FII flows into EMs may resume as valuations fall, says Mukul Kochhar

Valuations in other emerging markets (EMs) look better compared to India, says Mukul Kochhar, head of institutional sales (India), Investec Capital. However, the country will also stand to gain as flows into EMs may resume as valuations have become cheaper after this year’s correction, Kochhar tells Samie Modak. Edited excerpts:

Why have the broader markets seen a sharp correction this year?

In the four years ending 2017, roughly one of five stocks in India quadrupled. So, we entered 2018 from a period where everything had worked. It had been difficult to distinguish skill from luck. This year, stocks have corrected, which was somewhat predicted. Since, the rise had been extreme, the correction, therefore has been severe.  

How does the Indian market compare to other EMs?

India’s valuations are at a premium compared to other EMs. There are reasons why some premium is justified – India offers one of the highest standards of minority protection in the world, deep and diverse markets, and good corporate governance standards. However, at present, other markets may look better, purely in terms of valuation. However, if the EM pack starts getting foreign flows because they have become cheap overall, India will also stand to benefit. If the flows improve, it will help stabilise the rupee and also provide temporary support to the market.  

Given headwinds such as rising US dollar and bond yields, do you expect a turnaround in foreign flows? 

We believe that both the factors are related and may be close to playing out. The Fed’s rate guidance may already be baked into markets, with path being laid out for another four rate increases that will get us to 3.25 per cent by September 2019. This means that the Fed stands to overshoot its own neutral rate by sometime next year. By next year, if global weakness seeps into the US market, the path may be less steep, which will be less supportive of the dollar and yields. In addition, mid-term elections in the US may lead to a lame duck presidency as odds favour loss in the house of representatives by the Republican President. 

Till valuations become cheap on an absolute basis and macro environment more stable, FII flows will remain volatile. However, foreign flows also depend on overall EM flows, which should get better from here.

How do valuations look like after the correction? Do you see valuations under-shooting long-term averages?

Valuations remain higher than long-term averages by 10-15 per cent for the Nifty. Valuation premium is even higher when you move to mid-cap stocks. Such a premium is palatable if the macro environment becomes stable and there is visibility around the next government formation. Valuations can undershoot in the near term in case we get an unstable outcome in next year’s election, or if the US-China trade war takes a turn for the worse. Investors should watch the meeting between Trump and Xi in December carefully as a China in crisis in the near term is not good for EM flows.

How big an event, are the state and general elections from the market point of view? 

State, not so much, since any outcome will get discounted. If results are not on expected lines, the argument will be that people vote differently in the central elections. From the market point of view, any stable government formation is a positive. As of now, the only stable possibility seems to be a government headed by the BJP. If another stable outcome emerges, that is also not too bad.

What are the key concerns on the domestic front? 

Valuation, current account deficit (CAD) and politics are the key concerns on the domestic front. Valuation and politics are transient and will get resolved in the next 3-6 months. The CAD issue is a little sticky, which will put a lid on the extent of any potential rally in the market.

Which sectors and themes look good at the moment? 

We are positive on technology and high deposit-taking private banks. We like discretionary consumption stocks like Bajaj Auto, Maruti, Voltas, Bluestar and Havells, and select metal stocks like Tata Steel. L&T in infrastructure should also benefit from solid infrastructure ordering by the government.