US alone not enough, without China and India, global growth will fall: Aswath Damodaran

In an interview with Tanvir Gill of ET Now, Aswath Damodaran, Professor-Finance NYU, says Fed is not going to be the big driver of what happens in the US economy for the next year.


What is the takeaway from 2016?

2016 brought us two things. One is it brought us the realisation that experts do not know what they are talking about. So anybody listening to this expecting me to say something profound should give up on it right now because I think if nothing else 2016 taught us that that when people forecast the future, they are asking for trouble. I think 2017 is going to bring more of the same because I think this is part of a long-term shift in markets and economies that people have not anticipated.

The top discussion right now is around the outlook for the US economy. The rally in US equities and the dollar index pretty much reflect that. The world is extremely bullish as far as the US economic outlook goes for the coming year. But some see it as a hope rally. Do you think reality will catch up?

I think the most interesting that has happened in the last six weeks is what has happened to the T bond rates, interest rates. For seven years, we have been told that the Fed sets rates and that until the Fed raises rates, rates are not going to go up. What we have discovered in the last six weeks is actually how little power the Fed has over rates. Rates are going to go up if people’s expectations change. For better or worse, people’s expectations have changed about inflation and expectations and about real growth. There are chances that these expectations will come to fruition, that you are going to see more growth and more inflation in the US and that is I think part of what the bond market is reflecting. I am going to hold off on passing judgement on whether it is a hope rally or whether it is based on reality because there are real changes underlying what the new administration is planning.

But in all the talk about Trumponomics, the focus will be on fiscal spending pushing investment-led growth in the economy. Is that what markets are excited about?

I tend to be a little cynical about how much power governments really have to make the economy stronger. I think you can create a short-term push. But, in the long term, the fundamentals have to shift. For that to happen, you are going to start to see changes in the global economy. It is not like 30 years ago where the US could be an island on to itself. The US is very dependent on global growth and in particular on growth in Asia, China and India, because I think without China and India providing that fillip to growth, global growth will fall. The US alone cannot carry global growth for very long.

But do you believe that 2%, potential 2.5% growth makes the US economy look strong? In the last bull cycle, growth peaked at 3-3.5%?

To be quite honest, 2% to 2.5% is the long term growth and I do not see growth in the US economy going to 6% or 7%. It is not that kind of economy. 3.5% is really a good year and 1% is a bad year and 2.5% is the middle. That is why when I said earlier that Asia has got to provide that extra growth, the US economy is not capable of providing 6%, 7%, 8% growth. It is a mature economy. So 2.5% might become 3% or 3.25% but I do not see it jumping going forward even if good things happen.

So what are the markets the Dow at 20,000 is signalling because the only earnings we have seen so far have been sponsored by buybacks? When and how will the structural push to earnings come to drive markets higher?

Exactly. Companies finally are starting to put back. For six or seven years, US companies have held back on re-investing back into their businesses. As you pointed out, buybacks have provided a significant portion of earnings growth to US companies and that is not because investors are greedy and US companies are short term, it is because they look around and they do not see very many opportunities to make the kinds of returns on their capital they used to be able to make. So companies have to rethink this notion of whether investments can make them money and earned returns are sufficient to cover their cost of capital and that is what we are going to have wait and see whether the new year is going to bring a change in what companies do.

But the top dollar question right now is how many hikes will the Fed do next year? What is your own expectation?

I have stopped caring about the Fed. I think this has been one of the most unhealthy obsessions of the last decade is thinking that central banks set rates and looking towards the Fed every six months. I think the Fed has less control over rates. I have described the Fed as the Wizard of Oz in the sense that its power comes into the perception that it has power. I do not think the Fed has that much power over rates. At the margin, they can move rates a little bit this way, little bit that. To me the Fed is like one of those leaders that follows the crowd rather that leads the crowd. So I think what they are going to do for the next year is chase rates up but I think bond rates are going to continue to go up and I think the Fed is just going to chase those rates up. So I do not think that the Fed is going to be the big driver of what happens in the US economy for the next year.

So then what do you make of the dollar rally is it overbought what happens next to the dollar?

I think anytime you see a rise this quickly you are going to see some giveback so I think that you are going to see an adjustment back to a level which might be more sustainable but by itself I do not think the dollar is overbought and I am not going to go out there and do some currency trade hoping to make money on the dollar and dropping in the next year because that historically playing games with currency has never worked for me.

The other argument with higher rates and earnings growth is if the cost of capital starts to increase it will eat into earnings expansion as interest cost continue to rise and impact companies investments what is your own thought on that?

Actually I will be quite honest. As I said, the cost of capital going up could be the best thing that happens to US companies if they are going up for the right reasons. If the higher demand rate is an indication of higher real growth and higher inflation in the future you are going to see returns that you are making on projects. The growth in earnings in companies actually go up to reflect that so to me the 1% increase in the cost of capital is a small enough price to pay to return to a healthier economy where investments start to look good again and they have been for almost a decade.

How can we not discuss the India outlook now and let us talk about India at length what is your own view about India versus other emerging markets into the coming year?

As I said I am bullish about India simply because it is a competition so weak which is Russia is obviously a commodity country and now there is very little going on. Brazil is in political trouble. China has its own internal issues with its economy so I think from that perspective India is healthy. I think the question is how in 2017 how this will play out. I think that the pieces are in place for India to do well but that does not mean Indian companies are great investments.

India as an economy could do well and this I think is something worth remembering. 30 years ago how an economy did reflected, how well the market did and a country reflected, how well the economy was doing. I think there is an increasing disconnect now between how an economy does and how a market in that economy does you see it in the US, you see it in Europe, you see much of the emerging markets. So I think India as an economy would be healthy that does not necessarily translate into Indian markets being healthy and I think that disconnect might be what throws people off because for so long we have been told if we can predict what the economy will do that is going to tell you which markets are going to go up and which markets are going to go down. But in the global economy that we are in I do not think that is necessarily going to hold anymore.

Well this year for FY17 we are expected to see flat earnings, zero growth which has resulted in a largely flattish to weak performance for the markets, especially with the headline indices. Do you expect the same into 2017 as well, flat earnings, flat market?

That would be my guess. I mean, as I said I am not a great market timer. If you ask me to pick one particular scenario that one is the most likely one but I think that this is one of those cases where you can be hopelessly wrong in hindsight because something big can happen. And in fact it is not even something big cannot happen. Something big will happen during the year because every year for the last nine years we have had a crisis of the year, who knows what the crisis of this year will be and how it will play out? So investors have to be ready for that big event and how it is going to play out because it could be good for India, it could be bad for India, it depends on how that crisis plays out.

You have written extensively on family owned businesses in India and their management structures, also have said that a settlement is important on Tata-Mistry boardroom battle, how are you seeing this situation unfold?

I just think the whole affair has been a fiasco, I think that neither side has covered themselves with glory, I mean I am not pulling for either side in this battle but I think that that egos are involved and that is natural when you have fights between personalities but I think what I get out of this fiascos is not so much reflection on the Tata Group which I think, you know, you can look at this and say this is awful for the Tata Group but this to me is why family group companies have to be much more careful about separating family from companies because I think that there is always going to be this instinct on the part of the family to step in and try to bring the family group to the family.

And I think that is partly what you see happening here, it is not so much that Ratan Tata might have had specific issues with Cyrus Mistry but the feeling that Cyrus Mistry was taking the Tata Group away from what he thought the group should be doing. So I think that neither side has covered them with glory in this process and I think it has been awful for stockholders in Tata companies because they are the ones ultimately bearing the brunt of this battle, I mean both sides have lost money but I think shareholders are kind of the bystanders who are being affected the most by this fight.

But you said that you would not buy a Tata Group stock, you have gone on record with that, why is that? Is that just a case of the Tata Group of companies or you have just been put off by this episode for investing in any family owned businesses in India?

Well I have also admitted that any family group company I am reluctant to buy into because the problem I have with family group companies is you seldom get a clean play on a company. You buy the company and you get this portfolio by the companies with it whether you like it or not. In fact of all the Tata companies the cleanest play is actually TCS because the company with the least in terms of cross holdings. So when I invest in TCS, I am investing predominantly in TCS. I think that I would have the same view about any family group companies and this is not really about the Tata Group that I have an issue. It is with family group companies in general and the kind of conflicts of interest that I think play out under the surface that I as a shareholder absolutely no control over and that scares me.