November has been a volatile month for the market, and this volatility could easily last for the next few weeks. However, stock indices will flirt with the highs hit in early 2008 in 2010—that’s the word from Ridham Desai, managing director and co-head of equities at Morgan Stanley. Edited excerpts from an interview:
Risk assessment: Ridham Desai.
Do you expect such volatility to continue for the next few weeks?
Yes, it is quite possible that we may be in a period where volatility may be intense. There is a fair bit of scepticism around the world about how strong the growth recovery is going to be. A few central banks have started pulling the plug on the easing cycle—not necessarily tightening, but definitely putting an end to the easing cycles. So, there is a bit of debate on that as well. So, people are talking about the end of easing, “Are we going to get a sustainable growth recovery?” That is leading to a fair bit of scepticism on markets which are up a lot from lows of the year and, therefore, this volatility may be here to stay for a while.
The bullish view is that since the Fed is saying there is no tightening around the corner, the dollar remains weak and liquidity remains strong, which is what this market is feeding on anyway. So, if there is no change to that, why should markets correct?
Indeed, I would agree with that. The worry that I have with that statement is that it’s becoming all one-sided. It is always risky to have one-sided trades. It seems fairly obvious that the dollar index should stay weak because the Fed is not indicating any move anytime soon and if that surely is the case, then risk assets should do well. That is clearly a scenario that could play out over the next few months. We are getting into a period which is usually good for risk assets—the end of the year and start of the new year. The environment still looks quite positive for equities per se.
So, I am not getting perturbed about this. If there is volatility and if the markets correct in that volatility, then to me it’s still an opportunity to buy because 2010 should still be okay for risk assets, especially for Indian equities.
Even in this fall—the moment it fell to close to 15,000—people started saying, “We’ll buy at 13,000.” But that never came. Do you think it will be a case of that going forward as well, where you set price targets which never come and you end up with a frustrating wait?
Yes. That is my base case scenario. That doesn’t mean that I can’t construct a bear case scenario. You can construct a scenario where things change for the world and they do get a little messy. But that is not what we are seeing right now. Just take a look at the macro for India. We have a dovish Fed, which means that liquidity is going to be good for India, and what matter for India is global liquidity rather than local liquidity. So that is one side of the balance sheet, which is very clean for us and that doesn’t seem to be changing anytime soon. On the other hand, we have a very solid recovery in growth. I am very impressed with the type of growth recovery we are getting.
I think numbers each month are coming ahead of expectations. There is still a lot of scepticism around these numbers, which is good. This means that we may get a few more surprises. Take the case of the demand for cars in the month of October.
Everyone around me is telling me that this is coming way ahead of expectations because people thought that post the festival season things will slow down and it’s not that we have run some cash-for-clunkers programme or some really low interest rates to drive car demand. This is genuine consumption recovery. It’s not driven by some massive stimulus like the US has fed its economy on.
So we are seeing a recovery in growth, which I think is going to be fairly solid in 2010.
You said you could construct a bear case scenario. What is that? Is it that the dollar trade goes wrong or is there something more fundamental than that?
That could be one part of the trade but we also need to see some domestic factors go wrong. For example, if we do not get enough infrastructure focus, (of) which a lot of has been promised to us and investors around the world are looking for some execution in 2010, and for some reason we don’t get that—that would clearly set us up for disappointment.
The second is that we have an exit policy to deal with. The central bank has done a very good job so far, but we are clearly dealing with acceleration in growth and the central bank would have to put an end to the easy monetary environment that we have been in. There is always a risk attached to that—how this end of easing happens and how it is conducted. There are always market risks relating to that.
The third thing is that we have a large fiscal deficit and I don’t think we should lose sight of that and again the finance minister has promised us that it will decline next year. That’s a promise that I would like to hold on to right now because he is one of those people who has done a good job so far. So, we will get some reduction but, again, if that doesn’t happen then the markets are at risk.
There are some tax reforms that have to be pushed through in 2010. So, the market will be keenly watching those tax reforms. There are a few things that can go wrong at home, apart from what happens to the dollar trade or what happens to the global liquidity, what happens to financial stocks in America. Obviously, those things also have a major impact on how Indian equities behave. So, it’s a combination of various things and if all of these go wrong or they go against the market, then clearly the market could go back to where it was on the election result day.
Some of these factors the market knows will come at some point. It doesn’t know when, but it is aware that these things will happen over the next few quarters—they cannot be pushed back indefinitely. In that sense do you think these are known devils and the market may not sell off—it may correct a bit, but may not completely sell off whenever they happen, which is the US exit or even the Indian exit or marginal raising of interest rates in India or overseas?
I am not worried about the Indian exit. I would argue that an exit by the central bank, which in some way has already started by the October policy and will only accelerate from hereon, will reaffirm the growth environment that Indian equities are dealing with and, therefore, cause markets to actually do better. Just wind back to 2004-05. That was the period when the Reserve Bank of India (RBI) had started tightening and equities actually did quite well in that period because it just reconfirmed that we were in an accelerating growth environment.
The worry will stem from any untoward event that is related to an exit policy, which causes volatility in marketplace and then causes confidence loss. So it is not per se about the exit that I am worried and the same applies to the US where it is a massive amount of stimulus that has been given to the world both by the US as well as the other governments and central banks. It is always going to be tricky when that stimulus is withdrawn and therefore it is going to be a difficult moment for the market. And when it happens, if it is not done appropriately, the markets can falter a bit and then correction may be deeper than the 10-12% that we have seen through the rally.
So, that could be the bear case outcome. Again, as I said at the outset, these are not base case scenarios for us. The base case scenario is that we get a smooth exit from the central bank. We are going to get a prolonged liquidity environment from the US and we are going to get an accelerating growth in India. So on a base case scenario I would argue that may be another 20% upside for equities in 2010 is pretty much possible.
I heard you say a 20% upside from here. So you are saying at some point in 2010 the market would really get close to its all-time highs again?
Yes, in a bull case scenario it gets past its all-time high and will get into a new high. In a base case scenario, we come quite close to that. We will start flirting with the 2008 high sometime in 2010. That’s what we think right now.
So you are sticking to the view that this is another multi-year bull market that we have embarked on because some other people who are also bullish on the market seem to believe that it’s not so easy to call—as it was may be three years back when the last bull market was on? They feel that this could be a series of the boom/bust kind of cycles with 40% kind of rallies and sell-offs maybe punctuating the next 12-18 months?
That is a very tough question for me to answer. I am not too sure actually and I cannot be absolutely certain that we are at the start of a big bull market. But my gut feel, and this is where my heart comes into play, is I think we are dealing with probably the grandmother of all bull markets. But again it’s very hard to paint that scenario. If I use my head then it seems all murky out there. Going into 2011, growth in the developed world is all set to slow down. There is a big payback coming from what has been the huge credit pinch that the western world has created over the past several years.
There will be some impact on growth in India. We still have to do a lot of things in India. It’s just not about infrastructure and tax reforms. There are so many other things that the government needs to do. So if you look at all those things, my head will tell me that this is it, 2010 make your money and go home.
But my heart tells me India is on a breakout path. India is at an inflexion point in terms of growth. We have a population that’s getting younger. We have a massive influx to our workforce that is going to happen over the next five-years. These are precisely the factors that create a bull market. So even while the globe is not supportive and that is why all these people that you mentioned who are not confident about this not being the next bull market—they are looking at the world and saying this is not the environment in which equities do well.
India is clearly standing out. The idiosyncratic factors driving India are pretty much in place. So, there is a case for a bull market in India whereas it’s not there globally. We are torn between these two scenarios.