Broad market benchmarks climbed to all time highs with the Nifty 50 crossing 10,000 mark. However, I don't think there is much to cheer about as valuations remain on the peak side (compared to 2000 and 2007 peaks) indicating a scenario that the party might soon end. There was one change to the portfolio in the month of July. We/ I exited out of Torrent Pharmaceuticals, a Gujarat based pharma company with significant presence in India as well as the US. With continuing pricing pressure on drugs in the US as well as changing prescription environment (mandated by the Medical Council of India) in the company's home market, it has become hard to determine what changes the pharma industry in India will go through and who will be the winners thereof. The exit of Torrent has not been a company specific call but rather a dimming of the business prospects vision, barring which, any company specific valuation is just a guess at best.
Now coming on to the broader picture of where valuations lie, it is but unlikely that one should notice that the price earnings multiple of the top 500 companies by market cap in India is above the 2007 peak (figure below). Of course there may not be any validity in the argument that multiples generally revert to mean but what if history rhymes? Generally looking at multiples in relation to government bond yields give a fair view about the opportunity cost of holding equities. Indian earnings yield is more than 3% lower than the government bond yields so I don't think there is much room there as well.
Earnings growth has been below 0-5% for broad markets since the past 3-4 years and all the rally we have seen in Indian equity markets has been multiple expansion driven. India, which generally trades at 20-30% premium over Asia x Japan, now trades at about 50%. Earnings growth has been elusive and everytime sell side analysts come out with optimistic guidances for earnings growth (of course they would do so), they have been embarrassed further down the line with wide off- the- mark reality.
Globally, the US is on an upward cycle on interest rates and so is Europe reducing its monetary easing, or indicating to do so. There are some who argue that India has room to cut interest rates as India's inflation (WPI inflation price index change at 0.9% vs. 6% just three months ago) has been on a downward trajectory. However, I believe it is more because of a lack in demand rather than actual softening of prices.
Given where all things stand, I do not think that Indian Reserve bank would be able to cut interest rates much to revive credit demand and hence CAPEX in the country, failing which, the heavy lifting for growth has to be driven by Government expenditures, which also hasn't been visible.
We remain cautious therefore, and while we have a policy of not undertaking a portfolio short position, we have hopefully neutralized the portfolio via Index hedging to a large extent. Our cash levels are above 30% and net position is about 7% (not beta net).
I am not in a position to ascertain that we are already in a bubble because even though in hindsight, bubbles are easiest to pinpoint, what pops a bubble is I think impossible to determine. Adding to that, the veracity of the cause may not be at times as deep as the most recent one and therefore price action may be more or less dramatic than in notable 1929 or 2008. Conservative portfolio management mandates that if prices go to a level where the duration increases to absurd time frames, appropriate action should be taken. The risk is of course missing out on possible gains that might still exist.
On a lighter note...
I have met managements of various companies, although I don't think it is mandatory for me to see or talk to management before investing. In India, it is very entertaining to listen to public sector bank executives in media after quarterly results. Here is usually how the interview goes...
Reporter: "You guided last time that the worst of your NPA issues are behind you. So what happened? Even this time there has been a significant increase in your gross NPA..."
Bank executive (usually the CEO or CFO): "You see... I like to see the glass half full... even though we have increased our gross NPA, the growth rate has not been more than our previous quarter... we are in a very comfortable position... our future is good"
Mind you, I have taken inspiration from a recent interview where the banks NPA was close to 20%.