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'Bull run to last this decade'
October 20, 2006
A lot has happened in the global markets over the last six months, with big corrections and pullbacks. Ruchir Sharma, managing director and head of emerging market at Morgan Stanley and a very well known columnist, speaks to CNBC-TV18 on the potential in store in the next 12 months including global influences and India's role in the global puzzle.
Excerpts from CNBC-TV18's exclusive interview with Ruchir Sharma:
So much has happened in the last few months we had that big burst in May, a lot of people called it a bear market then we have pulled back, how do you see global markets placed right now?
Our sort of operating assumption for a while has been that, every decade there is some theme, which captures the imagination of investors. In the 70s, it was commodities, oil, gold. In the 80s, it was Japan. In the 90s, it was the US led by technology and my own feeling is that this is really the decade of the emerging markets and this is not just something which happens out of thin air.
It is based on some very fundamental change which takes place, which investors are first slow to recognise and once they recognise it, they obviously go overboard on it. I think that we are somewhere in the middle of that stage of emerging markets being the hot area. So in that regard, I think what we saw in May and June was a classic mid-cycle correction.
Some emerging markets are still working that out, India obviously had a more spectacular comeback than many other emerging markets. But we are still working our way around that. But this is really the decade of emerging markets. India is at the heart of it and therefore I see a multi-year bull market that lasts pretty much for the length of this decade.
Even on hindsight you would say that what happened in May and June was just a blip and we may have seen the worst for the moment?
Before we started seeing the worst, I think that was a very important event, that you needed to shake off some weak hands, needed to shake off some complacency, needed to get demand and supply back in equilibrium, too much supply was coming out of the Indian market, too many people were getting very excited.
So, we needed some sort of a pullback to almost scare off the weak hands because that is what makes for long term trends. So I think that is what happened then and it is quite likely that we will keep getting such phases or not keep getting them, but atleast keep getting one or two such phases through the course of this secular uptrend.
If you recall the big US bull market which lasted from 1982 to 1999 early 2000, there were a couple of events there which really shook the confidence very badly. There was the 1987 stock market crash, which happened in the middle of a multi year bull market.
There was the 1998 crisis in Russia, in LTCM, the hedge fund that blew up in 1998, which really made it look as if the world was coming to an end and even in 1990 we had a recession in the US and yet that did not break the multi year bull market.
So I think something similar is playing out in emerging markets such as India. This is a multi year trend but nothing goes up in a straight line, we will keep getting these sort of violent attacks and May June was very violent. Infact it was the second most violent emerging market correction over the 5 week period in the history of emerging markets. So it is only natural that such things happen in the midst of a long-term trend.
You used the term weaker hands. Do you see that in this run into emerging markets, a lot of inexperienced hands are sort of running the money, which is going into emerging markets?
That is always the case though which is that you will always have new players. In any big trend new players get very excited and they do not understand the asset class fundamentally. So there are more inexperienced players here. At the margin the so-called marginal price setter has changed. It has become much more hedge funds oriented and not by the dedicated emerging markets managers like us who used to form a very major share of the trading volume and liquidity in these markets.
But I think that is only natural. It gets much more participation but that is not something I would not take it as either a negative or a positive, it is just a sociological phenomenon that happens in any long term trend
It did definitely raise the risk premium and I don't think that we are out of the woods as yet. In fact although the Indian markets obviously made a very nice comeback there are some concerns which are out there. One thing that we keep forgetting is how important a role the US still plays and that this entire bull market began once the US economic recovery got going in the middle of 2003. So we still have concerns about the US.
We need the US to have a soft landing. The housing market in the US is in a free fall currently so we need that to just remain a sectoral event and not spread more widely to the rest of the economy and the rest of the world. It is too early to say that we are completely out of the woods as yet.
That is an important point because when you look at what people are generally saying about emerging markets, a lot of people echo your view that we could be in a structural run for the next 4-5 years. Do you see any sense of euphoria, which has crept into emerging markets as an asset class or we are not quite there yet?
I don't think we have seen euphoria as yet. The one very important things if you notice is that the emerging markets over the past three years have tripled in value and yet the valuations haven't changed that much with the exception of India and some other emerging markets. In aggregate the valuations for emerging markets haven't changed that much.
Why is that? Has earnings growth been so strong?
Exactly. This time earnings growth has been very strong and typically what you see at the end of major bull markets also when you see euphoria is that not only are earnings elevated but valuations too are elevated. So, that is what for example we got in technology in early 2000 that not only were earnings very strong in some of the tech companies but the valuations associated to them were extremely high.
That is what we saw in Japan too in 1989, that earnings were very strong because the economy was doing very well but in the end it led to too much euphoria because investors extrapolated way too much out into the future and the valuations got extremely expensive.
In emerging markets, earnings growth has been very strong but valuations never reached even in May June the so-called euphoric levels. Now India, people are bit concerned about that I think - it is a bit of a simplistic concern because looking at PEs does not reveal that much.
So we keep quoting PEs incessantly without realizing as to what makes for the PEs, what potential earnings growth can be. I still remember that Infosys was seen to be very expensive company in early 1999, but the earnings growth was so strong that if you backed out the earnings and calculated the PE of Infosys, based on the earnings it gave out in the entire year of 1999 and early 1999, it was trading in a single digit PE but at that point of time the forward projections weren't that robust, so it seemed to be an expensive company based on very low earnings growth projections compared to expectations.
So, I think something similar could also happen in emerging markets and even in India that we could be underestimating the earnings power. Even in India, if you remember the bull market which ended in 1994, the valuations were nearly twice what they were in May and June and even now.
In PE terms?
Yes in PE terms and of course there are some other valuation metrics which have got a bit more stretched, but the broad story is that big bull markets end with very high earnings and very high multiples assigned to those elevated earnings and we never saw that in emerging markets or haven't seen that as yet. When we see that, then you know that this is true euphoria
You are an emerging market fund manager. How much of the optimism that you feel is because you are invested in that asset class. What convinces you that this is indeed the place to be over the next 4-5 years for equities?
I have been doing emerging markets now for over a decade and I have seen the various moving paths. This is not how I felt about emerging markets, in fact when I first started doing it. In 1994, I thought that this was ridiculous what people were thinking about emerging markets.
You were actually bearish?
Through much of the 90s, people would be always be sort of critical of such a bearish line but that is how I felt. Currently I feel differently and it is about putting your money where your mouth is and that is a part of global asset allocation committee, which is what I also sit on.
We had been overweight in emerging markets for the last 3-4 years and we continue to do so. We could be wrong and you are very right that specialist fund managers either tend to be very bullish or very bearish about the asset class or the stocks or markets that they are covering so that is something, which could be a risk in any of the things that I am saying.
But I truly see a different picture with emerging market and this does not feel like the 1990s. This time it feels that something different is going on this decade.
What is different? Is it economics, is it more stable politics or are companies suddenly re-inventing themselves?
One thing, which I always remind myself, is that many of these countries are essentially run by people who may not be that competent. In fact, many emerging markets tend to be what I call cyclical societies that for many years, like in Latin America the per capita income hasn't changed for decades etc.
So if you were to ask me that will the world in 2030 or 2050 look the way that has been projected by some investment banks with India, China, Brazil, Russia dominating the economic landscape I would say no, I don't agree with those projections at all because success tends to be cultural and these long term projections mean very little.
But I am a market player. It is not necessarily only about fundamentals - yes it is about fundamentals but it is also about what you think is going to capture the imagination of investors - which fundamentals are going to capture it.
Countries like Brazil, Russia are all trying to repay their debt down which is very different from what was going on in the 1990s. The companies today are playing a very different game in many emerging markets. They want to grow in size by increasing their market cap rather than trying to sort of just make the quick buck. The game has changed. The companies today are much more focused on returning wealth to shareholders than there were in 1990s.
Would it be fair to say that you are not entirely convinced about the long term picture?
I think that is the most accurate way to put it. I am very conscious of these long-term projections and the value of that. In the 1950s, Burma and Philippines were projected to be the Asian tigers, you know what happened to that. In the late 1980s, if you remember the world thought that Japan was going to gobble everything up and Japan was going to completely displace the US as the dominant economic super power, we know what happened to that.
In the mid 1990s, we thought that countries like Thailand, Indonesia and the so called ASEAN region, the East Asian tigers were the new superstars and you what happened to that.
So these themes tend to run for a while, I just don't believe in long term projections because we know that something will happen where these countries will shoot themselves in the foot or loose the willpower to reform at some point in time, because they will rest on their current success.
It's just not yet the time to be contrarion?
Exactly. I think it is too early for that. For the next 3-4 years, this theme could run some more because we aren't seeing that happen as yet.
You run more than USD 20 billion in emerging markets. What are your favourite markets and what do you like particularly in Asia?
Overall from an emerging markets perspective, the market that we have liked a lot over the past three-four years is Russia, whose potential has been underestimated. There has been too much focus on the lack of democracy, human right issues in Russia and not enough on what is happening on the economic front in Russia. Obviously, the oil and the commodity boom has helped them, so that is the market that we have liked a lot.
I think that the eastern European countries, is where the action lies. The so called east Europe is a new east Asia and is one of our favourite investing lines. The countries which were the former communist countries like Poland, Czech, Romania, are some countries I think are doing very well.
It is a top down call or are you finding good companies to buy there?
Both. I think that is the big difference between Asia and some of these countries in eastern Europe and Latin America, which is that Asia has been spoiled by too much capital. There is too much hype, too much focus on Asia. They get a lot of capital, so the companies also don't focus that much on returning money back to shareholders in terms of targeting metrics like return on equity, whereas because these countries in Eastern Europe and Latin America have been starved for capital the companies there are much more focused on using that capital very efficiently and trying to increase ROEs.
Does the starvation of capital breed efficiency?
Exactly. So I think that is why if you see a very long-term history, the markets of Brazil and Mexico have outperformed the markets of Thailand, Indonesia, Korea, Taiwan over a very long stretches of time, even though the economic performance in those countries has been better over the past fifteen-twenty years. That is because they have been starved of capital which leads to better efficiency.
But now what we are seeing there is a bit of a double kicker-one that they are more efficient with their capital and two, that the economic growth profile is also improving. So I think that, that is why we are more bullish on some of those markets in that part of the world.
Within Asia, I really feel that the investing game has been turned upside down, in the 80s and 90s, the hot markets of Asia were the smaller markets, Thailand, Indonesia were the big stars than Korea and Taiwan subsequently. But this decade we are seeing big population countries with a competitive advantages like China and India have got their economic act together.
Even in Indonesia, economic reforms haven't been that impressive but their size and scale is what has drawn investors to Indonesia. I think it is the big population countries of Asia, is where the action lies and those are the markets that we are at the margin more positively engaged with.
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