Withdrawal symptoms refer to a variety of symptoms that the body of an addict shows when he stops or reduces consumption of an addictive substance, like a drug or alcohol.
In order to alleviate the financial crisis of 2008, central banks the world over, especially in the US, pumped in huge amounts of liquidity into the financial system. For example, the US Federal Reserve increased its balance sheet about 5 times from $900 billion to $4.5 trillion, effectively pumping in $3.6 trillion into the system. The European Central Bank also pumped in money and so did the Japanese Central Bank.
A side-effect of this huge money pumping was that financial markets got addicted to easy liquidity. Of late, these central banks have reversed course. The US Fed, for example, is withdrawing $50 billion a month instead of injecting money. The swoons in the markets that we have been seeing of late can be partly attributed to these liquidity withdrawals.
In my view, the most significant thing to watch out for in 2019 will not be Indian general elections, but the extent of these withdrawal symptoms of the markets. Elevated valuations, or valuations only, on rosy futures projected will be difficult to sustain in a scenario of higher interest rates or tighter liquidity.
We have seen a flood of funding in the startup ecosystem globally and in India. All that mattered was the number of customers and scale. It did not matter that these companies have become loss-making, and further, they do not seem to have any clear path to future profitability.
Multiple food delivery startups and online grocery stores are indicators of such a situation. We saw in 2018 a technology/startup fund having a corpus of over $100 billion and those times reminded us of the euphoria last seen in the late 1990s in the technology space.
In India, we have taken our own consumption story too seriously and we have seen a huge increase in valuations in anything having to do with Indian consumers. We have started seeing very high double-digit and even triple-digit price to earnings multiples (P/E ratios) in this space.
Investor returns can come from three sources: earnings growth, dividends and re-rating (an upward revision of multiples – say a higher P/E ratio). Given that we are already at high multiples and that dividend yield is negligible, all that can give returns is earnings growth, which has to exceed the optimistic projections in place.
We like private banks compared with NBFCs and PSU banks, and they should do well going forward. RBI seems to have solved liquidity issues for NBFCs for the time being through OMOs, but the bigger problem for the NBFCs is the asset-liability mismatch. Also, with lower cost of funds and higher retail deposits, private banks have an enduring advantage over the NBFCs.
PSU banks are a strict no-no for us, given the asset quality issues and weak corporate governance. PSU banks currently have about 70 per cent market share and with restrictions on incremental lending for some of the PSUs, there is a huge runway for growth for private sector banks.
I am not predicting a fall or a crash. I do not know what will happen. Investors are best advised to stick to their asset allocations. Also, in each euphoria, there are neglected stocks and sectors, which are attractively valued. All I am saying is, do not take risks that you do not understand or cannot tolerate. Further, it is to be always remembered that equity returns do not come by smoothly, and returns can be all over the place for one or two years.
Disclaimer: The views and opinions expressed in this article are those of the authors