What kind of signals are you getting as far as global markets are concerned?
The Fed and the US markets are currently the globally leading indicators. Whatever is transpiring in the world over depends a great deal on what is happening in Wall Street. There is higher correlation not only to developed markets but the emerging markets as well and in that space the Dalal Street is no exception.
If you put aside the dichotomy that exists between Wall Street and Main Street in most leading economies and emerging markets, one can clearly understand the leading indicator and the leading policy response to the level of monetary intervention. No one could have imagined that at the start of this year, with interest rates almost near zero in most of the developed world and further promises to keep going with such aggressive intervention for years to come, the bottom line is money supply growth.
At the Fed website alone, money supply growth is tracking at almost 29% year on year and it is at a 60-year high. Since the post World War II era, we have never seen money supply grow to such an exceptional levels and more importantly the signals from the Fed are very clear. Jeremy Powell in his speech announced that the Fed had unanimously adjusted slightly higher to a more flexible form of average inflation targeting. Basically, the Fed committee is seeking to achieve inflation that averages 2% over time. The 2% inflation is far stretched. It is currently averaging around 60 bps in the US. That means aning the Fed will continue with its QE money printing programmes for years to come.
Currently at the monthly rate of $120 billion, that is nearly $1.5 trillion per year. That is leading to this money supply growth not only in the US but in developed economies the world over and Fed’s easy money is pouring into a relatively smaller number of tech stocks pushing these stocks higher and higher. Most of the media and twitter is full of FANG stocks but let me give further analogy to our viewers. I would rather view the FANGMAN stocks which also includes apart from the FANG stocks Microsoft, Amazon, and Nvidia. May be for retail euphoria, you can add Tesla and Zoom in the last couple of weeks. The market cap of these seven stocks alone is $8.3 trillion that is more than the combined valuation of the 37 largest tech stocks that we saw in the 2000 boom.
In 2000, the largest 37 stocks got to an average of about $7.95 trillion and individual stocks like Apple valuation was almost at $2.3 trillion. That was more than the combined valuation of the entire RUSSELL 2000 which is the small cap index in the US and more or less equal to the Indian market cap today. The elephant in the room is the NASDAQ.
Charles Kindleberger’s Manias, Panics and Crashes identifies the framework for analysing the anatomy of a bubble. So the question remains still out there — are we in a bubble? In terms of valuations during the tech peak in 2000, Microsoft got to 75 PE. Today it is at around 45 PE. Can we continue to move up? Absolutely, but the more important thing is this concentration that has happened not only in NASDAQ with seven stocks but even in Nifty. There has been a 50% rally from the March lows till now and not only Nifty but in every leading indicator index, you can attribute it to just five, six or eight-nine stocks globally.
We can blame today’s crazy valuations or this concentration to a very aggressive policy stance of what is transpiring in the active versus passive mind. If you were to just look at what has transpired in passive money over the last four-five years, let me give you some more stats. Passive strategy has now controlled almost 60% of US equity assets while quant funds control another 20% and that is a staggering 80% of total combined that is being controlled by passive strategies.
In terms of absolute numbers, the AUMs of passive titans like BlackRock and Vanguard which control the bulk of these passive ETFs, were $8 trillion just five years ago. Today they are almost at $13.8 to $14 trillion and for the first time in the history of capitalism, as of August 2019, we had passive money strategies overtaking active money and what is resulting is this. If you add the endowment funds, the pension plans and the sovereign wealth funds, that number in the US comes to almost $20 trillion –an amount that is being managed by passive strategies. It is equivalent to the annual GDP of the US alone.
So this concentration itself is providing us in my view a false sense of belief that retail investors cannot move money on great tech stock names because even passive funds are loaded with them but the longer this lasts, the more unbalanced the market becomes because inherently long-term stability creates instability in itself. As bubbles pop, investors will learn a hard lesson but just as buying begets more buying, reverse selling begets more selling which was prevalent from end Feb to March.
I want to understand from you in this kind of environment, do you see these extra flows make their way into emerging markets like India on a sustainable basis causing our own asset prices to rise further from here?
Absolutely and the reason I say that is because in the world today, bulk of the money is chasing yields. Not only in Europe and Japan are the yields negative, we have about $17 trillion in negative yielding assets. The reality is that with the Fed coming out and saying what they have said and most of the developed markets with near 0% rates, yields in emerging markets still look very attractive.
The first bulk of the money that is coming back to markets will always go into regimes that are actually printing money and Fed being the reserved currency of the world, that has probably seen the first leg of this mania that we call the Nasdaq bubble. But I would like to believe that works. Let me give you an analogy like if Apple continues at the same rate of speed for the next five years that it has done over the last 18 months, its market cap will be larger than the entire stock market is today and that is just the impact of compounding.
Now you and I both know that is not possible. It could be a fantastic company. It does not mean it is a great investment in the stock right now. To me it means that it may more be a great trading vehicle right now for a lot of the strategies. The first bulk of the money has gone into developed markets as the US dollar and we are seeing the bulk of the DXY starting to see a down trend. In in my view, the US dollar will peak out in the next six months and that provides a kicker to emerging markets like India.
Now even in emerging markets India is probably at a better threshold than it was 10 or 15 years back because at that point of time, we had BRICS — Brazil was the market darling, China was the market darling, Russia was completely correlated to oil which 10 years back was at its peak of almost $140-150. So, we have large three emerging markets which are completely opposite of what they were 10-15 years ago.
There is a lot of talk about how we can benefit from an anti-China stance the world over. I look at history a lot. During World War II, Germany was probably the most hated country globally. We are probably in a similar phase today and India can benefit, The government understands it, a lot of the policies and reforms have been announced. Now the onus is on both the government and private sector to take the lead and win back this manufacturing and service industries that the Covid opportunity has provided.
Do you see broadening of the rally because of the Sebi circular which came in or even otherwise too because this narrowness cannot continue and a recovery in the economy is taking place?
January 2018 is when the mid and small cap indices peaked in India. We have already gone through three years of pain in, asset allocation within equities. We are almost near January 2021 and in my view, the Sebi circular has catalysed and accelerated the underlying theme where people were looking at largecaps and saying that these valuations probably are not sustainable. They can be sustainable in the event that liquidity only follows more and more momentum and the momentum has been with the largecaps for a while. But the reality is that I do not expect the entire spectrum to see the kind of euphoria that lasted during 2016 and 2017.
What it means is that more and more fund managers are asking us about strong balance sheets, right kind of growth areas and small cap stocks and midcap stocks that could be the next leaders in the next up-cycle that is about to take turn the world over. I do not think that inherently we can have the large cap names continuing with the rate of compounding that they have seen over the last couple of months. At some stage there will be sector rotation and asset allocation will move away as we have been seeing from bonds into equities. Growth has been the number one phenomenon and momentum has been the second. Within that, techs have been leading. Within the domestic cycle let us be very categorical that the global money supply trade is here to stay for a while and no sovereign central bank is under any illusion or pressure to pull it back soon.
RBI is in a similar format. It has been really a boon for India. Among BRICS, look at the currencies and what happened to the Russian rouble in March and April and Brazil Riyal through the entire Covid period. The Indian rupee has held up really well and that has provided of course the kicker to the government.
Let us not forget the biggest import for us is oil which is still hovering $40. That provides a big kicker to India in terms of getting its balances right. Also, one more point that I would like to add is that the bulk of the optimism that has happened has been mainly monetary led and I would say that fiscal is very much needed as it gives us the intermediation channel. The financial institutions are still overwhelmed and in itself will not support an economic revival. External support, kicker and a booster is needed to jumpstart this activity as we come out of the Covid crisis.
One more analogy in terms of the domestic markets; I think the Indian domestic cyclical rally needs to be watched closely. There are a lot of sceptics out there. My view is that between now and Diwali there will be enough business euphoria and enough optimism built. Even if Nasdaq blips as we saw in the last couple of days, we will continue to uptrend between now and Diwali. The real test for markets will come around the 14th of November when Diwali kicks in which will be the real test of demand for corporate India.
Businesses seem very optimistic around it and so am I but what I am trying to say is it will coincide with the biggest event of the second half of this year which is the US elections. For me, the way that plays out will form the narrative around the short term blip in the markets that you are talking about.
Whether Trump continues to be in power or Biden wins, the biggest blip or risk factor is that for the first time in the US, there will be postal ballots. Should Trump lose and say that he does not agree to the outcome, that can add another one or two months to this period of uncertainty and markets hate uncertainty.