A long-term investor should never waste a crisis

By Morningstar |  03-12-18 | 

Pankaj Murarka, Founder of Renaissance Investment Managers, shared his views at the Morningstar Investment Conference held in Mumbai on October 23 & 24, 2018. Below in an excerpt from that discussion moderated by Sanjoy Bhattacharyya, Managing Partner at Fortuna Capital.

Are we in a bear market?

Depends on the quantitative definition of a bear market.

Do you feel like you are in a bear market?

 Not really. A bear market is an extended period of significant decline in markets across the board. I think it’s too early. It's just been four weeks since the market has started correcting. To me, it's a cyclical correction.

The Nifty Midcap 100 is down 22.83% for the year, whereas the Sensex is up 23 basis points, neither here nor there. Isn't that a sign that we have a 2-tier market?

Absolutely. The same thing happened in 2017 as well, where the Midcap Index outperformed the underlying benchmark by some 25% odd.

So this is mean reversion?

Exactly. Mid and small caps have been frothy because of the kind of retail flows that we've seen into the market and those indices have been trading at like 2x or 100% premium to the broader indices.

Broadly speaking, it's a bear market when you relate it to the underlying economy. The real economy has not done really well in the last 4 to 5 years. India actually experienced an industrial recession in the last 4 years. But because India is a very diversified economy, we never experience a consumer recession. Consumers did well in India in the last 5 years. If you look at India's industrial growth over the last 5 years, it's half of the long-term average of the last 30 years.

If you look at the behaviour of the market over the last 5 years, the index is nothing but an average of the good and the bad. It doesn't give you the true picture. If you decipher the index, then actually you had a 2-speed market for the last 5 years where you had a pocket of market which relates to all your consumer and consumer-related stocks, be it your consumer, consumer durables, your shadow banks or NBFCs and retail businesses, they have done exceedingly well. They have been in bull market for the last 5 years and that bull market has peaked.

If you look at the industrial side or the manufacturing side of the economy, they have actually been in a bear market for the last 5 years, not for the last one month. If you look at the whole pain of the economy is relying on corporate banks, you look at what's happening to the engineering and capital goods sector and that's because India's real economy has been growing below potential for almost 5 years. And if you average the two out, effectively what you get is a NIFTY CAGR which has been about 11% over the last 4 or 5 years.

You are talking about price CAGR?


Earnings CAGR has been horrific.

About 7%-8%.

Because the real economy has not been doing well, there is a very narrow section of market or section of economy which has been driving earnings and at the same time, you have this broad section of market which has been dragging earnings. So, effectively, we've had a situation where the NIFTY earnings CAGR has been significantly below the nominal GDP growth. This has not happened for such an extended period of time in the last 20 years as it has happened in the last 5 years.

So what you are seeing in the last 4 to 6 weeks is nothing but mean reversion.

I relate it to something like a NIFTY 50 bubble which happened in U.S. in the mid-60s and in the early 70s, where all these consumer companies went to P/Es of 50, 70, 90. Coca-Cola peaked in 1972 and it took 17 years for it to get back towards same price. All these 17 years Coca-Cola's earnings were still growing, and this happened to many other consumer companies in the U.S.

So, I think, what we are effectively seeing is a mean reversion. And if you say that we are in a bear market or the bull market has peaked, I think it's peaked for these consumer stocks because the kind of valuation they were trading at, the implied growth – meaning for them to sustain that valuation, the implied growth could not have happened. Meaning, if a staples is trading at 50 P/E, meaning just a caveat, I am talking about some names, so for Unilever to hold on to these P/Es, the implied growth is something like 17%, 18% for the next 20 years. If you see last 15 years, Unilever's revenue growth is like 10% or 11%.

So, we did create a froth or a bubble in some of these names but not in the aggregate market.

Consumer staples, the high-quality ones, traded P/E multiples in excess of 50 across the board, yet they have many of the characteristics that will help you to deal with turbulent times. Should one still be buying consumer staples at current prices in today's environment?

I think India is going through a Nifty 50 bubble, so I'll stay away from all consumer names.

At this stage, as you find yourself presently in the market, given the circumstances you're confronted with, would you have cash as a meaning part of the assets that you manage? When I say meaningful, in double-digits at least.

We do have 10% to 12% cash. But essentially, we are not fascinated with holding cash. We want to buy great businesses at great prices. The times of uncertainty or times like these are the best of the times. Investing is real fun because you see capitulation on the street, you see stock prices falling. These are the time when you can buy some of the finest businesses at prices where you would like to buy them, rather than just trying to chase, these are times when you can buy them comfortably at your comfort zone.

You are not worried about the elections? You are not worried about a mechanical approach to rupee cost averaging?

Not really. If you have a 3 or 5-year perspective, I think there are enough number of businesses in India which are growing at 2x, 3x of nominal GDP. Irrespective of election outcomes, I think India's nominal GDP has been pretty stable, and I see it accelerating over the next five years, seven years. So, in that case, for – anyone who has a slightly more medium-term to longer-term perspective, I think – I mean, as I say, volatility is the nature of the business. Every crisis is an opportunity to buy into some high-quality businesses. Don't let go a crisis go waste. You can't waste an opportunity. You can't waste a crisis if you are a long-term investor.

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