Mumbai: Some analysts have called the recent stock market surge a renewed bull run, others have described it as a bear market rally. Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management Pvt. Ltd, says it’s neither. Sharma, who foresees some more pain for investors in the short term, says in an interview that a new bull market is likely to set in only by the end of 2011. Edited excerpts:
Have things changed really? We started by saying, “maybe it’s a bull market, maybe it’s a bear market.” Do you ask those questions yourself?
Market mechanics: Morgan Stanley’s Ruchir Sharma. Ramesh Pathania / Mint
Yes, but I think the very important thing you laid out is to figure out what the overall regime is, because once you know the overall regime, it’s easier to know what the rules of the game are. In that regard, there were three possibilities that we 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 a 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. The implication of this is that there is some turn in fundamentals, not meaningful enough to start a new bull market, but enough to have markets rallying by anywhere from 50-100% over the space of a year.
You’re saying that, going by history, this usually lasts for a year?
The average duration of this, going by what happened in Japan in the 1990s, was about 6-12 months.
Fair enough. But going by history, when you had these cyclical bull markets in a structural bear market...when they ended, have markets gone back to retest old lows, or have the bottoms been arrested at a much higher level?
Well, the evidence is mixed. As far as Japan is concerned, in the 1990s, markets basically remained in a trading range... So I think my best guess is that the S&P 500, which is the benchmark in the US, is in a trading range in a long-term construct: the lows made in March will hold, and on the upside, the levels that existed before the Lehman crisis will never come back. So for a while to come, or at least in the next three-four years, I don’t see those levels being breached. (Lehman Brothers Holdings Inc. went bankrupt in mid-September.)
And has a cyclical bull market ever taken you to the previous high of the bull market?
Not really. Because if you look at Japan, etc., it has not done that.
What makes you think 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?
That is a basic assumption. India can exit this bear market regime a lot quicker. I just don’t think that what we have seen since November when we made the lows in late October, and we retested them this March... I just don’t think these lows will crack. But neither do I feel the conditions are in place for a new dawn to begin. Because if you look at the big bear markets in history, they typically tend to last about three years. The Great Depression lasted from about 1929 to 1932, Japan’s bear market lasted from 1989 to 1992, the last tech boom-bust cycle lasted from about 2000 to 2002. But the Indian market, if you remember, made its lows in 2001 and then it spent some time in a trading range over the next 12-18 months. So I think India can, emerging markets can, exit this bear market regime a lot quicker than the developed world...
So you are saying essentially Sensex should not go back to 21,000 before the end of 2010?
Yes. I would be shocked if it does. Even in dollar terms, the Indian market is currently lower around 15-20%. That’s where it was just before the Lehman crisis broke out, because in nominal terms, the Sensex is at the same level. But the rupee is about 15-odd per cent weaker. 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.
Are you saying that because you think earnings will not move at the pace at which optimism is moving, or valuations will get terribly stretched by then?
I think valuations have already moved now from being cheap in March or late October, to being sort of relatively fair to slightly expensive...
No matter how hard the governments tried—the market believes that the government will try very hard—is it over-expecting, because of the mandate which came of the political verdict?
I am not sure if it is over-expecting because even as (the election result) week ended, the relative outperformance of this market had been whittled down to about 10% versus other emerging markets. So those expectations have sort of faded as time goes by. Typically, in the first year of a stable government, the reform momentum tends to be the strongest on a relative basis...but I think the big picture, which will come back to haunt India later on in the year, is going to be that at 80%, we now have the highest debt to GDP ratio of any emerging markets in the world. The reason we are able to sustain this is because a lot of the debt is held internally. The second reason is our financial and consumer sectors are quite underleveraged... But there is only that much the government can do, because beyond a point what will happen is that if an economic recovery begins, 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.
You don’t think there will be an aggressive capital receipts programme, such as divestment, 3G auction, etc., which will partly compensate for it?
Of course, it will partly compensate for it, but I think this is another reason as to why this market will have trouble going higher by, say, another 10-15%. Because it is going to be a constant demand for capital, whether from the government or from the private sector... But sooner rather than later, we will get a relapse. We just haven’t spent enough time working out the structural excesses in the global economy.
What’s your best guess as to when this relapse will slowly starts working itself into the market?
I think the relapse might come possibly at the end of this (calendar) year, because if you look at all the government spending programmes across the world that impulse begins to die down by the end of the year... My suspicion is...by the end of this year, it will be quite clear that the global economy is not being able to sustain on its own the sort of growth rates policy makers want despite all their best efforts.
So you are saying that if you truly think of a bull market, that’s not here before 2011?
If you are looking for a true new bull market... I think the base for that will be set by the middle of the next year. Then I think we will see some sort of a bull market move towards a Sensex’s highs of 21,000 or so by 2011. I think broadly, the bull market rules will come back to play only in the second half of 2010.