Valuation Concerns Are Hanging Over Global Markets
Analysts are repeating their concerns about high valuations pumped up by the AI frenzy
On Episode 719 of The Core Report, financial journalist Govindraj Ethiraj talks you through the big business stories of the day. We also feature an excerpt from The Core’s How India’s Economy Works, hosted by journalist and author Puja Mehra and featuring Dr. Nisha Taneja, Professor at the Indian Council for Research on International Economic Relations (ICRIER).
SHOW NOTES
(00:00) The Take
(06:36) Valuation concerns are hanging over global markets
(08:37) There are more private equity firms than McDonald’s restaurants in North America
(10:58) What Indian exporters need to become more competitive, learnings from China
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NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regarding any feedback, you can drop us a message on [email protected].
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Good morning, it's Thursday, the 6th of November, and this is Govindraj Ethiraj broadcasting and streaming weekdays from Mumbai, India's financial capital, but in transit right now.
The Take
The state of New Jersey in the United States, which houses a fair number of Indian immigrants, legal and some sub-legal, elected a Democrat governor yesterday.
At the same time, Indian origin Zoran Mamdani won his election as New York City mayor, but today's focus is on neighbouring New Jersey. 53-year-old Mickey Sherrill is also a helicopter pilot who graduated from the United States Naval Academy in 1994. She flew missions as a seeking helicopter pilot in Europe and Middle East.
After serving in the Navy for around a decade, the mother of four children studied law at Georgetown University, subsequently joined the US Attorney's Office in New Jersey, and then moved into politics. So what could someone from such a background promise to work on on being elected? Admittedly, it's a rhetorical question since we are far away, but here are some of our promises. Freeze the state's high electricity costs by declaring a state of emergency on her first day in office in January.
Get cell phones out of classrooms and hire more mental health counsellors for schools. Using data gathered through a new social media addiction observatory, she said her administration will take on digital platforms that use algorithms to lure in children and teenagers. So the question is, could these promises be relevant to a regional or national politician in India today? Well, the answer could be no, because our issues are different and our politicians could rightly be focused on livelihoods, jobs, and the other big trend of late cash transfers to women voters.
But could these be additional issues? Okay, let's skip electricity. Though it's a burning issue in many parts of the United States right now, recent prices are rising sharply also due to the proliferation of energy-hungry data centres. Retail power prices in New Jersey were up 19% in August from a year ago, according to a Wall Street Journal.
But admittedly, high power costs do not surface so much as an election issue in India, also because of subsidy responses. Let's examine the other two issues, getting phones out of classrooms and the fight against algorithms. Now, the fight against algorithms is a larger one and may appear more distant, so let's put that aside too.
In the last week, several prominent voices, including Michael Bloomberg, former mayor of New York, as it happens, and owner of Bloomberg News, have made a strong case against children using artificial intelligence as a tool or aid in their education. Bloomberg starts off by saying elected officials are finally waking up to the educational harms of mobile phones in public schools. As more districts ban them, the reports are highly encouraging, though hardly surprising, he says, given the positive results they saw in New York City when they removed them from schools nearly 20 years ago.
Yet he laments that even as phone bans spread, elected officials and Silicon Valley executives are trying to open classrooms to a technology that could set students back even further than mobile phones have, that's artificial intelligence. A New York Times article by Anastasia Berg, who teaches philosophy at the University of California, Irvin, says, Higher education aims to create cognitively mature adults, which in turn requires us to ensure students learn to read, think, and write all on their own. But, she says, our students are about to turn subcognitive.
At stake are not just specialised academic skills or refined habits of mind, but also the most basic form of cognitive fluency. Her argument, to leave our students to their own devices, which is to say to the devices of AI companies, is to deprive them of indispensable opportunities to develop their linguistic mastery, and with it, their most elementary powers of thought. This means they will lack the means to understand the world they live in or navigate it effectively.
Now, arguing against artificial intelligence is not the same as arguing against cell phones in class, but there is obviously a link between cell phone usage or devices to extend Dr. Berg's or Michael Bloomberg's analogy, since they are the primary gateway. In many households in India, the smartphone is the only computer in the house, as was evident during COVID, when many children attended classes via their parents' cell phones. Now, this is a much longer discussion, but there is little doubt that overuse of cell phones, whether in classrooms or outside, is causing damage to a host of neural and cognitive abilities.
There is also little doubt that you can't educate your way out of this problem if you are to think of today's youth as the harbinger of tomorrow's bright future. China offers some insights into tackling this challenge worth looking at. While replicating China may not be the best recourse, given that this does come up with some caveats, there are threads worth picking up.
A report in the Information Technology and Information Foundation, Washington, D.C.-based nonprofit, quotes the Cyberspace Administration of China Minor Mode Initiative, a series of requirements for mobile device settings that give parents more control over their child's online experience. The report says that while China's overall approach to digital policy is known for being authoritarian, sensorial, and privacy-invasive, an approach democratic nations should avoid, this customisable device-level solution to children's online safety can serve as an inspiration. The plan, for example, includes daily usage limits, blocking non-essential applications between 10 p.m. and 6 a.m., and reminders to take a break from the device every 30 minutes, amongst other things.
Parents can customise these settings, and all settings require parental verification to change or remove. It's very clear, even in India, that parents and educational institutions have to work today together to ensure that there is moderation in use and exposure to social media, and we are obviously talking beyond classrooms. India has over 750 million smartphones, and for many youth, the smartphone is as much a means to connectivity, commerce, and, of course, content.
Smartphones are also the gateway to slick apps to buy now and pay later, for daily expenditure or trade derivatives in the stock market, on the run, and until recently, gambled on cricket scores. Now, you can't stop a 25-year-old from gambling their income savings, and maybe their parents as well, by swiping away at their smartphones, but you can surely control their exposure in their teens, where they are quite likely more vulnerable. Parents in schools across India are already embarking on banning cellphones in classrooms.
We may or may not follow the Chinese model, but there is a midway between full and self-regulation that we must look at. More importantly, while New Jersey may be far away from India, the issues that matter to us as a generation are coming closer.
And that brings us to the top stories and themes of the day…
Valuation concerns are hanging over global markets.
There are more private equity firms than McDonald's restaurants in North America.
What Indian exporters need to become more competitive? Learnings from China.
Valuations Again
Concerns about AI valuations are once again shaking up the markets. On Monday, chiefs of two big investment banks, Morgan Stanley and Goldman Sachs, predicted the markets could lose over 10% in the coming year.
Other analysts are repeating their concerns about high valuations pumped up by the AI frenzy. Michael Burry's Xeon Asset Management disclosed bearish wages on NVIDIA and Palantir technologies just days after the hedge fund manager posted a warning to investors about market exuberance, according to Bloomberg. Burry is best known for his 2008 bet against the US housing market.
He's now bought put options that profit when prices fall on NVIDIA and Palantir, according to regulatory filings released on Monday. Shares in Palantir, which raised its annual revenue outlook on Monday, fell as much as 8% in pre-market trading, and NVIDIA shares were also lower, falling about 2.6%. As we pointed out on the Core Report earlier, the promise of the future might be singularity, but what we are seeing instead is circularity. Waves of circular deals involving OpenAI, NVIDIA, and other AI-focused companies, and all of this is obviously sparking concerns.
On Wednesday, Indian markets were closed, but Asia took a knock. Japan's Nikkei 225 fell, and Japan's SoftBank Group fell more than 14% amidst a broader drop in Asian AI-linked companies, according to CNBC. South Korea's Kospi fell as well.
Now, India seems to be sailing somewhat calmly in this AI storm. It's not a major one, but it is a storm nevertheless, because there is or never was any AI attraction here, and there is a good chance that India could attract more contrarian capital, looking at long-term stories, because that is what Indian markets have to offer. The problem, of course, continues to be valuation.
Elsewhere, oil prices were higher on Wednesday with Brent crude futures at about $64.89, so just under $65. Oil has probably found support from US data that was not as bad as feared, thanks to large product inventory declines, suggesting demand was holding up, according to analysts who spoke to Reuters.
A New Bubble
There are many ways of testing a proposition of a market bubble. Most of it, of course, happens in perfect hindsight. At peaks, people often ask, is the financial economy bigger than the real economy, a question that worries policymakers in many parts of the world, including in India, and has at institutions like the Reserve Bank of India.
Now, it must thus come as a bit of a surprise to hear that there are more private equity funds in North America than there are McDonald's franchises. Pointing this out at the Global Financial Leaders Investment Summit in Hong Kong, KKR and company's co-CEO, Zhou Bei, on Tuesday said that US has about 14,000 McDonald's fast food outlets and about 19,000 private equity funds. Now, CNBC reported that at the Global Financial Leaders Investment Summit in Hong Kong, KKR and co-CEO, Zhou Bei, on Tuesday said that the US has about 14,000 McDonald's fast food outlets, but 19,000 private equity funds.
Now, one could say that the numbers in isolation have no bearing on each other, which is also true, but it does matter when a giant like KKR talks about it. The widening gap followed a private equity spending spree in 2021 as firms rushed to deploy unspent funds with activity also boosted by ultra low interest rates. As PE firms typically hold portfolio companies for more than five years before exiting, many of those investments are now harder to sell or revalue in a higher rate environment, according to CNBC.
Elsewhere, Howard Marks, co-founder and co-chairman of Oak Tree Capital Management, told CNBC that the era of ultra low rates is over. He estimates that the current easing cycle will see US interest rates fall to just 3% to 3.5%, which would be neither stimulative nor restrictive. The Federal Reserve lowered its interest rates to a range of 3.75% to 4% last week.
The CNBC report says private equity groups have struggled in recent years to raise new funds with a significant backlog of unsold assets and a slowdown in cash returns to investors. Only about 5,000 of the private equity firms that exist today had successfully raised funds in the last seven years, according to analysts who spoke to Financial Times quoted once again in the CNBC. They also said that 80% of these companies were likely to turn into zombie firms within the next decade, managing only the existing investments because they cannot raise fresh capital.
Chinese Imports
China is India's second largest trading partner with a total trade reaching about $128 billion as of last year. This jump in India's trade has been driven by rising imports from China, which peaked at $113 billion in the same year, increasing 88% in the last decade.
Exports to China from India only stood at about $14 billion, growing only about 19% in the same period. So the trade deficit with China, that's India's trade deficit with China, is about $99 billion, or close to $100 billion, which accounts for 35% of India's total trade deficit and also reflects the largest trade deficit India holds with any single country. So much so that India is importing goods from China which are actually cheaper elsewhere.
So what is the reason for this? Dr. Nisha Taneja, professor at the Indian Council for Research on International Economic Relations has argued in a paper co-authored by her titled Calibrating India's Economic Engagement Strategy with China Amidst the Changing Geopolitical Landscape that China firms get far more support from the government, but there's also a lot of specifics to this, as we will find out.
INTERVIEW TRANSCRIPT
Dr. Nisha Taneja: So there is a need to look at other markets for imports. And if you look at the top 50 imported items from China, almost half of them are uncompetitive. By uncompetitive, I mean that the prices at which we import are actually higher than they are if we imported it from other countries, other suppliers.
So then why is it that our importers are still drawn towards Chinese imports, even though the prices are higher? And then I think what really lies behind this trend is the way the Chinese government supports its exporters. And that is what is very striking.
Their export-import bank called SinoShare offers credit insurance. And the magnitude of that insurance is huge. For instance, they insured goods worth, merchandise worth $700 billion in 2022.
And that covered 240,000 exporters. So imagine these exporters, and they're completely covered for risk against non-payment. So they can actually reach out to small importers, large importers, any kind of importer anywhere in because they have the backing of SinoShare.
This magnitude of $700 billion is very telling because if you compare it, say, with the kind of export credit insurance that the US offers, it's only $2.6 billion. So that's the kind of difference that there is. And that's why it's not surprising that not just India, it's the entire world that is so dependent on China for its imports.
So even though we are finding now that other countries are trying to bring in packages, resilience packages to deal with over-dependence on Chinese imports, the magnitude is way smaller. We've heard about Japan, which is about a billion dollars. Australia is also offering this kind of assistance to its exporters, but it can't really make up for what China is doing.
India has also offered to its exporters rupees 20,000 crore under the export promotion mission, but we don't really know how this will be implemented, how it will pan out, how would it improve the competitiveness of Indian exporters. So all this is still a big question mark. But then one way of reducing dependence on imports is by attracting FDI.
And especially because we are seeing that there is a little bit of investment in manufacturing, especially in the labour intensive items, maybe we should attract more FDI. First of all, what we need to do is basically revisit Press Note 3 and recalibrate it to allow for FDI through the automatic route. Because we do know that there was a time before 2020 when Chinese imports were actually coming through the automatic route.
So we should do that. But at the same time, we could put in bar drills for scrutinising investments.
Puja Mehra: Ma'am, many of my listeners may not know what Press Note 3 is because not everybody is as versed in economics. So if you could help us.
Dr. Nisha Taneja: Press Note 3 is basically under the FDI policy, it's called Press Note 3, but it's a notification, which the DPIIT brought out, basically saying that neighbouring countries that are investing into India will have to go through the government route and not through the automatic route. And with neighbouring countries that share a land border. So that really covers all countries like Nepal, Bangladesh, Pakistan, and China.
But we all know that the investments that are coming from the other countries other than China is just a trickle. And so it was really meant for China. So that is what needs to be revisited, Press Note 3.
Puja Mehra: And also the other side of the trade equation is India's exports. And you've said that they've been stagnant. They're not growing.
What are the reasons for this? And where is the potential for India to increase our exports? I know your study has said that we are right now not doing as much of high-value-add exports as we can.
So if you could also explain some of that.
Dr. Nisha Taneja: I think before I get into the export side, one very striking observation is that post-2020, we've seen a rise in imports and stagnation in exports. But let's look at the trading community in India. We have exporters and we have importers.
Why is it that the importers are able to import, but exporters are not able to export? So there is something to do with signalling. So the importer is feeling safe.
Even though the political relations are not good, we can still import. But why is it that the exporter is not confident about exporting when the political relations are not good? And so that is where I feel that maybe the government needs to play a proactive role in getting the chambers together or in signalling that exporting is fine or saying that if our political relations are poor, our trade dependence is very high.
And therefore, this is the package that we're offering or this is the insurance that we're offering in case your payments don't come through. So we could develop a mechanism because how do we gain the confidence of the exporter to be able to export and kind of cushion them against the political uncertainty?
Puja Mehra: The importer has been cushioned against that political uncertainty by the Chinese side because they are cushioning their exports.
Dr. Nisha Taneja: Yes, yes, exactly, exactly. And therefore, we need to play the same role. If we have limited resources, then let's at least do it for countries that are being impacted adversely and especially where we think that the trade balance is adverse.
Even though theoretically we're all students of economics, we know theoretically a bilateral imbalance shouldn't matter. But today, we're thinking differently. So we're talking about a more balanced economic relationship so that no country has leverage over the other.
And that's the context in which we are again talking about bilateral deficits and bilateral surpluses. And therefore, we're looking about a more balanced economic relationship, which is why we're also talking about FDI. And we've always talked about, oh, what do we do about our imports, the over-dependence on imports, but never have we talked about what do we do about expanding our exports to China.
So that's a huge gap. And when the political relations are adverse, you will not see any study that is being done on trade with China. We've been studying India-US tariffs, thread wearing it, what does each commodity item mean, what does each HS code mean for India.
And all newspapers are full of it. But have we seen any study on China? We haven't.
But it is equally important. Let's not forget that China is the second largest importer in the world, only next to the US. So it's importing $2.6 trillion worth of merchandise. So can we ignore it? We can't. It's a huge market sitting there.
We're talking about diversifying our exports. We're talking about Latin America. We're talking about Africa.
We're talking about ASEAN. We're even talking about CIS. We never hear about China.
