It’s Time To Start Putting Cash To Work, Says Morgan Stanley’s Ridham Desai
Despite the seemingly bottomless rout, Morgan Stanley’s Ridham Desai says the market is not acting irrationally.
Watch | Morgan Stanley’s Ridham Desai On Finding A Bottom In This Market
Indian equities, having tumbled the most in at least a decade this week tracking global coronavirus selloff, maybe just a “handshake away” from a bottom and investors should consider buying, according to Morgan Stanley’s Ridham Desai.
“My view is that in a year we will be a lot higher than where we are today. So this may not be a bad time to start putting cash to work,” he told BloombergQuint in an interview. This, however, has to be done with a clear understanding that the next one month could be “pretty bad”, he said, suggesting that investors shouldn’t go all in.
Everybody was complaining how difficult it was to buy a good business in India. Well, now you’re getting it at cheaper prices.Ridham Desai, Head of India Equity Research & Strategy, Morgan Stanley
Indian equity markets continued to plunge after markets on Wall Street saw their worst one-day fall since 1987 and an equally poor sentiment across Asian Markets. The S&P BSE Sensex opened 7.6 percent lower at 30,281 points—the lowest level seen since May 24, 2017. Trading was halted for 45 minutes after the Nifty hit the lower circuit.
Despite the seemingly bottomless rout, Desai said that the market is not acting irrationally but simply pricing in the worst-case scenario.
Desai’s views come at a time when a number of funds are waiting for signs of some recovery before they part with their cash.
Expecting the markets to shrug off a problem as significant as this is “foolhardy”, First Global’s Shankar Sharma said, adding that none of the previous two crises got over in two months. India’s largest equity hedge fund manager is also hoarding cash as it’s too early to call the bottom to a free fall.
Desai is now depending on a personalised indicator—one which tells him the market is worse off than it was in both 2008 and 1998.
“That indicator as of yesterday went to an all-time low. It went below GFC [Global Financial Crisis], below 9/11, below 1998 which is very crucial because 1998 was the previous low. During GFC we did not go below 98,” he said.
At the same time, valuations are close to what they were at the bottom of the “great financial crisis” and the average of other historical market selloffs, he said.
We are not there, but we are at a handshake distance to the low.Ridham Desai, Head of India Equity Research & Strategy, Morgan Stanley
The Bit About Hotel California
India remains less effected from the threat of coronavirus when compared to other countries and continents, Desai said, days after the government temporarily suspended all visas for foreign nationals.
While the policies being announced by global central banks are not as coordinated as during the 2008 financial crisis, the market veteran takes comfort in the fact that the Narendra Modi government and the Reserve Bank of India have spoken about their preparedness to take action, and are likely to do so if needed.
Speaking about the impact on markets, Desai said fixed income markets are likely to be worse off than equity markets.
“It’s not the same with equity markets, you can only take so much money out. I always cite this line from Hotel California: ‘You can check in anytime you like but you cannot leave’. Prices will fall so precipitously, so dramatically the selling stalls. So it’s much harder to take too much money out of the equity markets.”Ridham Desai, Head of India Equity Research & Strategy, Morgan Stanley
Edited excerpts from the conversation:
We’ve seen selloffs a number of times but the velocity and the pace at which this is happening, is this something that is new to even a veteran like you?
See, every crisis is different. We try to match it with history, but it rarely does. GFC was different from 9/11, was different from the Asian financial crisis and different from the Harshal Mehta scam. Each market has its own character. Some markets fall slowly, some markets fallen precipitously. So, this is like that, it’s a different crisis and it will have different characteristics. When we look back on this, we will say oh, this is not comparable with history and it never is.
While you are in it and if somebody is trying to figure out what would happen in the near to medium term, what is your assessment, if it’s possible to assess?
No idea. Let’s not even try to guess this.
We are dealing with a very different type of problem. We don’t have a solution for it, and we don’t know when we will have the solution. In the meanwhile, things could get really murky. So, the markets are not being irrational for a moment. The markets don’t know where the trough of the fundamentals lie. So, the instinct is, let’s price more than what could be the worst. That’s what the markets around the world are doing.
They will continue to do that what we can do is and what a lot of countries have reacted- India has ring fenced the entire nation. So, we have quarantined the whole country. That will stop the spreading of the disease. It doesn’t cure it; it stops the spread. So, that’s the first step we can take. Hopefully the quarantine works, and it is getting more and more aggressive which comes with significant damage to economies and growth. So, the near-term growth gets wiped out. The next thing is, when do we have a real cure for the virus? Who knows when that happens? So, when the markets think that maybe a cure is at hand or the quarantine has worked, and the virus is now fading away or maybe the heat is risen. Mumbai is so cool today. When we want the heat, it doesn’t come. So, maybe that’s when the fundamentals may be a little bit clear. I do think prices may trough a long time before the fundamentals actually clear up for us.
So, what are the changes that have happened? I mean for you in terms of the Morgan Stanley call that was earlier done. Pre-corona virus versus during the phase of the virus?
We have not changed our call because you know it’s all relative. India has actually relatively underperformed. I would have argued India would have outperformed but it hasn’t, and I think the reason probably lies in the fact that we were coming out of a growth slow down and things were actually looking up for us. In February, I think we had some really good growth numbers so the stimulus of the past few months was finally finding its way into the real economy and suddenly this thing has come and hit us. At a time when we were just coming out of bed like a sick person coming out of bed and now, we have a new situation to deal with. That could be quite damaging for us because a sick person is inherently fragile, and a new sickness could cause significant damage.
So, I think that’s why India has underperformed. Otherwise I think whatever we have done in terms of policy what is happened should have actually worked in our favour but it hasn’t. In fact, direct impact on the virus is also a whole lot less in India than most parts of the world. So, actually if you look at it from a logical perspective, India should’ve outperformed but it hasn’t. I think the reason is this that we were already weak, and we’ve been hit hard by this or we will be hit hard by this.
A lot of countries and central banks are taking coordinated efforts to make sure that they can, in a way, help stimulate the economy. But the RBI, on its part, out of the monetary policy is not giving any indications of whether it wants to take any measures, except for the fact that it will be looking at the dollar liquidity in the market and will take measures to address liquidity. Do you feel that could be a little late and there could have been a coordinated effort even from the Indian RBI?
So, there are two things. Firstly, let us not underestimate the importance of policy response. I know there are a few jokes floating around that policy doesn’t fix the virus, but it does fix the second-order effect and the flexibility of share price in the economy. The virus is already taking its toll. Falling share prices will actually cause businesses to go bust and we’re seeing liquidity issues, especially in the U.S. and certain parts of Europe, though not yet in India.
So, I think it’s important that there be policy action. Secondly, I don’t think it’s been that coordinated. I mean there was a promise of coordination, but it has not been coordinated. It is nowhere compared to the coordination we saw during the global financial crisis. So, it still feels like policymakers are not absolutely in-sync. Maybe overnight the Fed probably got a little bit more urgent in its actions but not necessarily at the scale and global level that we saw in 2008.
Thirdly, I think the RBI and the government both have shown a preparedness to act. Therefore, I think that they will act. So, I think the forex swap is useful. I mean, it puts liquidity in the forex markets. India has not yet faced fresh trades in terms of liquidity in the bond market, but I think if it does come then I think the RBI will act. I mean, could they open up financing lines for new SME loans or new financing lines for NBFCs? I think all that is pretty much possible.
In the short term, liquidity will reign supreme over fundamental values. What your sense of what happens to liquidity over the near-team? You would be talking to a large global client as well. One, because of the global schedule because if the currency weakens and that’s also an added hit. Do you think money outflows continue and do they keep on impacting the spot levels?
I don’t think so because I think we also have a simultaneous positive oil shock. So, there’s an offsetting factor. So, the balance of payments will be okay. I don’t expect it to (take a hit), it’s not an India-centric thing that’s affected directly. I think there are still bids on Indian assets and therefore I don’t expect it to get to that level. But again, as I said, it’s very hard to make those forecasts with a great deal of certainty. So, we have to keep a watch on it, and we have to be ready to act in case there is a massive flow of money out of India.
Historically, this goes back to the age-old debate. India has kept its bond markets under tight control and that’s where you know the stresses first come. When there is a global problem, it is the fixed income markets that face the maximum outlook. In equity markets, you can only take that much money out. I always cite Hotel California- you can check at any time and you cannot leave.
Prices will fall so precipitously that automatically that the selling stalls. So, it’s much harder to take loads of money out of the equity markets. In 2008, we lost 20 billion dollars in a single year. Today, 20 billion dollars is not the same money as in 2008. Twelve years later, 20 billion is a lot less for us. So, even if we got to 20 billion dollars it will not cause the same type of external problems that it caused in 2008.
It is actually almost impossible to predict but I’m still asking you. Where do you think is the sweet spot when it comes to levels and valuations? I know these things happen. Let’s talk about it, the near-term fear may overtake but eventually, things will revert to meaning.
That is the only thing I can talk about. I don’t know what the virus will do to the economy, but we can compare valuations and sentiment and there are levels. So, I have a composite sentiment indicator which I’ve been running for the past 35 years which puts in various things in it implied all the usual market metrics that we look on an individual basis, it combines all of that into one single indicator.
That indicator as of yesterday’s close went through its all-time low. It went below GFC, it went below 9/11, it went below 1998 which is very crucial because 1998 was the previous low. During GFC, we did not go below ‘98. This thing went below 1998. So, sentiment wise, even though we don’t maybe not be feeling like that, it is very bad out there. That’s why I love this indicator because it does not rely on my memory of how I felt in 2008. I felt a whole lot worse in 2008 from what I’m feeling today, but it looks like the market is behaving a whole lot worse than it did in 2008. The reason here for the indicator to have plummeted could be the point you made which is the pace at which this has fallen. It’s not like it happened in 2008. So, that place matters to how my indicators behave.
Let’s look at valuations, which I prefer to look at price to book because I don’t know where earnings are going to be. Price to book is a more stable indicator, book values don’t fluctuate as much. So, where are we today? Today we’re at 2.3. If the Nifty is going to be down 5 percent, then we’re going to be at 2.1’s. GFC bottom was 2.1, ‘98 bottom was 1.7.
The average of the last five bear markets is about 2. So, we are not right there as we’re in sentiment, but we’re getting there. We’re pretty much at a handshake distance, but we’re not there. So, I have a leading indicator for returns on stocks, that number is about 20 percent today, but at the GFC low, it was about 40.
So, valuations may have a little bit more room and maybe we’ll see that in the next few days. My view is that, if you look out for one year, I think we’ll be a lot higher than we are today. So, this may not be a bad time to actually start putting cash to work with a clear understanding that the next one month could be pretty bad and you could get lower levels. So, you don’t go all in, but I think you start because I will not be able to time the bottom.
A lot of quality businesses have seen sharp corrections to share prices, we’ve been waiting for that to happen for several months and quarters and years. Everybody’s been complaining about how expensive it was to buy a good business in India, but now you’re getting it at cheaper prices. The good businesses remain good and they may go through one or two-quarters of pain, but they’re not fundamentally altered. As Warren Buffett said, “Nothing that has happened in the last two months has changed the 10-year cash flow forecast for most American businesses.” But the prices have changed a lot. So, I think if you have the gumption, the stomach to experience and feel this volatility, I sometimes feel I do have it. So, I can go out and say this and I don’t worry about going wrong. My valuation and sentiment stuff is telling me it’s time to actually start buying and get courageous with a clear understanding that as we saw doing GFC, it takes several months for this to bottom and prices could go a lot of whole lot lower.
In GFC if I remember correctly, the buying signal first came in June. It wasn’t until December that we actually put a low, but the fall between June and December was quite large and the indicators hit all-time bottom in October. Just for context.
Obviously, this also changes earnings forecast for corporates. Do you feel now the focus for most businesses, because of various factors, will shift to margin performance rather than volume performance and how they do? Do you feel that EPS will be driven more by margin performance and the kind of pricing action that you see which would benefit them because of raw material prices probably coming off? Because volumes will definitely not coming back in a hurry.
I think that’s a pretty good assessment. We’ve got earnings, earlier this week and I keep vigilance because I think there could be more downside to the fund house as we have highlighted this before. So, we have to keep a watch on this, but margins look like they’ll be okay, revenue growth will get crushed. So, that’s a good template and of course we also still have a year on year tax gains. So, if you look at it on a net basis margin, we are still looking at it to go higher.
So, what’s your assessment on how the EPS impact will go for the year?
So, we’ve actually cut F-20 because I think this quarter will also experience some pain. On that lower F-20 base, I have also lowered F-21. So, the cumulative cut is about 7 1/2 percent on earnings- absolute EPS number.
Which according to you is okay, not too harsh?
So, we’ll see how that goes. We have to see because that’s a global thing. It’s not just India so I have to see what my colleagues globally do and then I will react accordingly. We have one round of GDP growth cut in on Monday.
Do you think that these macros will provide a silver lining because you’re seeing inflation print coming off; that will come off because crude prices in the crash that we’ve seen will have its own impact on inflation coming off. You’ve got a lot of GDP headroom now because of the crude oil prices coming off. CAD is at 0.2 percent, so all of these factors probably at least for India provide that little bit of a silver lining, don’t they?
They provide it for the whole world, there’s deflation everywhere. Inflation is not coming anywhere. So, there’s room for us to cut interest rates. Therefore, we will see how the RBI is responding; whether they need to respond on an emergency basis or not is debatable but I think the emergency response should be more focused on liquidity. I think then they can take the rate cut up whenever they need to. But inflation will remain benign for quite a while.