In an interview with Nikunj Dalmia of ET Now, Devina Mehra, Global Head of Research, First Global and Shankar Sharma, Chief Global Trading Strategist, First Global, say commodities are where you should invest this year rather than non-commodity or non-cyclical businesses
Shankar Sharma: Actually it was business that brought us together. It was not love at first sight but you know in an environment like Citi Bank which was very dog-eat-dog, I found her to be very uncomplicated, very humble and especially in the context of her having been an IIM Ahmadabad topper. For such a person to be humble was a rarity in Citi Bank and that was an attractive quality.
Nikunj Dalmia: You are partners in real life as well as business partners. But who is the ultimate boss?
Devina Mehra: I do not think in such a relationship, you can have an ultimate boss because then it would not last that long. Earlier, when we had started working together, a number of clients used to be taken quite aback when they came to know and they would say I should never worked with my spouse because we would be divorced in no time at all. But we really enjoyed being with each other and we have been working together for almost 23 years.
Nikunj Dalmia: So are you a henpecked husband like me?
Shankar Sharma: I always say I am very henpecked but you know she disagrees. We have difference of opinions. We disagree on things, especially in the investing business you can disagree on almost everything but that is the fun part of it because due to disagreements, your arguments become more rational, more analytical and so it keeps escalating. This is what has happened over the last 25 years or so.
Nikunj Dalmia: You know Shankar has been making a case of late that largecap stocks are getting tired, they are not going anywhere and that it is time to revisit the tiny toons, the mid and smallcap stocks. What is the thinking behind this call?
Devina Mehra: That has been our thinking for almost a year and a half because the largecap space is very much driven by either overall national or international factors like commodity prices and demand drivers tend to be some derivative of the GDP or some portion of the GDP whereas, in medium and smallcaps, we had not seen any big upside. It did not seem that suddenly there would be a big revival which we have seen in the last two years. We have just sort of chugged along. We have not really had a big revival which could drive largecap names, but the smallcaps drivers can be quite different. I mean, it can be debt restructuring, it could be pricing of something which has nothing to do with overall demand drivers in the economy. It can be that you are exposed not to the nation’s growth as such but maybe to a state, maybe to a city, where you can get an order. So that has been very different and at that stage, they had been very beaten down also. So to that extent, as long as chosen carefully, that was a space that could give you the returns which were unlikely to come from the largecaps.
Nikunj Dalmia: When we rolled from 2015 to 2016, there was a sense of optimism in air but you went on record to day that let us not lose sight of what is going on in China, let us not lose sight of global cues and then we saw a big crash across the board in all financial markets and everybody started drawing parallels between 2008 and 2016. Do you think worst of the print is behind us?
Shankar Sharma: I do not think globally markets are done with being bearish. I think we are still in a broad bear market within which you know we will keep having kind of rallies. But what I do believe has changed or at least is in the process of changing is that the big bear market in commodities is near an end if not already ended. So we turned bullish on oil around the $27-28 mark where it was a couple of months back and simultaneously on other industrial commodities. We have seen a good rally, I mean oil has been up about 40-45 per cent since then. I do not think that is completely done so my belief is that one part of the big global macro trade has changed and which is extreme pessimism on emerging markets, extreme pessimism on commodities, extreme bullishness on the dollar, all these three trades are up to be questioned and there is too much consensus on all three and we like to be seen in places where there is too much consensus because consensus is always going to be wrong. You just said choose the moment carefully and I think we are at that point. I would want to bet on commodities being really the space to be in for this year rather than non-commodity or non-cyclical businesses.
Nikunj Dalmia: So does that mean that as a house, as a firm, you are bullish on Brazil, you are bullish on Russia largely commodity producers, not commodity importers?
Devina Mehra: Yes, and if you have seen in the last few weeks they have already been moving and even going forward we think in general emerging markets will outperform and within that it is the commodity driven emerging markets like Russia, Mexico, Brazil that are likely to further outperform within the pack.
Shankar Sharma: And then the other thing is that Tata Steel is being sold. So if you want the final confirmation of what is the bottom of a commodity cycle and what was the top, I think there you are again.
Nikunj Dalmia: In terms of positioning, how are you positioned in equities because you have been very vocal about the fact that India is a crowded trade. India is still a crowded trade, India is still trading at a premium to other emerging markets and other developed markets. So do you think the India position needs to be hunkered down at global level?
Shankar Sharma: Our take is India has been over owned on largecaps. In light of the fact that people expected economic growth to genuinely revive as opposed to optically reviving by way of the fudging of the GDP data that has not happened, whilst on the other hand, because of that factor India became over owned and thereby more expensive, commodity markets on the other side, commodity driven markets on the other side have been crushed in the last 12 months or so. So I think the needle has swung in favour of those markets and away from commodity consumers, particularly a commodity like India, particularly within that the large caps, so the case we are making is large caps are not going to go anywhere in India, at least broadly speaking. The real space to be in India is small, mid transforming into largish companies and there is enough opportunity out there but if you want to look at a global macro trade, in our view, India is definitely not a hot trade right now.
Nikunj Dalmia: So what is the hot trade then?
Shankar Sharma: Commodities are a hot trade.
Devina Mehra: And therefore commodity driven markets as well.
Nikunj Dalmia: So when you say commodities are a hot trade are you talking about crude or are you bullish on commodity as a complex?
Devina Mehra: Crude as well as industrial commodities so some of the metals as well.
Nikunj Dalmia: So you will not shy away from buying metal stocks as well?
Shankar Sharma: Yes, provided you look at the balance sheets. That is the additional overlay on top of the core metal itself but it does help if the core metal is doing well, I mean, look at steel in India, balance sheets are stretched but the anti-dumping duty which has come in top of a revival in iron ore prices and therefore steel prices, has put some kind of a floor on their financials and their fundamentals. The stocks have done reasonably well in the last few weeks time. So those are the kind of plays. If you have the tailwind of good commodity prices, all those stocks are beaten down, all their bonds are beaten down and they are good places.
Nikunj Dalmia: For the longest time you have argued that avoid banks, the trust factor is missing, what is important for buying banks is that you need to have the trust factor and that is not there with PSU banks which is visible and that is also now missing with some private banks?
Shankar Sharma: Most or at least some private banks in my view are quite good at managing or window dressing or ever greening. We as a house like distressed companies or companies with a lot of debt because that is where you can make big delta, if you can get the structuring of their debt right. So obviously you know the companies, you know their bankers, you know what kind of stuff keeps happening and that is not pretty and these are coming from private sector banks, not the old line PSU banks. It is not as if those banks walk on water. Banking is a very tough space, they are good spaces to be in on the up-cycle, in the down cycle, when the loan growth, asset growth slow down, as it has, these numbers start to go up apart from core delinquencies. So we do not like banks as a general business, some of them have been exceptions like HDFC Bank. We have liked from the time it listed in what, 1996 or something.
Devina Mehra: We had brought out a report right then. We had brought out a report which had a baby and Arnold Schwarzenegger on the cover saying this is where it is now and this is where it will be.
Shankar Sharma: Yes, you should ask Aditya Puri or Shailendra Bhandari about it.
Devina Mehra: Yes, everybody in HDFC Bank still remembers that report.
Shankar Sharma: Yes, you should ask Aditya Puri or Shailendra Bhandari about that report and they will tell you.
Devina Mehra: We do not see a big revival in banking simply because we do not see credit growth reviving big time. That again comes from talking to companies and ut finding oythat now companies are so scared of taking on debt ever again. We may talk about taking on risk and investing etc but most promoters are in that mode that you know once I get out of this debt trap I am never going to take any debt or any significant debt ever again. And I think that will cause the balance sheet recession which can really take a generation to go through the systems.
Shankar Sharma: We know a promoter whose son has seen his father get hounded by calls from bankers or even bankers visiting the home in the last six years. The son is 14 now, he started seeing that when he was eight, imagine what impression it creates on a child’s mind to see the parent being under so much stress day in day out, do you think that father is ever going to take a bunch of loans to set up a plant, no way.
Devina Mehra: And also now the whole mindset has become that anybody who has defaulted on a debt has stolen the money in a sense which may not be true at all, it may be just, you know, that it might be bad business decisions, it might be you know just a change in commodity prices which has caused the distress.
Nikunj Dalmia: Pricing power is gone, commodity prices have come down…
Shankar Sharma: This is a very negative thing that has happened post the Vijay Mallaya episode that thanks to social media, everybody has an opinion and suddenly anybody who has defaulted or has owed money to banks is a thief or something, I think that is a very wrong thing.
Nikunj Dalmia: How should one invest in this new world? Interest rates are low. The central banks will follow a loose monetary policy, they are committed to do that. Earnings are not going anywhere, deflation risk is real and growth is going to be precious?
Devina Mehra: In fact, some time back when the consensus was that US would raise interest rates and go on raising interest rates, we were always of the opinion that is not going to happen because again you have to go back to the psychology of the nation and because of that institutional memory of great depression that is one mistake they do not want to make. They might make other mistakes but they do not want to raise rates and hence again tell other countries that they must take the pain but they would not do it themselves. Now, it is a tough environment for investing no doubt because in India, the fixed income side the returns are not still not too bad. So I would still think that a significant part of your portfolio should be on fixed income. Whatever you can lock in at this stage would make sense, otherwise again it is still the small and mediumcaps you should be looking at in the Indian market.
Shankar Sharma: The interesting data you are looking at is since 2008, how many companies have churned out of the Nifty? 40 per cent of the Nifty is something like that.
Nikunj Dalmia: Commodities is out completely, autos have very large problems…
Shankar Sharma: Let us not look at the companies. I am just telling the level of churn that exists in any index. and go back to FTSE, go back to NASDAQ, go back to S&P you will see 40-50 per cent churns happening every three, four, five years. What did they tell you…that a static mindset in investing…that this is a great company? I am going to believe it forever? We do not subscribe to that, it is as simple as that. Just look at Nifty itself from 2008, 40-50 per cent has changed completely.
Devina Mehra: This is not a very long period, not even a decade. It has been seven years.
Shankar Sharma: You have to find the guys who will get into the Nifty maybe four, five years from now and that…
Nikunj Dalmia: So where are you picking your spots there? What are some of the names, companies or themes which could find their way into Nifty in the next five years?
Shankar Sharma: As we have spoken also, the speciality chemicals space we have liked a lot. The beaten down infrastructure sector also we have liked a lot. We have seen it coming over the last two years that China because of the huge pollution problems has no option but to clamp down on chemicals. Globally, all chemical companies have problems on pollution. I think there is a G-20 meeting in August…
Nikunj Dalmia: Second half of this year, yes.
Shankar Sharma: Yes, I think it is in August, right. So again, if you remember same thing happened in 2008 when China hosted the Olympics. They shut down industries to improve the air quality so that people from across the world do not see China as a polluting country. Exactly the same thing is now being done three-four months ahead of the G-20 summit. You are seeing plants get shut and chemical prices going up several times. I think it is a huge trade on a secular basis because India will be the beneficiary of production moving from China in the chemical space and that is a big macro shift which is happening already. We have liked infrastructure selectively and we continue to like it.
Nikunj Dalmia: So when you say you like infrastructure are you trying to spread your basket to companies or themes which will benefit because of government spending whether it is defence or railways or roads?
Shankar Sharma: It could be any or all of them. All we are looking at are companies which have at least got a hope of surviving their credit issues or companies that never got into the credit issues to that extent and there were a few. So either you get into a company which has problems today but you can see a roadmap that they can address even 50 per cent of their problems and there are quite a few out there. So pick your spots carefully. Again, this is very tough and smallcap investing is extremely difficult. To do one company and get it right takes months and months of thinking, understanding the promoter, understanding the management teams because none of the promoters have the skills to really build great businesses, they have to be coached a lot of the time. It is a backbreaking work. I mean, it is not like buying ICICI Bank or HDFC Bank where management processes are set, their businesses are generally in good shape. So it is a different kettle of fish.
Nikunj Dalmia: Couple of shows ago when I interacted the Shankar I told him that I suddenly notice that you got white hair on your moustache… is that age or is that wisdom? He did not answer that question and blamed it on the video link. He says he is not able to hear me. So, is it stress or is it age?
Devina Mehra: I have spent a number of decades and find markets fun but and not greatly stressful anymore at least.
Nikunj Dalmia: Where else do you smell consensus because a couple of months ago there was lot of consensus in banks and for those who were overweight banks they are suffering now. I get a same feeling selectively in IT and surely in autos?
Shankar Sharma: Pharma. It has been exactly the same. IT, we are a little queasy that does the long-term look as good as what it did in the past and there are question marks around that. It is too early to call it but I do believe that being away from the consensus that PSU banks are being bad, it is too early to start calling the end of that consensus. Remember, you do not have to be against consensus all the time. It is only at absolute pitch points on both ends — bearish or bullish — that you have to start thinking differently. If you start thinking differently continually you will go bankrupt and that is not what investing is about. I do not think the concensus that PSU banks are bad is necessarily wrong at this stage.
Nikunj Dalmia: What about the pain in pharma? Everyone thought nothing could go wrong in pharma. Now the general view is nothing could go right. Everyone is blaming the USFDA, nobody is recognising the fact that Indian generic pharma companies do have an inherent advantage. The current fire sale in the pharma sector is more like a Flipkart sale where you should be a buyer or is it too early to be a buyer?
Devina Mehra: Too early. We are still watching that. We still do not think it has turned yet.
Shankar Sharma: Over the past few years, quality issues have been genuine.
Devina Mehra: Yes, it is not as if you cannot just blame that the USFDA, the competitors are putting them on to this because a lot of the things that had come out in the inspection reports are not wrong in terms of the quality standards.
Shankar Sharma: For one pharma company in Mumbai, I remember they are keeping samples along with workers’ food in a fridge. That cannot make you look very good in the eyes of the USFDA.
Nikunj Dalmia: Every time Shankar comes on TV, he is expected to make a big call. Today it is a power not of one but of two. So I do not want one but two big calls starting with you?
Devina Mehra: As I said that right now we do not see a big move in the largecaps so selective buying in smallcap stocks remains the theme and if you are a small investor then do keep significant portion of your investments in fixed income.
Shankar Sharma: Commodities are a big call if you are talking a big call. I would be a buyer rather than a be a seller of commodity. I could be wrong I mean in all these trades you can look very foolish but that is okay. That is part of the game.
Nikunj Dalmia: Last time you told me that it is a Jekyll and Hyde kind of a situation for Indian markets. So what is the Jekyll and what is the Hyde right now?
Shankar Sharma: It is a same Jekyll and Hyde. So Mr Hyde basically are your largecaps and Dr Jekyll are the smallcaps. They continue to be so. Even on down days, smallcaps are holding up very well even now and many of them are actually higher than where the index was in the Nifty and Sensex were couple of months back. So they are showing a lot of strength and I always like, you know I am a good tape reader so I am more than a balance sheet reader so I watch the tape very carefully. The tape is telling you where the action is.
Nikunj Dalmia: So what are the next 25 years telling you?
Shankar Sharma: That is too long. That will take me into my 70s or late 70s.
Nikunj Dalmia: One thing you regret not doing in last 25 years with Shankar?
Devina Mehra: I do not think I have any significant regrets. What about you?
Shankar Sharma: No, none whatsoever. I think 25 years should have lasted longer.
Nikunj Dalmia: Life in Mumbai or life in Dubai.
Shankar Sharma: I like life in Mumbai. Devina like life in Dubai right.
Devina Mehra: No, actually I really enjoy both. I would not say.
Nikunj Dalmia: Your favourite movie as a couple?
Shankar Sharma: There are things we have lot of differences.
Devina Mehra: Yes.
Shankar Sharma: I like all smuggler kind of movies — Deewar and all that.
Nikunj Dalmia: Shankar once told me that if he was not a stock broker he would have been a Don.
Devina Mehra: That was his father’s ambition.