Pramod Gubbi, managing director and head, equities, Ambit Institutional Equities, says there are a few signs of economic recovery and earnings growth this financial year could be better than in FY17. He also says the aggressive pricing in the bond markets could turn into a bubble scenario and impact domestic flows in equities as well. In a conversation with Sheetal Agarwal, he talks about these and other market trends.
Is there a bubble in the making in this liquidity-driven rally?
I think ‘bubble’ is an extreme definition of the situation. We are not there yet. We have seen liquidity driving markets in the past. There is a recovery in the economy and corporate profitability, but nowhere close to the extent that the market is suggesting.
At the margin there could be excess of aggressive pricing in the bond markets, given the aggressive pricing that we saw recently. Companies have managed to raise money at 6-6.5 per cent on three-month and six-month paper. Our worry is that it could turn into a bubble scenario.
There are stocks trading at 40-50 times the earnings but these are not driven by hopes. These are solid companies with good managements and would not turn loss-making suddenly. That sort of a bubble does not exist in the equity markets.
We see that excessive mismatching of the risk in the bond markets. That’s where the worry is. And that can very quickly have ramifications on the equity markets as well.
What is your outlook for the equity markets?
We can hardly justify 18-19 times the earnings for the Sensex. But in a scenario in which inflows continue, you cannot arrive at a target based on inflows. The valuation of the Indian market is around 31,000, considering the structural reforms and the current earnings trajectory for the underlying stocks. We are not revising our target. We closed FY17 at 4-5 per cent earnings growth, which was even lower in FY15 and FY16. We expect FY18 earnings growth to be 8-10 per cent but it will definitely not be 15-20 per cent as expected by the consensus currently. There will be some disruption because of the goods and services tax (GST). So FY18 will be yet another year in which H1 will be a washout and H2 is when recovery will begin.
Will PSU banks see better earnings growth in FY18?
Just because last year was weak, this year is unlikely to be any better for the PSU banks. With provision coverage ratios of around 30 per cent, I think the worst is ahead of them. They need to get closer to 60-70 per cent, but if they do that, their capital position would be even more vulnerable. Even if 30 per cent goes up to 35 per cent for PSU banks’ provisioning, earnings are unlikely to grow much for these banks. We like only one or two large PSU banks.
With signs of economic recovery, is it time to look at industrials?
We cannot see where the capex will come from for industrials. Two sectors that are missing in action are power and real estate, which were huge in earlier cycles in terms of capex generation as well as employment generation. Power is not coming back. Roads and renewables are seeing some improvement but are too small to make a difference.
A pick-up in real estate can drive capex in other sectors like cement, building materials, home loan demand, and so on. Then we get on to a virtuous cycle. I am not sure if we are there as yet.
While there has been a lot of noise around ‘Make in India’, too little has been done on the ground. It is time to look at manufacturing for exports, which can attract a lot of foreign companies to come and start operations here. These include auto, auto ancillary, auto equipment, and engineering products. They can use the basis of a large domestic market and then create an export hub. Foreign companies want assurance on land acquisition and labour reforms before investing in these sectors. Overall though cyclicals and high beta industrials are cheap and have seen some deleveraging, real estate recovery and labour reforms are the pre-requisites to improve investor sentiment in these sectors.