Mkt to recover 100% but may fall by year end: Ruchir Sharma
Published on Saturday, May 30th, 2009 at 5:17 PMAuthor: admin (5507 Articles)
The Indian markets have seen a massive bounceback from their lows in October and March. There have been many a debates on whether the market is currently witnessing a bear or a bull market rally. In an excusive interview with Ruchir Sharma, Head of Emerging Markets at Morgan Stanley Investment Management, said that the Indian markets were currently in a cyclical bull market and that he expected the bounce to be about 50-100%. When asked what a cyclical bull market meant, he said: “A bull market means that you’re starting a new era where the highs of the old bull market are going to be taken out. Instead there is a middle path, which is what we call a cyclical bull market within a structural downtrend.” However, Sharma added that by the year end or next year, the market would come down again as the structural problems had not yet been cleared. “As the duration of this bear market still hasn’t been long enough to set the scene for a new bull market to begin.”
“I feel that, emerging markets such as India, will exit this trading range and this overall structure bear market regime a lot quicker than the developed markets.”
New bull market rally by 2011?
Sharma said that he saw a new bull market rally where the market would once again hit its highs at 21,000 on the Sensex. “I think the base for that will be set in the middle of next year or so.”
Commodity Check:
Sharma said that he expected crude to be towards USD 30-40 per barrel more than being at USD 80 per barrel a year to 18 months from now as forward markets or lot of the bullish consensus tend to currently imply.
Here is a verbatim transcript of the exclusive interview with Ruchir Sharma.
Q: Have things changed really, I mean as we started by saying this may be a bull or a bear – do you ask those questions yourself?
A: I think the very important thing is to figure out what the overall regime is because once you know what’s the overall regime then it is easier to know what the rules of the game are and in that regard there were three possibilities that we had sort of outlined at the start of the year, which is that we could either have a bear market rally or this could be a cyclical bull market within a structural downtrend or that this is the start of a new bull market. Our bias has been that we are in a cyclical bull market within what is still a structurally difficult environment.
Q: Can you define that?
A: A bear market rally is basically just a rally that takes place on the back of technicals, which when the markets get oversold, they have a sharp bounce to clear out the oversold but there is no change in fundamentals.
Q: That bounce could be as much as?
A: That bounce is varied over history. If you go back to the 1930s, there were bounces of as much as 30-40% even from the lows but here I am talking about the US markets. For the Indian market it is probably going to be more because you have got to adjust it for volatility and the Indian markets are more volatile, so the bounce could be bigger. So a bear market rally is just that. Now what does a new bull market mean? A new bull market basically means that you’re starting a new era where the highs of the old bull market are going to be taken out. Instead there is a middle path, which is what we call a cyclical bull market within a structural downtrend.
Now the implication of this is that there is some turn in fundamentals. The turn fundamentals is not meaningful enough to start a bull market but it is enough to have markets rallying by anywhere from 50-100% over the space of a year and this is something which we saw in Japan quite often in the 1990s.
Q: The time period is important. Usually it last for a year you say going by history?
A: The average duration of this if you look at what happened in Japan in the 1990s was about 6-12 months. So it varied a bit. So about 6-12 months was the average duration and there are some signs of what’s going on now with the first big cyclical market that took place in Japan in 1992-93 which lasted for about 10-months and the Nikkei went up by about 50% in that space. So I think that’s the paddle that we are using for the US market at least and what exactly is this cyclical bull market?
It means that a lot of the structural problems have not been written down or not purged from the system but enough has been done to cause some sort of an economic upturn and that is exactly what we are seeing now that the amount of government spending that has taken place over the past few months has been enormous. It is almost as if that was the only part of the balance sheet of an economy that was under leveraged so to speak and so now the best efforts are being put to work here to make sure that we end up getting some sort of a cyclical economic recovery on the back of huge government spending. Something similar is also happened in India. If you look at India’s profile, government spending as a share of GDP all of sudden moved to higher plane from about November-December onwards. Before that it was running at about 14-15% of GDP, from November-December it jacked upto about 17% of GDP.
Now that is partly because the economy is slowing down but it is more because the supplementary and other sort of assistance measures that the government passed. So this is a massive global effort going on here on the back of governments to reflate the economies and our view is that it will succeed at least for a while. But come next year or the end of this year we will see a relapse just because the structural problems have not been cleared, and the duration of this bear market still hasn’t been long enough to set the scene for a new bull market to begin.
Q: I’ll just ask you one question going back to history, when you have had these cyclical bull markets in a structural bear market, when they have ended, have markets gone back to retest old lows or has the bottom been reset at a much higher level?
A: I think the evidence is mixed. As far as Japan is concerned, in the 1990s it basically remained in a trading range, it went back to its old lows but it never really made new lows until you got a new deflation shock later in the decade.
So, I think that my best guess basically is that the S&P 500, the benchmark in the US, is in a trading range in a long-term construct where the lows that were made in March will hold. On the upside, the levels that existed before the Lehman crisis will never come back for a while to come or at least for the next three-four years I don’t see those levels being breached. So, that was about 1200 or so on the S&P.
Q: So, 700-1200 broadly speaking?
A: Exactly, it is in a very long-term construct. The S&P is going to remain in that range and torture us because every time it goes on the lower end of that range, you think that this is breaking down and the world is coming to an end and every time it gravitates to the higher end of the range, we think this is a new dawn. But in fact the truth lies in the middle, which is this is a lot of slush and we are just working our way through this slush.
Q: A cyclical bull market, has it ever taken you to the previous high of the bull market?
A: Not really, because if you look at Japan et cetera, it has not done that. So, therefore the S&P 500s previous high was about 1550, I just don’t see that happening in the near future.
Q: What about India? What makes you think that India is also in a cyclical bull market? Is it the assumption that we will do pretty much what the world is doing or something else?
A: That is the basic assumption. That said, I think India can exit this bear market regime a lot quicker. I just don’t think that what we have seen since late October of last year when we made the lows and retested them almost this March, I just don’t think that those lows will crack. But neither do I feel that the conditions are in place for a new dawn to begin. If you look at the big bear markets in history, they typically tend to last about three years. The Great Depression lasted from 1929 to 1932; Japan’s market lasted from 1989 to 1992. Similarly, the last tech boom-bust cycle, of which India also was a part, lasted from about 2000 to 2002. But the Indian market even back then made its lows in 2001 and then it sort of spent some time in a trading range over the next 12-18 months after making its initial lows in September-October of 2001.
So, I think that India and other emerging markets can definitely exit this bear market regime a lot quicker than the developed world. But after the run that we have had of late, I think that it is going to trade water for a while, maybe make some upside. But I still feel that even markets are going to take a while to break above the levels that existed before the Lehman crisis broke out. So, in many ways the Lehman episode basically was a defining moment, and in history it will go down as a period where Before Lehman will be referred to as BC and After Lehman will be referred to as AD because the dividing line. The credit bubble, which was inflating economies and asset markets burst decisively with the Lehman episode. No matter how hard the government’s tried they could not get us back to that era from ’03 to ’07. But they can prevent the world from falling apart, which is how it seemed in October-November last year.
Q: So, you are essentially saying that 21,000 Sensex should not happen before the end of 2010 calendar?
A: Yes, I’d be shocked if it does. So, I’d say that even in dollar terms currently if you look at it, the Indian market today is about 15-20% lower than where it was just before the Lehman crisis broke out because in nominal terms the Sensex is at the same levels, but the rupee is about 15% odd weaker since then, or maybe a bit less now.
So, my own feeling is that another 10-15% in dollar terms for this market and after that it will sort of struggle to break above that.
Q: You said that because earnings will not move at the pace at which optimism was moving or because valuation will get terribly stretched by then?
A: I think that valuations have already now from being cheap in March or in late October of last year to being sort of relatively fair to being on the slightly expensive side. So, I think it just takes time for these problems to work their way through. See how the mechanism is working just now even in India. As the market has moved higher there is a flurry of new issuance that is going out in the market. Over the past month or so, Indian corporates have raised about USD 3 billion or something in new equity or other deals that they have done – QIPs etcetera and another USD 3 billion is out there, maybe more depending on how the market does. I think that our own team sort of estimates about USD 12-15 billion needs to be raised to just clean up the legacy mess from the previous bull market going sour. So, I think that is going to put some sort of a cap on this market as we go ahead.
Q: Do you think that supply will dry up or squeeze out the money from the secondary market?
A: Maybe not squeeze out, but it will definitely put a cap. That is how it functions because you will have to again think about some serious disinvestment because the government’s finances are in a mess. So, I do feel that supply is going to be a bit of an issue and that valuations for the market have already become fair. They are no longer cheap like they used to be and they can get more expensive. But I also feel that after the pain that investors suffered from the boom bust cycle, will be very wary of assigning an expensive valuation to any stocks and sectors after being burnt so badly in the boom bust cycle in the past five years.
Q: So, you don’t belong to the camp that believes that there is such a big left out feeling that at every dip money will come in and chase the market and downsides could be very limited and in the near-term maybe we can trade at fair valuation plus?
A: That can happen. But I just don’t feel that beyond that 10-15% there is not much upside. So, that can happen. But the way that can happen basically is that the corrections for the time being can be shallow. But my point is that eventually it is about fundamentals. Technicals can drive the market beyond a point. What has happened is something that is not unexpected. We were looking for some sort of a cyclical recovery to take place, because we knew that the government’s spending efforts across the world were incredible and enormous.
But I think that at some point in time a cap is going to come because the government’s finances across the world are in a mess whereas the private sector wouldn’t have de-leveraged enough and that is going to cause some sort of a relapse next year, not a full blown crisis, but a widespread recognition that the 2003-2007 era is not coming back. That is a dream, no matter how hard the government’s try.
Q: The markets belief now is that the government will try very hard- is it over expecting because of the mandate which came last weekend or the political verdict?
A: I am sure if it over expecting because even last week by the time the week ended the relative out performance of this market have been whittled down to about 10% versus other emerging markets which is a fair out performance to take place and typically if you look back at history since 1980, whenever a stable government had been elected in the first year the market has done reasonably well but those expectations have faded as time goes by. So I am not sure if it’s over expecting because typically in the first year of a stable government the reform momentum tends to be strongest on a relative basis and we could see some signs of that but the big picture which will come back to haunt India later on in the year, is going to be that we now have the highest debt to GDP ratio at 80%, of any emerging market in the world and the reason we are able to sustain this is because lot of the debt is held internally, it is not held by any foreign investors.
Second reason is that our financial and our consumer sectors are quite under leveraged, so they will be able to compensate for the over leveraged position of the government but it is only that much that the government can do because beyond a point what will happen is that, if the economic recovery begins here then you will have a massive surge in bond yields just because the pressure on borrowing from the government is going to remain enormous through this period.
Q: You don’t think there will be an aggressive capital recedes programme- divestment, 3G etc which might partly compensate for it?
A: Ofcourse it will partly compensate for it but this is another reason why the market will have sort of trouble going high beyond another 10-15% because there is going to be sort of constant demand for capital whether its from the government or whether it is from the private sector which is going to put a lid on any meaningful advance that takes place.
Ofcourse the wild card here is that if global equity markets truly fire and that opens up the international tap a lot because over the past couple of months, I have been speaking to some Indian corporates and their borrowing has been done largely from Indian banks, as the foreign banks have sort of withdrawn from the market or have cut back a lot on their lending to Indian corporates but if that were to open up then the game might change. My own feeling is that now a lot of this is getting into the price across the world and so we can see this year get by but sooner rather than later, we will get a relapse because we just haven’t spent enough time working out the structural excesses in the global economy.
Q: With the Chinese markets would the commodities also start showing you cracks before this insipient relapse that you are talking about?
A: Absolutely in fact I already feel that the irrational pockets in this market, is what is happening with the commodity complex because commodity prices have never been a leading indicator of economic activity. We have done a lot of work on this going back past 50-100 years and typically commodity prices tend to act in line with economic activity or in line with global industrial production. This is the first time in history that commodity prices have rallied a lot before the turn in economic activity and a lot of this is happening because many people are buying into commodities for two reasons. One you have the Chinese effect, they have been scarred a bit by the rise in commodity prices in the past and so this time they have been building up inventories out of the fear that they don’t want to be caught short important metals or oil. So there have been a lot of commodities and that is a financial investment. I feel a lot of people have been buying commodities as a hedge against inflation. This notion exits that commodities do well in inflationary environment, I think both these arguments have run their course.
So my own feeling is that commodity prices in the next couple of months are going to start falling well before the stock markets even begin to rollover because that is one market when I think the fundamentals have run way ahead of reality.
Q: That includes crude as well?
A: Absolutely. Crude is in a broad trading range of around USD 30 per barrel to USD 70 per barrel and we are getting close to the upside of that trading range. My best guess is that a year to 18 months from now crude is more likely to be heading towards USD 30-40 per barrel than being at USD 80 per barrel as forward markets or lot of the bullish consensus tend to currently imply.
Q: As a global investor you would track the rupee dollar quite closely- the first appreciation in the rupee after the election verdict has left most investment banks to go the other side- now talking 40/41 to the dollar in 12-18 months, do you believe it will strengthen that much?
A: I don’t think so. Because the legacy problems are still there in terms of funding of the corporates, how much they need to raise, how much they need to repay, there will still be some mismatches. I think the rupee is basically still highly correlated with the stock market. So the stock market might have another 10-15% upside, I doubt very much that the rupee is going to get beyond 45 to dollar or so, because there has to be some adjustment of some reality and so I don’t believe the forecast of the rupee going to below 40 to a dollar anytime soon or close to 40 in the next 12-18 months, I don’t buy that.
Q: If 15,000 for the Sensex which is 10-12% from here is the top end for the markets, what is the bottom end of the market for the next 12 months?
A: I would say the worse case scenario is about 8,000 because I think that will hold, I don’t see us going back, I would say to about 10,000 but its possible that we would get to 8,000-10,000 in the relapse situation sometime next year. So I would say 8,000-10,000 somewhere in that zone we could get back to that. So when we look back at this period in history, it will seem like a big trading range but when you are living through it, there are periods of lots of excitement in terms of both greed and fear as alternating emotions. So it seems that way, but when we look back in history this will seem like one big trading range.
Having said that, I still feel that, emerging markets such as India, will exit this trading range and this overall structure bear market regime a lot quicker than the developed markets. My rough path at this point and these are all best guesses, that we do find for a while here, we start to get signs that economic activity across the world including in China is beginning to fade towards the end of this year, we get some sort of a relapse early next year and then we make a true double or triple bottom for the Indian market and other markets in the emerging market space by second half of 2010 and then that sets the stage for the new bull market to begin.
By then you would have cleaned out a lot of the excesses, in the system, a lot of corporates would have paid down their excessive debt that they took, they would have readjusted their P & L’s, other operating metrics for the new environment which this 9% economic growth was caused by excessive liquidity that is not coming back. Indian GDP is more likely to be at 6-7% unless you get a new burst of productivity enhancing reforms. People would have made those adjustments and then the stage would be set for a true new bull market to begin.
Q: What is going on with the midcap universe that has been the story of the last one week, a huge catch up for the midcaps and the smallcaps – deserved in your eyes?
A: I think the midcaps tend to do well once there is some sort of bull market gains traction and this is a cyclical bull market but till about a month ago people just thought this was a bear market rally. There was a lot of sneering about what was going on that this won’t even last that long that is where people got it wrong. This is a cyclical bull market and not just another bear market bounce and this catch up taking place. Historically what we have seen is that when the domestic economy does okay that is when the midcaps and the smallcaps tend to do well.
So we are seeing some signs of a cyclical recovery. Even in India the economic activity has shown some signs of turning around in terms of car sales and cement numbers etc, so we have seen some signs of that. So it is not that surprising in terms of what is happening this catch up which is going on.
Q: If you truly think of a bull market, its not here before 2011? Is that what you’re saying?
A: In terms of that we are looking for a true new bull market where the Sensex is on its way to new all time highs, I think the base for that will be set in the middle of next year or so. We will then begin to see some sort of serious bull market move towards the Sensex highs of 21,000 or so by 2011, that is what my base case is. But having said that we cannot dismiss what has happened just now, this is a pretty serious cyclical bull market that we have seen.
Q: With lots of trading opportunities?
A: Yes with lots of trading opportunities and we will still see that in the months ahead and I think as an investor there will always be an opportunities and the sectors will always matter. There will always be relative trades to do. But to me the most important thing about the markets basically is that you need to figure out what is the overall regime. In that regard, I think there is an overall quote which I live by which is, “If you board the wrong train, there is no point running down the corridor in the opposite direction.” So it is very important to figure out what the overall regime is to understand that markets go through phases and cycles and the rules are different.
The rules in 2003, and 2007 were different, the rules after the Lehman crisis had been different and now we are seeing a cyclical bull market with the rules change a bit but broadly the bull market rules will come back to play only in the second half of 2010, when you will see a much broader thrust and a surge to new high by 2011-2012 something around that.
Source : MoneyControl
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