Maneesh Dangi on bubble, inflation & valuations

The real rates are super low and in that context PEs have to stay elevated. Big money or small money has to invest somewhere and the alternative is bonds. There is no option but to invest in positive real rate assets like equity which may deliver a significant equity risk premium, says Maneesh Dangi, Co Chief Investment Officer, Aditya Birla Sun Life AMC.

When we met in September-October, you made a serious case for re-visiting equities. Why should one not sell equities?
My template of investing is to buy valuations and sell macro. I do not buy stocks directly, I buy markets and then my suggestion is do not sell your positions until the macro has turned bad. The argument against equity going around now is that it is a bubble and I have said many times that it is not. Some like me argue that equity markets are always pricked by central bankers as they start to see inflation at some point in time. Now, would there be inflation any time soon? The macro watchers say look at the money growth — it is 20% up; look at the huge fiscal stimulus by developed economies and also emerging market economies; look at the commodity prices – copper prices are up 70%, oil has doubled in the last six-seven months. All of that would result in inflation, goes the argument.

But then let us do a bit of a reality check here. The last 10-12 years of infinite quantitative easings have not resulted in any inflation. The inflation in the developed world has been less than 1%. Of course, in India also during 2014, 17, 18 inflation was pretty tamed. So from a macro standpoint, until there is some slack in labour markets, meaning as long as there is unemployment, the negotiating power of wage earners would never go up to the extent to exert pressure on inflation. Right now, unemployment is still significantly higher than what it was at a pre-pandemic level. So my argument is that it will take three-four years for the labour market to heat up and create inflation.

More bottom-up investors look at the PEs and price to book ratios and then say that from a historical standpoint, they are expensive. They are absolutely right but then all these ratios actually have to be contextualised with respect to where the interest rates are and today, interest rates are at the lowest level. The US has never had such low interest rates in real terms. Today the 10-year US treasury is minus 1% in real terms because markets are pricing a 2% inflation over the next 10 years. The same case is there in all OECD countries.

Essentially, the real rates are super low and in that context PEs have to stay elevated. So when people argue of valuation, the big money or small money has to invest somewhere and the alternate is bonds and if bonds is going to reduce your purchasing power year after year because of negative real rates, you have no option but to invest in positive real rate assets like equity which are still likely to deliver a significant equity risk premium.

I do not know how convincing this is but I do not think both the macro and micro arguments stand on firm ground to prove that markets are bubbly. They are, of course, expensive for the reasons that we mentioned.

Last time you argued that banks have raised capital, the moratorium numbers do not look all that scary and they have enough capital to grow which means the contingency in the system is not bad. But banks are not saying that everything is looking hunky dory. Some of the banks continue to maintain that credit growth is not picking up?
No. Even this quarter, a couple of banks’ numbers are out and they are in line with the estimates that Street made after the September quarter results. There was a lot of positive surprise in September and December would actually confirm that the total losses for banks because of Covid would not be substantial.

I had shared with you last time that the Covid cost for the banking system would turn out to be about 1.5% of the total lending book. We have Rs 150 lakh crore of total credit and I would not surprised if the total cost is less than Rs 2 lakh crore now for the black swan event of Covid. The losses would be relative to whatever happens to Indian banking every time a crisis hits us. I think it is pretty low. I am beginning to see credit growth pick up sequentially.

In the last three, four fortnights there was quite a sharp pick up in credit. If I were to annualise, the last three, three-and-a-half months of credit growth is already tracking 13-14%. After a long time, credit is actually showing traction. There are two points here; one, so far as we know, in April, May, June, markets in aggregate thought the financials would end up losing 4-5% of the book because of Covid. It appears banks will not lose more than 1-2%.

Second, banks that want to give credit, those private sector banks and NBFCs have been able to capitalise themselves very well. Third, most banks are still showing rock solid performance both in terms of growth as well as NPAs. My sense is they would begin to pick up the thread where they left it before the pandemic and we would see retail growth flaring up over the next three, six months.

In the last two, three months, the annualised growth of credit is already 13-14%. The year-on-year growth of all sorts of credit I aggregate is more like 8% right now. In an economy which has slowed and contracted, 8% nominal growth in credit is not bad and I am not too worried. We are on track to achieve a significant double digit growth in credit also over the next one year.

You say one should sell when macros are poor. What will be the indication of a poor macro because the first indication of a poor macro is inflation and according to you, inflation is not coming. What would be the first harbinger of macro turning bad?
The very first sign is of course inflation. The majority of asset prices today is because of intrinsic value but it is also a reflection of the kind of job the fiscal and monetary authorities are doing and pumping. So there is much money out there. Real assets have to adjust higher if you have so much money.

Now central bankers and fiscal authorities will take a backseat only when a binding constraint begins to appear. There is no limit to the kind of debt the government can take and the kind of QEs Fed and ECB and RBI can do. The only limit is inflation and if the economy begins to overheat and inflation starts to reappear, we will have no other option but to tame the economy and take the demand down so that the inflation can cool off. In the modern economy, inflation is not only about high commodity prices. Commodity prices were skyrocketing during 2003-2007; oil went up from $10 to $100 in five-six years time and yet it did not create inflation. So do not look at commodities and start to think that inflation would return. Inflation would return when the labour markets start getting too hot in the sense that there are more jobs then the number of people available and they can renegotiate the wages. That is what drives inflation in modern economies.

That would come when the labour participation rate has improved and unemployment numbers have fallen enough. We are possibly very far from that point. In the US, unemployment is still 6.5%. Yesterday the UK’s unemployment numbers were up 5%. In India no one knows the real numbers but it is very high. There are still a lot of labour staying at home who do not have jobs. There is a lot of slack in the labour market and that has to ease.

After the Great Financial Crisis (GFC) of 2008, it took really long for the wages to start growing in most developed countries. In India it happened during 2011-2013 because of the food prices because we lifted MSP dramatically suddenly to align our prices with global prices. But that is not happening right now. MSP rises in India over the last two years on a CPI weighted basis has been only 3-3.5%. So some will argue that food inflation is going to drive India’s inflation but they may be getting it wrong because we are a food surplus economy and one of the other reasons why we used to have food inflation is because of higher MSP rises but that is not happening now. As supply side disruptions have eased, India’s food inflation is actually likely to dive over the next six-eight months. It can already be seen in last month’s numbers.

So to summarise, the time when markets would be pricked by developed world central bankers is still two-three years away and it is more of a 2023-2024 story. RBI’s role in pricking the markets is limited because it is a global money which actually prices most assets.

But do not get me wrong. Markets have run up a lot and have nearly doubled since April when we last spoke. So the market would show their characteristic of 5%, 10%, 15% draw downs but then people who argue that it is a bubble basically hint that a 50%, 60% cut in markets is imminent. My argument is against them that nothing of that sort is likely to happen because it is not a bubble and the macro is still quite sanguine right now for it to create enough tailwind over the next couple of years for the markets to rally further. From an asset allocation point of view, I would still advice that people should be overweight equity even today.

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