2008 financial crisis may not be reprised in US or India but play out in some other countries: Maneesh Dangi
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Synopsis
“India's overall leverage is very low and has sort of stagnated over a decade. I would not be surprised if we do not make any major macro mistakes as a country. I would not be surprised if leverage goes up quite sharply from here or next 10 to 15 years’ time.”
Yes, it is a sensible Fed because having taken the rates higher by about 550 basis point, Fed is deeply aware as we all are, that interest rates work with a lot of lag and incidentally I was reading a research report today early that perhaps today's interest rates operating in US could be of last Diwali. So, a lot of rate hikes which have happened in the last 12 months are yet to percolate down to the economy.
As a matter of fact, the US households are actually paying only 3.5% on their mortgages when the 30-year mortgage is at 5.5%. The US corporates are paying barely as much as they were paying pre-Covid wherein in reality the markets have repriced coupons significantly or yields significantly. So, this very idea that monetary policy works with great lags – sometimes 8, 10, 12 months or even longer is the reason why the Fed is choosing to pause now. It is not because they are taking their eyes off inflation, it is because they understand that all of that they have done would continue to sort of take effect in the economy over next 6 to 12 months.
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One thing is very clear that for tentative or uncertain times, investors who are not yet ready to dial risk of any sort carry a great asset all over the world but more specifically and most attractively placed in the US simply by buying a two-year bond today is marginally below 5%. If you do a little bit of an investment grade portfolio there, you will get 5.5, 5.70 dollar yield and that is likely to deliver you more than -3% real returns over next one to two years’ time. So, carry is a great asset in the US and one could say something similar for India, both investment grade as well as high yield carry in India looks extremely attractive for the kind of cycle that we are in right now.
What does it spell into the current macro picture right now, especially in the West? How is it going to translate into yields, will they continue to be elevated at 5% and then the India implication of course because we have seen FII exodus? If the yields continue to give returns, it is going to be status quo and FIIS would not come back to India anytime soon.
True, it is unlikely that FIIs would come back until Fed literally pivots and because FIIs trade is lot less about valuation and a lot more about underlying dollar markets and if the dollar continues to stay strong, it is very unlikely that FII would not return and dollar would likely stay strong for various reasons. Why the US real rates are actually higher than what they are in the rest of the world including perhaps India is because the US dollar actually is a safe haven currency and the US tends to be a little bit of a less cyclical economy. So to that extent there is a lot of money flocking to the US and of course, many other countries including emerging markets, so that is one.
But actually to take a step back as you said, I have been thinking of what exactly is going to happen, for last couple of months and I have actually articulated that we could very well have a 2006-07 analogue at play which basically means that Fed even then took rates higher from zero to five quarter, five half between 2004 and 2006, then also actually the US economy was doing very well and corporate balance sheets were fine but eventually after one-and-a-half years of pausing, ended with a recession in US.
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Look this is the point I was trying to make that it is very unlikely that the US would have a 2008 play out because the US balance sheets are pretty clean in terms of household balance sheets and corporate balance sheets are not levered. But that cannot be said for Europe, cannot be said for China, it cannot be said for many other emerging markets. So I do not know and I do not think a GFC kind of liquidation or credit events are going to play out in the US but then it is more likely that it could pay out in some other places.
But do you think India’s returns at an index level could be capped when it comes to equities purely because of the US yield and we ourselves have a very big impending general election coming up in 2024?
There are a couple of things; one of course is India macro, especially the micro macro which is corporate balance sheets health, bank health and therefore high capacity utilization. All these hint at a very likely capex surge now over the next two or three years. I would say that it is a very high probability event that we will have a corporate capex starting to kick in which is extremely positive for India. India has to solve only two major things as far as Indian equities are concerned; one of course US Treasures because until they stay high and real rates are high in the US, the US dollar will continue to appreciate and that is a bad news for generally risky assets across the world.
What is your assessment of the earnings season so far because given a few disappointments here and there, by and large earnings growth has been fairly robust?
Absolutely, India surprises there as well in terms of most emerging markets that the margins have collapsed and in some places are below pre-Covid levels. India had a little bit of a drawdown in margins in 2022 but then they have actually risen again. They are higher than any time since 2015-2016 and very healthy. That is also a reason why I think capex will kick in because margins alone explain a large part of corporate capex recovery at least empirically.
I agree with you that the Indian results are so far pretty decent and for FY24, analysts would meet the Nifty earnings targets or even the broad complex earnings targets as they had anticipated last quarter. There is very little disappointment except one area, which is banking that I highlighted to you. Last time also, we discussed that a lot of levers of banking earnings growth are actually getting chipped off and to that extent there is going to be some disappointment over next 12 to 18 months as far as banking profitability is concerned.
If I have to extend that point in banks that banks are growing, the credit offtake is in the range of about 14 to 15%, 25 to 30% depending on the balance sheet size you are looking at but if I look at the real economy, especially the rural economy, FMCG companies, two-wheeler dispatch numbers are not growing. My point is if banks are growing, where is growth moving because rural India is not growing?
No, no, India is very big and most of the leverage goes to the top quartile of the population and you do not do not want to repeat this K-shape recovery and stuff that we've discussed since 2020. There is a bit of a resumption of the leverage cycle. When I talk of households, what matters to banks are top quartile people and also a likelihood of a leverage cycle kicking in in the industrial side. Service sector, also by the way, has been doing very well. So where is it going, it is certainly not going to the bottom quartile but that segment is not even a bank's catchment area unfortunately.
India's overall leverage is very low and has sort of stagnated over a decade. I would not be surprised if we do not make any major macro mistakes as a country. I would not be surprised if leverage goes up quite sharply from here or next 10 to 15 years’ time. Though the bank stocks are going to be perhaps staring at disappointment, the reason I said is because the margins in banks have peaked now and for the competition that they have on rates that they are competing, their NIMS are going to be lower, the slippages of have bottomed and credit growth also will normalize. given that nominal GDP growth is going to be only 10-12% over the next three, four years time. That would mean a lot of positivity priced in banks could be, they could be up for some disappointment.