Markets in midst of liquidity boom; time to be cautious: S Naren

The liquidity fuelled by global central banks is likely to come off over the next year, says S Naren

India has been one of the best-performing equity markets across the globe, with a rally of over 25 per cent in 2017. S Naren, executive director and chief investment officer of ICICI Prudential Mutual Fund, tells Puneet Wadhwa the country will remain an attractive market for foreign investors despite the rich valuations. Edited excerpts:

How will India fare in 2018? 

We are in the midst of a liquidity boom, with huge inflow into equities from both, domestic and foreign investors. While these are no longer cheap, we are positive on the markets, as we believe corporate earnings will catch pace over the next 18 months. That said, liquidity is likely to remain one of the key drivers for the rally. 

Indian markets are in fine fettle compared to other emerging ones, given the structural changes underway, positive for the economy. India will remain an attractive market for foreign investors, despite the rich valuations.

How do you see policy action by various global central banks over the next year? Are the markets pricing this in? 

The liquidity fuelled by global central banks is likely to come off over the next year. This could tighten the money markets, though in a limited manner. It is difficult to assess if the capital markets are factoring in such a possibility, as markets across regions have been consistently going up. 

Has Moody’s been over-optimistic about pick-up in economic growth? 

India is one of the best long-term stories, over the next 20-30 years. So, yes, Moody’s is right that India is one of the best structural stories. On foreign investments, FIIs (foreign institutional investors) have been positive on the Indian market, and the upgrade will aid in strengthening one’s conviction on the India story. 

Mutual fund (MF) flows into the equity segment has crossed Rs 1 lakh crore in 2017. What is the outlook for next year? 

The trend will continue in 2018, with retail investors preferring financial assets over physical assets. With increased awareness around MFs as a product, investors are likely to approach the capital markets through systematic investment plans. Geopolitical tensions and crude oil above $65 a barrel could dent the sentiment.

Key takeaways from the September quarter earnings season? 

The transient effects of demonetisation and goods & services tax (GST) implementation were visible. The earnings cycle is yet to play out in India. However, over the next 18 months, a marked improvement in corporate profitability is likely, with pick-up in capacity utilisation across sectors. Over the next two years, we expect nearly 30 per cent growth in earnings. Banks, capital goods, power, technology and pharmaceuticals are likely to lead this revival. 

Your sector preferences at the current levels? Any contrarian bets? 

Pharmaceutical and healthcare services, transportation and power are the pockets we are overweight on. When it comes to pharma, at this juncture, we believe the sector multiples are at an all-time bottom and we see a case for both earnings potential and re-rating opportunity in two to three years.

In transportation, ports and the aviation industry are poised to witness expansion, due to the government thrust on infrastructure. The power sector is going through low capacity utilisation. With an uptick in the capex (capital expenditure) cycle, we believe it could register higher top-line growth and earnings. Also, government initiatives such as ‘Power for All’ by 2018 and scaling up of wind power capacity additions in the future could benefit.

Banks and finance (barring corporate lending banks), automobiles and consumer non-durables are the underweight pockets, due to expensive valuations. In automobiles, the sector earnings growth is likely to moderate from the current levels, while in fast-moving consumer goods (FMCG), the margins could be fairly range-bound due to explicit price hikes and modest cost inflation. Pharma and information technology are our contrarian bets.

Your advice to investors at this stage? 

The market is in a mid-cycle and one cannot invest blindly at current levels, as valuations are no longer cheap. This is a time to exercise caution and adhere to asset allocation. Over the past two-three years, the markets have been on an uptrend and investors who came in then have not yet seen a down-cycle. This could see them go overboard on equities, owing to the belief that equity is a riskless asset class, which is worrying. Investors should now consider balanced advantage/dynamic asset allocation category schemes for incremental allocation. Pure large-cap benchmarked funds are another category one could consider.