India has been one of the best-performing markets in calendar year 2017 (CY17). CLSA Managing Director & Equity Strategist Christopher Wood, and Executive Director Mahesh Nandurkar tell Puneet Wadhwa that the markets could give a return of around 10 per cent from the current level over the next year. They also share their sector preferences and how India stacks up amid recent global developments. Edited excerpts: How long can the global equity markets, including India, go up inflated by liquidity? Wood: If you are a fund manager and have been compensated by the performance of the markets over the past year, I would advise hedging of portfolio. It is time to lock in gains in case you have been invested all through this year. Some of the news flow from West Asia is destabilising, and given this, I would lock in some gains. The US market remains spectacularly overvalued and that has been the case for a long time. Asia is still in the midst of a long-term outperforming trend. I will buy if there is any pullback in Asian equities. The Indian (equity) story is looking a lot better ever since the government announced the recapitalisation plan for public-sector banks (PSBs). This has been one of the unfinished works of the Narendra Modi government. The Indian markets have done way better than anyone would have expected, given the lack of earnings growth, and weak investment data and lending growth. The rally so far has been due to investment by way of mutual fund flows, which were way bigger than anyone expected. Demonetisation, too, has been positive for the stock market and a catalyst for money moving into financial assets. However, there is a limit to which the markets can go up in the absence of a credit cycle recovery. Do you see any reason for the Indian markets to correct? Wood: They would correct if the fund flows were to stop or slow down. However, most people seem to think that is not going to happen; in that case, the markets will remain very resilient. One thing we need to monitor is the bank recap process. We do not want to see the deadlines extended. Another thing we need to monitor is when these stressed assets would come to the market. There will be some political noise and defaulting borrowers would try to buy back their assets. At a time when mutual funds/domestic institutional investors (DIIs) are lapping up Indian equities, what do you think is keeping foreign investors (FIIs/FPIs) at bay? Wood: Foreign fund managers have not really participated much in this year’s move. There was a negative pushback from foreigners as regards Indian equities at the start of the calendar year. That is because they have been buying in China, which is outperforming. So, they sold in India and bought into the Chinese market. That said, foreigners are still overweight on India, but much less than they were last year. But now, they see light at the end of the tunnel, amid recent reforms, so they want to buy Indian equities on a pullback. Until the government had announced bank recap, foreign investors had been becoming increasingly nervous; they saw the markets being driven more by mutual fund flows. How do you read the recent macroeconomic numbers – gross domestic product (GDP), index of industrial production (IIP), etc? Are these a cause for concern? Wood: I am not too focused on the macro numbers. I believe the rollout of the goods and services tax (GST) would lead to all sorts of distortions and have teething troubles. The problem with GST in India is its multiple rates, which will create problems. The bottom line is that if the Indian markets correct, foreigners will buy now. The new (fiscal deficit) target could be around 3.5 per cent (against the current 3.2 per cent). This can happen as early as December 2017: Mahesh Nandurkar Nandurkar: Fiscal concerns are rising. The GST collections, we think, are falling short of target. Besides, there has been a rebalancing of rates. All this is getting reflected partially in bond yields. So, what’s your one advice to the Indian investor right now? Wood: Stay invested and buy on pullbacks. If you see the Indian stocks correcting by a third from their peaks, buy more! Well, that is assuming you are already invested.
In any bull market, there will be short sharp corrections where prices can correct by a third from their peaks. I would advise to cut bond exposure and invest in equities.Do you see the government revising the fiscal deficit target going ahead? Nandurkar: I think so, unless the government is able to pull back massively on the other expenditure. The new target could be around 3.5 per cent (against the current 3.2 per cent). This can happen as early as December 2017. The markets are not factoring this in fully at the current levels. Which sectors are you still bullish on? Wood: I still want to own private-sector banks, and housing finance companies, as the government is pushing affordable housing. I also still want to own real estate companies that have been the beneficiaries of RERA, and cement companies. But why aren’t you increasing stake in PSBs in your ex-Japan long-only portfolio, now that a recap has been announced? Wood: One could buy PSBs, but they might be asked to do national service. Besides, some consolidation is likely in the sector; we still don’t know at what terms the bigger banks will be asked to buy the smaller ones. Where could the oil prices be headed? Wood: The spike is a short-term negative. The risk is that we have had a conflict in West Asia and there are supply disruptions. That is one factor that can cause a big sell-off in global equities. This is not our base case, but it still is a risk. Fundamentally, oil prices can’t go too high, given the supply of shale gas. Nandurkar: Our house view is that the sustainable oil prices should be $60 a barrel (bbl). There can be certain spikes in between, as we are seeing right now, but oil prices will not remain at elevated levels for long. Where do you see the markets one year from now? Wood: The main issue here is the bank recap. That needs to be completed. The current GST rates, too, don’t seem practical and need to be sorted out. The federal structure in India is a big problem for GST. Nandurkar: One can easily expect 10-12% returns from the markets over the next one year. These returns, though, might not appear very high in the context of the over-returns that we have seen in the past six months alone. We feel the market valuations are high and expect a small de-rating to happen over the next 12 months. Domestic flows would continue to remain robust; we feel that will remain a driving force for the markets for the times to come. What about corporate earnings growth? Nandurkar: We think the upfront costs that the economy had to pay for policy measures are now behind us. We will slowly start getting into a period to start reaping benefits. Corporate earnings growth should improve to 12-13 per cent in FY18 and close to 20 per cent in FY19. What are your key overweights and underweights? Nandurkar: We are overweight on financials, industrials and consumer discretionary. The underweights include consumer staples and information technology. Pharma could be the dark horse. What about telecom? Nandurkar: We have been surprised by the pace of consolidation in the telecom sector. We did lose out on the first move in the stocks. Given the consolidation and the fact that pricing pressure is mostly behind us, the worst might be over for the sector. What is your inflation projection? How much room does the Reserve Bank of India (RBI) have to cut rates? Nandurkar: Our projection for Consumer Price Index (CPI) -based inflation for FY18 (exit numbers) is 4.5 per cent. It should remain around the same level in 2018-19 as well. However, there is an upside risk in case there is a spike in oil prices. If there is a fiscal slippage, the RBI would have limited room to cut rates. The rupee should remain in a range of 64-66 a US dollar. We don’t think the dollar would remain too strong in 2018-19. How are you reading into Donald Trump’s presidency and the issues with North Korea? Can this destabilise the financial markets over the next year? Wood: On the financial front, the issue with the US presidency is whether the government could pass the tax reform. The existing government has a 50 per cent chance of doing that. The government needs to show before the mid-term elections that it has done something with the majority it got. So, in that sense, the US government is incentivised to make the tax reform work. It will not be easy, as it will have to find revenue streams. Americans will have to accept North Korea as a nuclear power. Meanwhile, North Korea will continue to test nuclear missiles until it has an intercontinental ballistic missile capability to hit the US continent.