Stern Biz School's Prof Aswath Damodaran warns of coming storm in markets

The Indian markets are on a bull run. Indian equity benchmarks ended a volatile session on Wednesday flat but over the past week, the Nifty has crossed the 16,000 mark comfortably and in the past month rallied 3.7 percent and 7.4 percent in the past six.

What are the risk factors at play? In a freewheeling chat with CNBC-TV18 valuation expert and Professor of Finance at Stern School of Business at New York University, Aswath Damodaran explained this and warned of a coming storm.

D: When we talk about P/E, we act as if it is a fact. But it is always an estimate, right? Because what goes in the denominator is a judgement call. If I take 2020 earnings, I get a very different P/E ratio than 2019. Normally, with markets, you don't care that much. But at this point in time, you need to care why? Because 2020 was just an unusual year.

So we can make an argument based on P/E ratios, but it has to be based on something beyond the last 12 months of earnings because we are in unusual times. And I would say this about every market in the world, the earnings in the last 12 months are not a great metric to scale upon, because it reflects an economy that was shut down at least for a portion of those 12 months. However, the multiple of earnings that Indian stocks are trading at is higher than it has been historically. I accept that as a fact.

D: What are interest rates in India like now, relative to 10 years ago, 20 years ago, 30 years ago? Investing is always about alternatives. And if you tell me that stocks are overvalued, I have a very simple question. You take your money out of stocks, where are you going to put it? Do you want to put it in bonds? See what you get in the area. Indians are very fond of fixed deposits and the rates you can earn on fixed deposits, go check out what you make on fixed deposits now as opposed to 10 years ago, 20 years ago.

You are going to put it in real estate, good luck with that. Indian real estate is just as pricey as stocks. So this is an argument that is not specific to India. I hear it all the time all over the world. Stocks look expensive but relative to what? Relative to history? I can't go back and trade history, I can't go back and buy stocks at 2010 earnings or prices. Unless you show me that there are alternatives that are attractive, I am stuck with what I have, not what I wish I had.

Central banks are the equivalent of the Wizard of Oz. Remember, the Wizard of Oz had no powers the power came from the perception that he had power. Central banks have to remember that their power comes from the perception that their power and central bankers.  The biggest sin for central bankers, is hubris, believing somehow they can decide what the economy will do, decide what inflation is going to be, decide what markets will do because then we are in a very dangerous place.

D: I think central bankers have let power go to their heads around the world. I have described them as insane for a simple reason. The definition of insanity is you keep doing the same thing over and over again, expecting a different outcome. Central banks around the world are certifiably insane. So don't pass the buck from them, they are just as responsible as investors are for this collective damage.

The worship of the Fed I think is greater than the worship of any other central bank. If you are a Fed Chair, I don't even know how you don't let this go to your head. You get treated like a God. I tell people about the example of going for a visit to the Fed. They have a Fed tour where people can go in and see the Fed. And I almost made myself persona non grata when I went in when I asked the person would you take me to the interest rate room – because that is the vision you get listening to CNBC, the Fed chair must have this room where he changes rate. Now, the only rate the Fed sets is an overnight bank borrowing rate. That's it. Everything else comes from perception. So that is a reality around the world now that central banks are driving investor decisions and that that is not healthy.

D: The best-case scenario is that the world realizes that there is a disconnect between what bond markets are saying and what stock markets are saying. Let me explain.

Stock markets are suggesting a very strong return to growth and a very strong return on the consumer. That is what stock markets say. Bond markets are giving the opposite message - low growth, low inflation. There is a disconnect here.

One of these markets has to adjust. And your best case scenario is that that adjustment happens gradually. Your worst-case scenario is that one day everybody wakes them. So what the heck have we done? I mean, why T bond rates are 1.5 percent when inflation is 3 percent and growth is 2 percent. That's when you get those massive corrections. So I think that the range of possible outcomes ranges here from a catastrophic drop to a kind of stagnant market for three or four years but things are just bad.

Let's hope for the latter over the former because I think there is definitely a disconnected market.

D: If inflation were 4 percent, would you buy a 10-year bond or a 30-year bond that uses 1.5 percent? Why would I do that? I would rather just keep the cash under my bed or buy gold or buy something else. This is insane. So it is amazing that people create this collective stupidity on the part of everybody else and use it to explain their own stupidity, which is you wanted to explain to me that rates are low.

D: If you invest in ESG (environmental, social and corporate governance) and you are driving an SUV and you are flying all over the place, you live in a big house that is air-conditioned, stop talking to me about ESG. The hypocrisy here is mindboggling. Do you know what we are doing? We as consumers, as investors want somebody else to do the dirty work for us without creating an inconvenience for us. Yes, he offers that, right. It is a look, we will give the label and it is like those labels you get on food organic, homegrown, made domestically, nice labels, but they mean absolutely nothing.

The problem with ESG is too many people are making too much money off the concept. Consultants, bankers, portfolio managers, are selling it like crazy. It is a cake for everybody calories for nobody. That is amazing if we can pull it off. Life is full of trade-offs. If we want the world to be a better place, we have to accept that that will mean sacrifices on our part not higher returns and you can do whatever you want. So I think ESG is a great concept behind which we all hide, but the reality is if we truly want to make the world a better place, it starts at home. You can't pass this off to compensate, you do the dirty work and I will just do whatever I used to do.

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