Here's Why Fed Rate Cuts May Not Drive India's Equities Higher

Vetri Subramaniam: Well, I think you know, the broad perspective that, yes, we may have seen a peak in the rate cycle in the US is certainly good for the economy. But as far as risk assets are concerned, I would actually submit that it looks like, you know, the risk assets have already climbed that wall of worry because, remember, it was way back in 2021 when we started to deal, you know, with the prospect of significantly higher rates and that did trouble the markets for almost about a year, or maybe slightly less than a year.

But markets stopped responding to rate hikes even towards the end of the rate hike cycle, and if anything, they've actually powered to new not just new price highs, but also significantly higher valuation levels in the expectation of rates starting to go down at some point of time. So I would actually say the rate cut cycle is pretty much in the price. I'm not sure there is any scope at this point of time to suggest that, because rates go down, you will further see assets getting marked up. Why? Because it's already happened. You know, the market is already looking forward. It's already factored into this.

Vetri Subramaniam: I mean, there are many elements to the question you are asking me and first of all, I would say it is not even clear that we are in a synchronised growth cycle across the world. China has been having its own issues, and their growth cycle is currently completely disconnected with whatever is happening in other parts of the world.

I would also submit that if you look at India, maybe because of the policy mix that we use, the fiscal conservator, not very aggressive on monetary side, our growth cycle came out, and it has sort of held up at a reasonable level, very different from what's happened in the west, where excessive monetary and fiscal stimulus is causing them to have to deal with the ill winds which have been caused by those set of policies.

So, this is a very desynchronized growth cycle across the world. I'm not sure I would, you know, look at, let's say, very simplistically, either the rate hike cycle which followed, or, you know, going back to 2001 where you saw a synchronised growth cycle and a rate cycle across the world. Neither is this a crisis period like post-pandemic, where rate cycles and growth cycles were coordinated.

So, my submission would be, you've got to maybe look at each market very differently, because the combination of policies and the position and the rate cycle is different. I think, as far as India is concerned, our view has been that the rate cycle will be slow. In terms of cuts, it will be limited.

In fact, the governor's continued focus on keeping the headline at 4% suggests that we should hold our horses. As far as rate cuts in India are concerned, we at best expect one to two rate cuts through the rest of the year, all the way up to March 2025. So in India, the case for rate cuts is quite limited, just given the policy, you know, framework that's being laid out.

Vetri Subramaniam: Well to call a correction is virtually impossible experience over the last 30 years. But what is always true is that forward returns are very often correlated, certainly at a market level, to your starting point in terms of valuations.

So, my suggestion to people would be that rather than focus on what will cause a correction to come, when will the correction come? There is a simple way to get past this, focus on what is within your control. What is within your control is your asset allocation. If your asset allocation relative to your goals, related to your risk appetite, is excessive in terms of equity, not because of any excessive risk you took, simply that equities have delivered spectacular returns, very healthy returns, over the last two to three years, then adjust your asset allocation.

There is no point getting into this speculation about when the correction will come. Why will it come? I've been doing it for 30 years now, and you know, nobody can forecast this stuff with any degree of accuracy. I've always said this, valuations are not like a school bell because school bells have a certainty associated with them. When they ring in the morning, you assemble at school. When they ring in the evening, you disperse from school.

Valuations tell you there is risk in the market, or there is a low level of risk in the market, but they are not a school bell, but it is up to you to arrange your affairs and take care of them by adjusting your asset allocation, and that is what I would encourage people to do. I think beyond a point the speculation about why correction, who will buy? When will the flow some this is all you know, beyond the point. 

Vetri Subramaniam: Good question. In pure equity funds, we don't take cash calls. You know, typically our cash levels are, you know, 2-5%, it's still very well within that range. But of course, we do run certain asset allocation strategies where we take the responsibility for asset allocation.

So, in a range of between 20% equity to 80% equity, or 30% to 90% depending on the strategy, we are currently at about 45% equity, which means it's less than the neutral weight that we could have towards equity. So, in a way/weight, our asset allocation model is currently underweight equity related to the midpoint that we could have, and that's largely driven by the fact that forward outcomes at an asset class level have not been very favourable for equities from this starting point in terms of valuations.

To be fair, the model has been saying this for many months now. You know, a year ago, we used to be at almost 65% equity allocation. It's continuously dropped as valuations have moved higher to about 45% today. So that's the message from asset allocation, and that is what I would encourage investors to look at.

Vetri Subramaniam: Well, interesting question. We actually just opened a NFO for an Index fund which only invests in private banks. Spoken about this earlier as well. If there is one sector where we have comfort in terms of valuations, it is actually the entire nanking and financial services space in general. This is one of the few sectors in the market, and thankfully, it's also a large sector in the market, so we can put money to work in this area, because here we have valuation comfort.

Well, is credit growth slowing? Of course it is. But I would also submit that it had been very high. Remember, nominal GDP growth, you know, even if you look at the release which came out for GDP growth, nominal GDP growth is currently below 10% in the economy. So, in the context of nominal growth being below 10%, a 13% to 14% credit growth is quite comfortable.

Remember, the RBI itself has been, you know, sort of tackling some parts of the economy, or some segments of lending where it has been growing very rapidly. They're actually trying to get people to pull back on that. So, there is both an impact of slightly slower growth in the economy, as well as actions by RBI, which are causing this credit growth to come slower than where it was a year ago.

But I don't see that as anything more than cyclical. I would actually submit that if credit growth were to turn down significantly, we would have a lot more to worry about, because that would be an indicator of significantly slower growth and significantly slower growth is going to hurt the areas which are priced for growth, rather than an area which is not priced for growth.

So, you know, my investing philosophy for many years has always been that cheap valuations or attractive valuations are a function of the market being unable to live beyond current data. But that is where the opportunity is. The opportunity is not where the market perceives the future to be bright and blue skies, and then it's already priced to perfection in those areas. So, it's a question of how you think about investing. There are issues in banking, but, you know, I'm happy that there are, because it's giving me that opportunity to get invested in an area where I have valuation comfort. 

Vetri Subramaniam: Fair point. I don't think any of us can call inflection points to a T. Again, the school bell analogy is very apt over there. But in fact, interestingly, we just launched two strategies, both in the Index fund space, which I would say are both out of favour at the current point of time.

One is the private bank index, where we think the fundamentals of the banks are very healthy, and at the same time, valuations are attractive and below long-term average. The second strategy that we launched is again an index fund, but this is a factor-based strategy, which is actually the Nifty 200 Quality 30 strategy, which means that it selects companies which essentially are identified with quality, which means these are higher ROE companies. These are companies with low EPS variability, and these are companies with low debt to equity.

Now, if you think about quality as a factor, if I go back five years, it was all about how quality was the only way to invest, and value was an outright disaster. 2019 to 2024 has been phenomenal outperformance by value, and particularly in the last two years, value has crushed quality. But again, for that very same reason, we do think that this is an attractive point to start increasing the allocation towards quality, and that's why we've launched the Nifty 200 Quality 30 strategy.

So is there an element of timing? Perhaps there is, but I'm not going to say this is the moment, but I think the window over the next six to 12 months is great, both for the private banking strategy as well as for the quality and you know, these are two Index funds people might find interesting to just diversify their risk in their portfolio, particularly given the composition of what has done very well over the past two to five years. 

Vetri Subramaniam: Sure, I'd say it's a little bit of a relative argument and maybe it echoes back to what I said earlier about Quality Index, because a lot of those quality companies tend to come from things like consumer and staples businesses, but specifically talking about consumer staples and discretionary, look, we know that post pandemic, you know, companies which were selling more to high-end consumers have done far better, but, you know, staples has been a little bit of a pain point, also discretionary when it came out of the pandemic, extremely strong has been very sluggish over the last two years.

So, to my mind, in consumer, the opportunity is more relative. It is more defensive. I think in staples, you will see a little bit of an uptick, because beyond the point, how much can people actually cut back on staples expenditure? You can't. So, I do think the outlook for staples is slightly better, and particularly if we see a good, you know, sort of agricultural upturn.

The portals for that are still not very great, because global agriculture prices are actually quite weak at this point of time. But if we do see a bit of an uptick over there, then I think staples can give you a little bit of a surprise. But I would not expect it to be very dramatic because these are middling in terms of their growth prospects, and they will not change dramatically because it is staples by definition.

Vetri Subramaniam: There are pockets which have done well, but again, I would say, you know, maybe there's a little bit of rotation just in terms of what the consumer is spending on and some of the trends you're talking about relate to that. But overall, I would say consumption growth has been slightly disappointing. You know, we're just starting to look at some of the auto numbers as they come through for the month gone by, and they're not too exciting, and they're suggesting that at the margin.

You know, trends in terms of consumer discretionary are not particularly great. You may have one or two companies doing exceptionally well, but at a sector level, I would not call this out as a sector which is, you know, particularly, you know, attractive in terms of a change in underlying trend growth rates. You know, it's funny that you mentioned travel, and you know, discretionary spend, at least in the US, if you look at some of the data that's come out in company calls over the last quarter, they're actually calling out a significant slowdown in both air travel as well as travel spending in general.

So, I wonder if you'll start to see echoes of that in India as well. Remember, the big element for travel has actually been pricing, but we've seen this in the past as well. If you use the pricing lever very aggressively, at some point, the volumes itself then start to sort of come under pressure. So, I do start to worry that this might be something you'll see in the travel sector as well in the near future. 

Vetri Subramaniam: Sure. Well, first of all, I think if you are thinking multiyear and you've got valuations which are at a fairly aggressive level, I don't think we can think of this in terms of the tenure of governments. I mean, I think you're investing landscape, and your investing horizon has to be much longer than that to be able to take calls on businesses, which are, you know, already building a significant growth runway.

Again, I've just been around for way too long. You know, we've seen how IT companies got priced to the roof in 1999–2000 and this is a great, you know, lesson and a humbling experiment for all of us, because has the sector become significantly larger than what it was in 1999-2000?

Remember, IT services today are larger than India's, you know, oil imports. That's how large that sector has become. But if you bought some of these stocks at the inflated valuations that they existed at, at that point in 1999-2000 you've had, you know, 20 years of regret in terms of the kind of forward returns that you earned out of them.

You know, I could go back to 2005-2008 the madness that went on in infrastructure and you know, India will always be short of infrastructure, so on and so forth. Once again, you find that you know the promise and the delivery in terms of returns very, very different. So I've learned the hard way. There can be individual companies that will completely surprise you in terms of the growth prospects over 10 years, 20 years and 30 years. But when the sector as a whole is incapable of distinguishing between individual companies, their managements, their strategies and their ability to navigate challenges, to me, that is a warning sign.

Therefore, when I see sectors which in their collective entirety, start to get richly valued, the alarm guns actually go off for me, very much, the opposite of what I spoke about when I was talking about the private banks earlier. When you see collectively, all companies being painted with the same brush, either positively or negatively, my instinctive reaction is to start thinking in the opposite direction. 

Vetri Subramaniam: Well, let's get one thing out of the way, management commentary is entirely pro cyclical. So, if you are going to rely on management commentary, I think you know, leave it to your good senses. But 30 years, my experience is management commentary is entirely pro cyclical. So please don't base, you know, 10 years and 20 years of outcome based on management commentary.

What you must base your thoughts on is the management's ability to run a company on very sound fundamentals, cash-flow generation, return on capital, and the strength of their capital allocation framework. That is what navigates companies over 20 to 30 years, not their commentary about what will happen in 20 to 30 years. I mean, who has seen 20 to 30 years in the future is, you know, always full of surprises.

Vetri Subramaniam: Nothing that I can call out top down, I think it's more sort of stock specific at this point of time. I must admit, as you go down the market capitalisation curve, actually stock picking becomes harder, because that is where, in general, there has been a lot more valuation updrift and, you know, I would just say, we can, you know, choose terms like bullish, bearish, etc.

They don't mean anything. I think as investors, our priority needs to be risk management at all points of time, when risk is being underpriced, you become more cautious. When risk is being overpriced and valuations are cheap, is when you start to get more bolder. I think this is one of those times where risk is getting underpriced. Investors just need to incorporate that into their framework.

Doesn't matter whether you're institutional or whether you're an individual retail investor. Be more aware of risk, is really the message that I would want to give.