Chandrakant Sampat talks to Chetan Parikh - PART 4
by Chandrakant Sampat
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Is 1929 repeating itself?

The basic concerns that I have today is are we going into 1929 or do the new technologies or the new economy have the power to take us out from a situation like 1929. Basically we will have to look at U.S. situation today. There the debt level is around 130 percent of the GDP, there the market capitalization sometime back was about 185 percent of the GDP. The USA current account deficits run at 1.4 percent of the world GDP. There's been an argument in the Economist about the savings rate and there are views that ultimately uncashed market capitalization is a saving. But is uncashed market capitalization something that is permanent? If it dips down then it will have a negative impact on consumer demand.

This is what the Economist ( Dec 9, 2000 ) stated:

"In the five years to 1999, rising share prices boosted the wealth of American households by $10 trillion. These gains encouraged households to save less out of their current income, pushing the personal saving rate into negative territory for the first time since the 1930s. This happened at the same time as business investment soared. As a result the private sector is running a record financial deficit (the difference between the savings of the households and firms and their investment) of about 6% of GDP. Over the previous four decades net savings has never before turned negative for more than a year. If private-sector net saving corrects to its historical norm, this would imply a big fall in demand as consumer spending and investment fell. Elsewhere in the world, a private-sector deficit on this scale (as in Britain and Sweden in the late 1980s) has resulted eventually in a hard landing. America looks highly vulnerable. If share prices fall further, the reverse wealth effect on consumer spending could be bigger than in the past. Households will be starting with negative saving, giving them no cushion to fall back on; and they have never before had so much of their wealth tied up in shares."

Lowering interest rates are not the answer

So what will be the consequences on an American economy if markets were to fall with a negative rate and with a current account deficit of 1.4 percent of the world GDP, then who is going to buy whatever is being given by the technology. So the basic question again comes to this: Does the technology have the powers to make all these negative impacts redundant and still go further beyond this to make the society richer. I don't know, I can't answer these questions. Another thing that is now in fashion is that in 1929 the central banks made mistakes by keeping the interest rates high when they saw a recession going on and so a recession is seen to be pre-empted by lowering interest rates. To my mind this kind of a thinking in today's circumstances needs a re-consideration. I don't think the interest rates are going to be that important. What I'm seeing is that lots of cleaning will have to be done and you can see the kinds of NPAs of the American banks, the way they have given the money.

Robert Rubin stated in the Economist 2001: "Today, the large inflows of capital to the United States, which finance our current-account deficit, the excess of domestic growth over output growth, our low personal-savings rate, and the high level of the stock market by historic standards, may-not are, but may-be excesses reflecting an overreaction to the real strengths of the United States economy, including the productivity growth stemming from information technology. If in fact these are excesses, they will have to unwind - in a soft landing or a hard landing - and that unwinding could possibly be a vulnerability for global financial markets."

Sometime back, just two companies constituted $ 1 trillion in market capitalisation - Cisco and Microsoft. The valuations embedded in the numbers would have required these two companies to grow at 50% per annum for the next ten years which if the valuation parameters remained unchanged would have meant a market capitalisation of $ 57 trillion of these two companies by 2010. To put it in perspective, the current market capitalisation of all the stocks on the NYSE is $ 13 trillion. The absurdity of such valuations have made financial markets and the global economics vulnerable to changes in investor psychology.

Investors seem to have sensed this. In the "Economic Times" (24 Dec 2000) a Reuters report stated: "The stock funds continue to pull in new money because about 60 percent of it comes from retirement accounts, where many investors are simply on autopilot. But investors, saddled with stock fund losses and big tax bills on capital gains, may decide to seek shelter in less risky stock funds, money markets and bond funds. Money markets, which now yield about 6 percent, are considered a safe cash equivalents and have already seen an increase in demand."

What is important is asset quality

Look at "The Fall of the Net Analyst" in Business Week ( Dec 18, 2000 ). Now this is something very astonishing that has appeared here and which made me think: `Unconventional wisdom from Lehman'. Now here is an analyst, an Indian analyst with Lehman brothers who talked about Amazon. His name is Ravi Suria. He downgraded Amazon, he was not an analyst in equity, he was an analyst of debt. He forecasted that this Amazon would go below $40 when most of these analysts were talking about $400 at the time Amazon's price was $250. Amazon is now under $40. Now what he is trying to say is that the position of Amazon's asset quality is so weak that it needs cleaning up. Now this is -- this is a thought that has come out -- anything that does not have good assets needs cleaning up. It's already been seen in Lucent. You see how the market is -- how long can Cisco go on giving credits in a world without compromising on the quality of assets. Now at some point of time for keeping on the growth this kind of assets they will have to put on the balance sheet. Would that not need any cleaning up? When the cleaning up comes what happens to the growth rate, what happens to the ratings and and what happens to this market which is more emotional than real?. Can it wait and say okay Amazon will cleanup. We don't mind but has it got a technology that's going to take us far after cleaning up for the next 25 years. So the basic question that I have in mind is that can the interest rates, really lowering the interest rates, can it clean the assets that has been accumulated in this bull run. To me the answer is that well if technology can really do that it will be great but it's very unlikely. It's very unlikely.

History teaches about the excesses of the capital markets

So now if this were to happen in 2001 in the U.S. where the dollar would slide down and as Rubin in the Economist 2001 has pointed out that if the things go wrong it will be not because of anything else but it would be only because it is the capital market valuing the way it does. This is what Robert Rubin said: "There is always a strong tendency to extrapolate from the present in predicting the future. This is a habit which I believe, based on my own experience and all of financial history, almost inevitably leads to the wrong conclusion as to the probabilities of future events. Times have been good, which has led to an expectation that times will, almost as a matter of natural law, continue to be good. But blithely assuming that to be so can increase the likelihood of consequences both unexpected and unhappy. This error reflected an inherent tendency to excess in markets, grounded in the human psyche and the pulls of fear and greed - an error manifested repeatedly in recent decades and throughout history. The probability is high that there will be serious disruption similar to that which occurred in Asia three years ago, at times in the future, though there is no way to tell when that might occur or where that might come from in the global financial system. I do not think any of this is being given appropriate weight by investors or policymakers.

The new information technologies may well be transformative. They will certainly substantially increase productivity. But these boons to economies may at the same time lead to excessive stock valuations and also to excessive assumptions of freedom from future economic and market downturns.

Economic history is replete with developments, such as the railroad, the advent of electricity, and the development of mass production that greatly increased productivity. None of these, however, eliminated the business cycle. They also generated excess optimism that led to trouble and painful corrections."

Many experts are worried about the direction of the market

What has happened on the NASDAQ is it a buying opportunity, or does NASDAQ still have a long way to go down. The answers of course are very conflicting, some like Bill Joy, chief designer of Sun Microsystems think we are nowhere near the bottom. This is what Bill Joy said in Fortune (Dec4, 2000): "We've definitely had a situation where the valuations were completely out of whack with the real potential of some of these tech companies. In some cases we had companies that didn't even have any business model, and people thought they would grow without a hiccup and never have any competition. The real question is to look at these things and and ask if they ever will make money. This whole phenomenon is based on the notion that "if we build it, they will come." There's been a suspension of disbelief". There are others who believe that the technology is the ultimate answer, that the growth rates will prevail irrespective of asset quality.

The Indian economy will be tested to the utmost

Now if you apply this to our situation here. Basically the situation we have had this year is okay, the tech stocks are great, growth rates are great. But what happens if the U.S. slows down? Will they have the same amount of growth rates as they have shown in last 7-8 years?. Can they really maintain those growth rates? If the whole world slows down do we have something very special which can keep on growing. The first question is will the world slow down? I am not answering the question. If it does then will these technology companies have the same powers to keep on growing at the same rate for any number of years. Now before you make an investment you have to make a call on this. If your call is right, fine. If your call is wrong I don't know how much harm you can do to your self. The second point is that if you look at the economic structure today 70 percent of our people are dependent upon rains. Good rains. That there is no productivity. And 70 percent of our land is dependent on good monsoons. There is no infrastructure that is ready to take over the difficulties should the monsoons fail. Now we have had a good run of about 10 monsoons, this is the first time that it is indifferent. The other piece of statistics that I read is that the farmland has now come to about 0.18 hectares as an average holding. So it's getting fractured, fractured, fractured, fractured. The hard infrastructure is not in place. Like roads, storage or ports. Now all these are not in place and as this McKinsey's report once pointed out that the UK consumption of wheat is equal to India's wheat loss by the way of bad storage, by way of transport. So how long we can tolerate this waste. What if the world economy slows down? The entire prosperity has come about because of good 10 monsoons and the software exports.

Market economics is no longer about unlimited ends and limited means, but about limited ends and unlimited means

Now if you look at the last part of what I have to say is that today the entire financial community is focused to what is going to be Morgan Stanley's allocations on the funds that are going to come. Okay. But why are they not talking about what's going to happen if one or two monsoons are indifferent?. What happens if the software sector slows down because of tech slowdown everywhere else in the world?. Or they should say we don't see any tech slowdown and we are going to grow and they say that we definitely know that the monsoons are going to be good for another 10 years so don't worry. That the allocations to this country are going to be permanently in. Morgan Stanley is going to allocate so much here and there is so much of liquidity which is going to chase the limited stocks. When I went to the college the first thing we were taught about the definition of economics was about unlimited ends with limited means. So is not the market talking about the limited ends and unlimited means at this point of time ( lots of money chasing a few stocks) and the second one which I pointed out which is that the technology is merely a means to an end. What happens, what would emerge if the technology becomes an end by itself. See these questions are not being answered to an extent that I can't make any definite call on how these markets are going to behave in the next few years. Historically the volatility is the greatest when the bull market is about to end. Do I have to consider all this as history or is it going to be different this time?

Momentum cult has led to unprecedented volatility

Now let's look at, what can happen to even a company like Hindustan Lever should the next quarter remain flat on earnings and on the top line. I think the market is going to punish it so severely that the growth of market capitalisation over the last 10 years may disappear perhaps in a day. So what are we doing here? What are we doing? The only way is to let the capital flows come in, direct, indirect by taking out these foreign investment boards, trying to preclude this closed economy so that we can use it for VRS. We can use it for hard infrastructure, we can use it for education. Are we going to really buildup the sustainable capital markets for the future generations or we're just talking about the Morgan Stanley index allocating so much. Or the growth rate of the next quarter is going to be so much and if the growth is not that we are going to severely punish that particular stock. So that the volatility can be anything. The answers should come from joint efforts of number of enlightened people. I am merely asking a question and I think these questions would be worth asking if the questions are answered by people who are in know of things. This is how I see this stock market. I mean just think of Hindustan Lever having a flat quarter and a flat bottom line, I do not know what can happen. Are you seeing the change. So what happens? And as we met last time I said the whole strategy of Lever to go in, go in, go in is not going to work because the purchasing power is moving to the urban areas and that they don't have the quality. If you look at the Indian Lux and imported Lux you see the quality differences are significant. Everyone has become more efficient -- as efficient as Lever. So the efficiency of Lever is getting commodotized. I'm taking Lever as merely an instance, not that I know that this is going to happen but what can happen to this market, how people can lose money and how the wealth effect can impact -- there's one more thing, that in the last 6-8 months from the little I know of this market, the cult that is working, 10 or 15 stocks which are having 80 percent of the daily transactions which are the momentum. Then there are values, but the values are being totally neglected if there's no liquidity and if nobody looks at it. And the third part of it is some of these stocks where the management are trying to defend their stock by trying to avert their takeovers. But they will ultimately yield 10 percent which is the bank yield. As Drucker has rightly pointed out that some industries are corroding from within like automobiles, chemicals and steel.

Many companies with high growth rates are not making economic profits

They are corroding slowly. So what kind of a valuation -- what kind of valuations are there when markets immediately jumps when a sector, say cement, put up their prices by Rs 20/bag. So run after it. As a matter of fact I have not known a cement company, may be Madras Cement is an exception, any cement company making any profit. And if you go to even these software companies and if you were to apply what the definition of profit is by Drucker in "Managing turbulent times" he says, profit is an illusion. It's merely a cost of staying in business tomorrow. So if you're really taking out the cost are you profitable? And there are profitable companies in this country which are being ignored.