gone up. But because Indians don't want to invest at all through fixed income, debt mutual funds, what happens is that they all are very equity-oriented.
So, what happens is that the markets are not obeying certain simple rules, like cost of equity goes up, equity valuations have to come down. But in India, when cost of equity goes up, equity valuations go up. Because for Indians, our debt mutual funds don't exist and that is the interesting aspect.
So, we believe that there is a structural growth market like India, but to believe that you're going to see a situation where the markets won't be volatile, I don't think so.
We are going to have a fair amount of volatility in the next three years, much more than what we've seen between March 2020 and November 2021.
That volatility will go down the day Jerome Powell of the U.S. Fed comes in and says, 'I'm going to start quantitative easing'. So, wait for the statement of Jerome Powell then then the volatility will come down.
In December 2018, Jerome Powell said 'I'm going to stop quantitative tightening'. From that time onwards, some global markets improved. So again, we have to wait for that statement of the U.S. Fed that we are going to start Quantitative Easing or stop quantitative tightening and increasing interest rates.
Till that point of time, we are going to see volatility. But again, volatility does not mean markets going down only. People have got around to believing that volatility means markets going down only. That is not the case. You're going to have periods of time when the market go down, then periods of time where the market go up. But having said that, it's not going to be an easy time to make money like March 2020 onwards.
The first quarter has been bunched up with so many events. We've had the budget out of the way, but we probably see the first of the hikes, so to say, from the Fed. We will have the state election verdicts and the uncertainty around that because it's a very long drawn seven-phase polling period in Uttar Pradesh and that might have its own implications. And, of course, Russia, Ukraine, and oil prices being what they are. Do you reckon the volatility that we speak about could be heightened in February and March?
S Naren: It will be heightened but it will be heightened for quite some time. When valuations are high and central banks are in hawkish mode, you are going to have it. We will have to accept it. Volatility has its own positives and you can try to make money out of volatility. It's not that volatility is a bad word.
Volatility is going to last for quite some time. Central banks dampened volatility for too long by taking more control of everything, and now they realise that due to that, we have had inflation, oil going up, so many things going up. We are going to have volatility from hereon, and we have to accept that.
While yesterday, the 35% growth in capex number was lauded, there has been a question mark around how strong that number would be. So, one of the notes says that against the headline capex growth of 35%, as mentioned in the speech, the actual core infra, defence, capex growth is budgeted at just 7% because the gap is partly addressed by the accounting factor of IEBR-funded Road Capex by NHAI onto the government balance sheet, etc. Nomura has written a piece on it, Morgan Stanley has written a piece on that. Is the capex bullishness a bit misguided or is it still a strong number, even if it's not 35%?
S Naren: The government's approach has always been — don't create a consumption boom, which leads to trouble. So, if you look at the 2009-2013 phase, we had a current account deficit and oil subsidies going out of control.
If you look at what has been done successfully now is that you don't have current account deficits going out of control or oil subsidies going out of control. You're being careful in ensuring that you're not creating a consumption boom going out of control.
That means that automatically you recognise that capex is superior than consumption. Whether the numbers are 24% or 23% or 16% — the fact that you're not taking current account deficit to record highs and you're not creating oil subsidies like what you did at one point of time, that itself is a big positive if you ask me.
You don't need to have a specific number in capex. That number can vary. But as long as you don't start inimical things like oil subsidies, and doing things like creating a new set of problems like oil bonds, I believe we are through with many of the problems.
It doesn't matter whether the capex budget goes up X% or Y%. That is more important than anything else, if you ask me.
So, you are not too perturbed by this, and you like the nature of the capex spend that has been announced?
S Naren: One of the real problems in the economy is the way discoms are handled. So, if the money which is given to the states is used to solve the discom problem, and the discom problem does get solved in the states, even if it is not capex, it's equal to multiple times the capex budget. In the last seven-eight years, the oil subsidy problem has been resolved.
Now, there is a discom problem that has to be resolved. And if the government finds a way of solving the problem through some route, (such as) giving interest-free loans to states, it's a massive achievement.
So, what if it is not capex, you have solved the discoms problem. If you have solved kerosene, LPG or petrol subsidy kind of problem, now (if) you solve the discom problem, it is a big achievement. You created a very good energy system. It depends on how things move and that's what we have to see.
For example, GST has created a national tax regime which is very good. You managed to create through Aadhaar and various ways so many digital things. I don't think you'd have been able to vaccinate a hundred crore people without Aadhaar and CoWin app.
If you manage to digitise land records and for that, some subsidies are given, it's a great achievement. There are things that have happened in the last 10 years through digital and internet and technology. Even if you call it capex or operating expense, it hardly matters because some of these things have actually led to massive benefits.
Recall how events had to be done and now how digital events can be done. Such a massive improvement in efficiency for everyone around you.
There was some gripe on social media about how there's not much that has been done for the MSME sector, as well as for consumption at the lower end of the strata. Do you think that is by design, so that a lot of things don't go out of control because some people do believe that that particular pocket needed some hand holding at these difficult times and that has not been done?
S Naren: Actually, the ECLGS (Emergency Credit Line Guarantee Scheme) extension by one year was one such step to help them. The government is grappling with a proper efficient model to help these people. So, the only thing which they realised was giving people rice and wheat at low cost through public distribution system was one such route. Otherwise the government is grappling with how it can dispense such things to the poor without creating a problem. The government seems to be struggling there. Otherwise, they would have come up (with schemes) because I don't think the government is not keen on supporting them.
But that's why the food subsidy model of giving them low price rice or wheat is one of the models that they have. ECLGS is another model and maybe they will come up with some versions of ECLGS.
I do not know whether the UP election code of conduct also had a role in not bringing out many more schemes at this point of time in the budget and maybe post the UP elections, they will come up with some more schemes. Over the next six months to one year, they will have to find ways to support. Maybe the UP election code of conduct had a role to play and I will not be aware (of it).
You already laid out the macro picture. You are known to be bullish on value per se. In these next 12-18 odd months, where it is that you believe equity markets would reward? Would it be value stocks, would it be export-oriented value stocks, companies which are made in India but cater to the world, or companies which are inward looking because of lots happening within the country on defence, capex, green hydrogen?
S Naren: It's easier to say sectorally right now. Banks have a lot of scope considering that they had very low credit growth for the last three or four years. They don't seem to have big non-performing loans (NPLs) at this point of time or an NPL cycle in the near term. So, banks are clearly in a good shape, comparatively.
Second is auto which has gone through a very big down cycle for the last four to five years. You have pharma. Between Pharma, IT and FMCG, IT has done very well. FMCG is still at elevated valuations, relatively. Pharma looks much more attractive relative to these two sectors at this point of time.
The government has been very careful in handling PSUs over the last two to three years. There has been selective rerating, but there is much more scope for rerating at this point of time.
So, I would say that banks, auto, pharma, PSUs represent some of these things. I wouldn't call them value or anything like that. I would rather say these are sectorally areas which look interesting.
From a growth-oriented perspective, people like infrastructure and capital goods, because there has been a long down cycle even today. Although, the sector doesn't appear cheap, cyclically, they may still do well because there has been a long down cycle.
In my opinion, for people who have a very high growth orientation, IT still looks okay. In my reading at this point of time, small and mid caps are something which vary or we would be very selective on at this point of time. So, you have to choose the sectors carefully at this point of time. This is how we look at it, from a sector point of view.
The two export-oriented themes which you mentioned: one, which is growth-oriented, is IT. I was thinking maybe specialty chemicals can also fall in that bucket; at least, the corporate commentaries say that there is a lot of growth on the global side. But the valuations are not necessarily in the comfort zone. How do you juxtapose them? Would you believe that high growth will take care of the slightly higher valuations or would there be a mean reversion of sorts?
S Naren: As an AMC, we have not currently believed in them because we think the valuations are far too high at this point of time.
We don't know whether China has genuinely walked out of the sector or not. If China does come back and start competing, some of these premium valuations which are there can't sustain. So, we've been very cautious in that sector and I don't think we are believers in this kind of a premium valuation in that sense.
What about the technology sector?
S Naren: Technology looks good but it's not a cheap sector. It requires growth to sustain. Frankly, the growth for the next nine months, people have visibility (on it), for the next nine months to 12 months. The problem in that sector is whether you have visibility for 2024, and that is the challenge. People have visibility for the next one year but whether you have visibility for the next two years, three years, four years. Periodically people get doubts (on that). That's where the question comes in and for valuations to sustain, you need visibility for the longer term. The visibility for the short term is certainly there.
Do you reckon Balance Advantage Funds are the recipe for success?
S Naren: We believe in Fund of Funds as a category and in that category, for example, we have debt, equity and gold.
We have a fund called Asset Allocator Fund (FoF) which can invest in debt, equity and gold. And after the first rate hike, we feel that gold can do well in America.
So similarly, for example, today passive is a very big way to go. So, we have created a category which again can invest in equity, debt, global and gold, totally on the passive side. And because it's on the passive side, the maximum expense ratio that SEBI permits is only 1% on the regular plan. So, that is another thing.
We are saying that do something more innovative and interesting, where you invest in debt, equity and gold through the Fund of Funds category.
And so, that is what we are looking at as a way of looking at asset allocation at this point of time. So, you invest in debt, equity, gold, and global ETFs.
Today, passive is the way to go for many people and this is passive. You invest across all asset classes through a multi-asset construct.