Current market levels capture expected earnings momentum: Harinarayanan

In the short term, election does matter and will play on the investor sentiment, says Suhas Harinarayanan

After the recent rally, the valuations are not cheap as they factored in the earnings momentum, says SUHAS HARINARAYANAN, head-institutional equity research, JM Financial Institutional Securities. In an interview to Samie Modak, he says investors with long-term horizon can use volatility as an opportunity to invest. Edited excerpts:   

The markets have rebounded since July. What is the reason behind it?
 

The benchmark Nifty 50 is up over five per cent in one month. The gains are driven by the positive movement in the three large corporate banks (Axis Bank, ICICI Bank and State Bank of India), Reliance Industries, ITC, Bajaj Finserv and Bajaj Finance. Hopes of an end to the bad loan cycle in the corporate banks and good quarterly earnings performance have been the underlying factors behind the latest rally.

Mid- and small-caps have playing catch-up after sharp under-performance in May and June. Will they outperform going ahead? Which is a better space to be? 
 

We still retain our preference to large-caps over mid- and small-caps. The large-cap space offers better risk-reward. However, we also expect some volatility in the markets in the run-up to the general elections. 

    

Will returns be better or worse in the remaining part of 2018 than what we have seen so far this year?
 

We do not give targets for the markets but suffice to say the markets are not cheap here. We have seen sharp outperformance by stocks where the current earnings are ahead of estimates and future expectations are robust. We expect this type of divergent performance to continue as well.

How will the elections impact the markets?
 

There has been an economic continuity here over the years, one could say from 1991 onwards. Hence, in the medium term, the elections may not matter. In the short term, though, it does matter and will play on the investor sentiment.   

How does one position itself from a one-year point of view or from three-year point of view?
 

It all depends on the risk appetite of the investors. There is no denying that volatility would increase, as we head towards state and central elections, notwithstanding the global risks due to crude oil and trade wars. Investors with low risk appetite in the short term should invest in reasonable valued large-cap companies. However, longer-term investors should take this volatility as an opportunity to invest, as India’s economy remains healthy and would continue to grow.  

Has the earnings and economic trajectory improved? What are your growth estimates?
 

Excluding corporate banks, the June quarter’s net profit growth of 23.3 per cent year-on-year is marginally below our estimates. For the Sensex, our estimate for two-year earnings compounded annual growth rate is over 20 per cent.

How do valuations look like? Which sectors and stocks could do well?
 

The Sensex is trading at 19.6 times its one-year forward earnings estimate. This is a premium of 22 per cent to the historical average. Given this valuation, we believe the Sensex captures the expected earnings momentum. Further upgrade looks difficult, as global events and associated stress on current account deficit and fiscal deficit could continue to pose risks to growth. We continue to recommend ‘overweight’ on private financials, rural-focused discretionary and pharmaceuticals.