Rakesh Jhunjhunwala - bull market thoughts

It is difficult to believe that the largest holder of the US treasury bonds is China. To me, I think it is geo-politically very sensitive issue and if I were to be the President of America I would redeem them the next day. They have forgotten where Hindi-Chini bhai-bhai led (Indians) to.

Having said that, the US economy was the engine of economic growth worldwide. It was an unsustainable methodology of growth, where you borrow, borrow,borrow and consume, consume, consume. Also we had a 25-year bull market in America and all bull markets, regardless of regulators, always produce excesses. Excesses are not products of loose regulations but more products of bull markets because then markets make people lose their sense and they become absolutely greedy.

I personally believe that the US housing market is not going to bottom in the next 36 months; because you built 21 million houses in 2 years as against 16 million every year. So you build one million extra and at least out of those 16 million normal ones, 40% of the houses in the last two years have been sold to subprime and allied alternatives.

In Miami, you have a building boom amongst the housing bust. So I think the world is underestimating the consequences of this subprime or the meltdown of the US housing. There was a vicious cycle in America where you gave money to people on credit to people who could not afford USD 50,000 - you gave them half million dollars; not based on their ability to pay, but on the value of their capital assets. They primarily drove the buying of houses in the last 24 months.

On interest rates:

It is not the question of interest rates. No one in his right sense now is going to give loans to sub-prime mortgages again. The resets are just starting.

So I foresee a few things.

One, the problem in the housing market problem is going to get worse because there will be a lot of foreclosures. Two, there is lot of housing under construction which cannot be stopped immediately. And third, people say there is full employment in America. But housing is 70% of America’s GDP and that itself would lead to a slowdown in America.

This slowdown in the housing industry is going to lead to a slowdown in the US economy. This again, would mean lower wages and lower employment, which could result in greater housing loan repayments defaults.

I read an economist saying that Europe has had faster increases in housing prices than America. There is a very large subprime market even in Britain. So I think this will continue to transfer itself even to Europe.

I believe there have been great excesses in the US bull market. That bull market, in my opinion, is coming to an end and the real excesses will be exposed only after the bull market is over.

Though at the moment we are all very happy and feeling that this is something like long-term capital management or the Russian debt crisis, where the Fed reduces interest rates and all problems go away. I do not believe that because credit is not only available on cost; it is also a question of risk appetite to borrow and risk appetite to lend.

So I think that credit is no longer going to be available in America or if it is, it is going to be available in a measured manner. There is going to be a slowdown in America.

There are various opinions that if US interest rates comes down money will flow into emerging markets. Let us put the impact in two parts – one, how they will affect economic activity and how they will affect asset prices.

On India:

As far as India is concerned, I personally foresee a big slowdown for the software industry. I do not think that if America slows down; more work will come to us. I think if America slows down, more work could come 36 months later. I think 25%-30% IT budgets are discretionary and there will be big cuts in IT budgets.

As far as other Indian exports are concerned, I do not think they are going to be affected very substantially. As far as commodity prices go, I think they will come down. Interest rates also will be down, which is good for India.

US is a very dynamic economy; it has great self-correcting measures. This recession in America depends on factors like whether it is going to be orderly, or create a lot of disequilibrium etc. If it is an orderly one, I think Indian markets will be not be affected to a very large extent. But if it is a huge disequilibrium, then things are going to be quite unpredictable.