Bull market: market needs to correct 10-15% to eliminate weaker players: Samit Vartak

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Rising interest rates are generally good for the stock market. That’s when they peak and that’s where the real risk of crashing comes in. I feel like we’re a long way from that and at least a year, two years, three years from this because we don’t know how long this tightening cycle will last, says Samit Vartak, Founding partner and CIO, SageOne Investment Advisor.


Each bearish call is a comment that the market is looking a little expensive and valuations are extremely high compared to historical trends. Even as we find ourselves at a new high, where do you think the market is getting this optimism?
The small cap index has almost tripled since March. The markets have been going through a pretty rough patch in the pre-Covid time and it’s natural for everyone to feel a little nervous about the markets. In 20 of the last 30 years, we have experienced a correction of at least 15%. For 17 months now there have been no such corrections and it has almost been like a smooth rise.

I find the fear to be quite real and you have to be careful in the market, but one of the underestimated factors is the statement of cash flow and the balance sheet. The multiple of PE that we have seen at the highest historical level is about 30 times the trailing multiple. I’m not talking about Nifty50 but the top 500 companies. Their average PE multiple is around 32 times, which was pretty high even in 2008 or one of the last highs. We did not go to those kinds of levels. But if you look at the value of the business versus the cash flow, the debt has gone down and it has gone down due to the cash flow generated by the business and most of the businesses responded that they wanted to be free. debt.

It will be surprising to see how many companies have deleveraged over the past 17 months and this is where the cash flow multiple, which is the value of the company relative to the cash flow, at around 15 , 8 times is lower than the historical average of about 16 times over the past 20 years.

Now compare that with the peak of 2018. It was about 25 times and even in 2008 the peak was about 25 times. We are still at 60% of that peak. At the same time, look at the balance sheet. The debt to equity ratio today is 0.16, which we have never seen in the history of India.

The third thing to consider is how the yield on cash earnings compares to bond yields. The bond yield today for India 10 year Gsec is around 6.2% and when you reverse the value of the company into cash flow from operations, which gives you the cash yield, it is around 6.3%, which is higher than the bond yield. Rarely in the past 20 years have we seen a higher cash yield than bond yields and if you compare that to 2008, bond yields were 8% and cash yield around 4%. So a 50% discount. Look through all the peaks – whether in 2000, 2011 or 2017 – the earnings yield was previously at least 30-50% lower than bond yields and that also gives you an indication that, relatively speaking, this isn’t. isn’t that worrisome in terms of valuations.

Very interesting point therefore instead of looking at valuations from a P&L point of view, we look at it from a balance sheet point of view and yes the balance sheets have been very well repaired over the last year and a half. Cash flow has improved. So why would you still be a little cautious in the market? Would you stick to the sectors where you saw an improvement in the balance sheets?
Yes, balance sheet repair has occurred in every industry – whether it is raw material inventories, material inventories or real estate inventories. Either way, consumer stocks never really had a problem. so I’m just not careful because of the kind of relentless rally we’ve had and you know there’s a high probability that one day we’ll get that 15% correction which has a two-thirds probability in a year and that is the only reason.

In the long run, if one is able to take that 15% correction, many mid and small caps can correct double or even more than that. This is the only reason for caution, but we do not know when this correction will take place. It can happen next week or it can come two years, three years later. There is no way to predict this. There are certain pockets, in terms of IPOs, where there is foam and that gives cause for concern. But when you look at a two to three year perspective, in terms of public finances, consumer finances, corporate finances as well as export potential, the conditions are favorable for all. This is probably the first time I have seen this happen.

So many companies are asking to double their capacity in the next three to four years and almost all of them don’t want to take any leverage. They are all based on internal approvals. With such solid balance sheets, I don’t really fear a crash-type scenario.

Who would have thought that India would collect taxes that exceed this year’s budget? GST collection as well as income tax collection are almost at an all time high and far beyond anyone’s expectations during the Covid era. Also look at consumers. About 95% of the population would spend mainly on basic necessities and this type of consumption is not really changing. But the wages of the 2-3% or maximum 5% of the population have increased. Salary levels for the June quarter on an annualized basis compared to a year ago increased by Rs 1.3 lakh crore. This is a fairly large sum.

Salaries have increased in all sectors. IT and pharmaceutical companies struggle to recruit employees and if they want to recruit employees they have to pay 30-40% more. The public finances are strong and that means they will probably need their sub $ 1.4 trillion spending which is higher than the US has announced and we talk so much about sub US spending. I think the public finances are strong, they should be spending. The consumer is strong with salary increases and an increase in wealth.

Over the past year the overall market capitalization of Indian companies has increased by Rs 100 lakh crore and this is $ 1.35 trillion and of that amount 30% is probably owned by non-promoters or the Indian public via funds mutual funds or directly. investments – so that’s 30 lakh crore. Now Rs 30 lakh crore is not even India’s budget for the whole year. This is the kind of wealth creation that we have seen that will promote consumption. There are big investments to come and there are companies that want to spend. So there are a lot of factors that give me a lot more confidence today where, coming out of the crisis, everyone’s balance sheet – government, consumers, businesses plus foreign exchange reserves – are probably in the bottom line. best conditions.

This has been a parabolic move for the markets, Nifty alone has risen 10,000 points from the lows of the pandemic. We have had virtually no correction in the past 17 months. If indeed a correction occurs, what part of the market will be affected and how far could it increase?
For a market to collapse, there has to be a drop of more than 25%. But if you look at the last real bull market we had from 2003 to 2007, we probably had at least a 15% correction almost every year during that time, sometimes twice a year. A 15-20% correction is therefore possible even in the best of bull markets. You have to be prepared for it and probably a lot of new investors may not have seen it, but I think even new retail investors are pretty smart. They are fairly well read and should not be underestimated. They are pretty much aware of the risks in the stock market and there is too much literature and talk available for retail investors today which probably was not the case in the previous cycle.

Today’s retail investor is much more educated and well aware of the risk, but when the market goes through a correction regardless of theoretical knowledge everyone will likely learn from this experience and I think it is necessary for the market. Markets need to fix at least that 10-15% that keeps everyone sane and it’s usually the teardowns that are needed as this usually eliminates weaker players. We need the market to have a solid foundation because if it keeps going up it will be supported by many weak investors and the more you let it go up the bigger the crash will be. So a good 10-15% correction would be very welcome.

Do you think there is a big oversight that when interest rates rebound or reverse the trend, the markets will too?
This is a general perception, but in my recent note I presented a chart for the US market that shows how the S&P 500 performed when the Fed hiked rates versus when the Fed cut rates and at through cycles. It was a very direct relationship. So the Fed rate hike cycle translates into good results for the S&P 500 because it is natural.

More often than not, the Fed raises rates when the economy is doing well and reflects moderate inflation. If that’s the case even this time the markets are positively correlated, it should be okay. In the short term, you might get a shock when the news comes out, but when you look from the bottom to the top of the interest rate cycle, the markets tend to do very well. This makes sense to me because in a cycle of rising interest rates, the competition of stocks is usually that of bonds. Now, bonds would lose value in a cycle of rising interest rates. So, in general, a larger investor would like to over-allocate to stocks rather than the bond market.

There will be a sudden shock if the Fed announces a much higher tap than the markets expect, but that shouldn’t really matter over the cycle. The risk arises when the Fed rate cycle peaks and the downtrend begins. This is when the markets really correct themselves. Rising interest rates are generally good for the stock market. That’s when they peak and that’s where the real risk of crashing comes in. I feel like we’re a long way from that and at least a year, two years, three years away because we don’t know how long this tightening cycle will last.

From a longer-term historical perspective, over the past 10-11 years our annualized dollar returns are probably only 3-4%, compared to around 15% for the US market. Many larger markets have grown much more than the Nifty over the past 17 months, since Covid. But from the January 2018 high to the March 2020 low, the Nifty smallcap index had fallen 67%. So just to recoup that loss he had to triple. The small cap index was around 9,700 in January 2018. Today it is probably close to 11,000, which is almost stable over a three and a half year period. We have a lot of catching up to do to achieve a longer term performance profile for India.


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