‘Economic cycle will hold on house-building activities, urbanisation’: Anand Shah and Anish Tawakley

As fund managers, does a coalition government worry you in the medium to long term?

We invest from a top-down perspective in which we take a view of economic cycles, and these cycles are of three to five years. An economic cycle is that in a slump period, you have spare capacity and in a boom period there is a tight capacity utilisation. As you go from a slump to a boom period, profitability increases and volume improves.

There is another way to do top-down investing, which is to take structural calls … there has been a fundamental transformation in public sector units (PSUs) and everything is very different from what it was in the past. That is a valid way to invest but I don’t do that. I am only taking a cyclical view of the economy … that the economy is recovering. I am also positive about manufacturing but I feel it is part of the normal growth.

If I had taken any such fundamental or structural calls, I would have had to evaluate if they would be sustained or not. I don’t think any changes because of the electoral outcome. The economy is recovering. In the next 2-3 years, the economic recovery depends on how fast we build houses and urban infrastructure. As long as these get built, I don’t think there will be any change in the next 2-3 years’ economic forecast. In an economic recovery, overall monetary and fiscal policies should be counter-cyclical. You could argue that spending could increase. That is pro-cyclical but then it should be offset by tighter monetary policy. So, as long as fiscal and monetary policies work in tandem in a counter-cyclical manner, I am okay. But if fiscal and monetary policies become loose, I would change my stance because then we would be in the 2011 and 2013 kind of situation when both the policies were loose.

How do you see the functioning of the new government?

The electoral outcome has been very significant. I think on an immediate basis, there will not be any changes. Here, at least, we are talking about continuity of policy and the same government. So, we don’t see any change as far as the direction of the economy is concerned.

Do you think the government will focus more on economic reforms and improving fundamentals?

Our economy is in decent shape. I am not praying for big bang reforms. If something happens, it will be good and if nothing happens, it will also be okay. The economic cycle has to be managed well. If fiscal policy is not as counter-cyclical as I would like it to be, I would want monetary policy to be more counter-cyclical. As long as the management of the macroeconomic cycle is fine, there will be stability. Whether we grow at 6.5 per cent or 7.1 per cent, it really doesn’t matter. It (growth) should neither be (-) 2 per cent in one year not 2 per cent in a year. Those are the disturbances that really hurt.

Macroeconomic stability was the hallmark over the last decade and as of now, nobody believes it is getting disturbed. The current mandate is for the NDA, which means political stability will also not be disturbed. The key from here on is that with macroeconomic and political stability, would businesses start growing capacity? If this happens, it will create jobs in urban India. Urbanisation is something which is needed for prosperity and then there is a transfer of wealth to rural India. You will then see spending in the rural areas and the rural consumption will rise. Without the transfer of people from rural to urban areas, it is very difficult to get the rural spending going.

So, reforms will continue …

We are basically looking at economic stability. We are not in anticipation of big bang reforms. We are saying as long as the (economic) cycle is managed well, it is okay. We don’t think people will stop building houses or stop buying houses. We don’t think people who have already committed to setting up cement or steel plants will not set up these plants.

Earlier, we had a long slump because our real estate market stopped functioning. Prices rose to a level where affordability became a problem and then prices did not correct. There was no real estate activity and therefore economic activity was low. The root cause of a prolonged slump was a lack of urbanisation and home-building activities. When the economic recovery started 2.5 to 3 years back, it was because of a correction in house prices. People started buying houses and interest rates were cut to the point where mortgages became affordable.

As long as urbanisation and home building activities continue, the economic cycle will hold.

If I find that house prices are shooting up and volumes are not there anymore then that tells me there is a disruption in that market, and it would worry me. The volume of house-building activities is the most important variable. I track four variables – cement consumption, home, power and automobile sales.

How do you see India’s valuation?

We publish an equity valuation index every month. There are three zones – green, yellow and red. If the valuation is in the green zone, you are buying the market so cheap that you will make money even if the economy doesn’t do well. If it is in the red zone, you are buying so expensive that even if the economy does well, you won’t make much of the money. Right now, we are at the top of the yellow zone, which means that if the economy does well and you stay invested for three years, returns will be fine.

The overall market valuation is heavily influenced by the large caps. In the small and mid-cap market, we think the risk-return trade-off is not good. Some and mid-cap is where the excessive valuation is seen. There are companies which are regarded as god’s gift to mankind but are fairly weak.

Is there a valuation concern around the overall small or mid-cap segment or just in specific sectors?

Both can be true. If any small-cap manager says that he has all 50 multi-baggers in his portfolio, they are only in his fantasy. When I invest in small-cap companies, I do not imagine that every small-cap company in my portfolio is going to be a super multi-bagger. That doesn’t happen. In most industries, market leaders remain market leaders as long as they do sensible things. It is only when a market leader makes a mess of his business, that somebody else can displace him. So, this kind of fundamental disruption where a new person replaces the market leader is very rare. Also, new industry creation is very rare.

Heterogeneity is also there in the small and mid-cap companies because there are many more industries so the opportunities for stock picking will always exist much more in the mid and small-cap segment.

Do you see private sector capex picking up?

I think it has already happened. What is private capex? Key private sector capex includes home building and adding cement, power and steel capacity. I am not saying that I am disappointed with private sector capex. It has come. It is very healthy.

A lot of private sector capex will be home building. We always tend to think of capex only in the corporate sector. All consumer goods demand depends on the size of the house.

Why are FIIs pulling out money from India?

The one big variable is the cost of money. It is not that India is a standout, they would have pulled out money from the other emerging markets also over the period when the interest rates have gone up. There would have been a shift of money from equity to fixed income also. I believe that as and when we get the first sign that the US rates have peaked and they might look at cutting interest rates, we will see one bout of money coming into India.

How do you see the interest rate cycle moving?

Our economy is strong enough and I don’t see a need for major cuts. Even the US economy is also very strong. In India, the housing market is continuing to do well despite the rates. At this point, I don’t see any sign of the economy needing cuts. Rates have to be cut when you feel demand is weakening to a point where there will be excess capacity. We are not there.