Market correction may last for a considerable time: Deepak Ramachandra

Deepak Ramachandra, head of sales, India Equities, Bank of America Merrill Lynch, says state elections are crucial and the outcome will give us important cues leading up to 2019 general elections

The markets have not been able to cling on to higher levels despite the government’s efforts to stem the rupee’s slide and find a resolution of the crisis at IL&FS. Deepak Ramachandra, head of sales, India Equities, Bank of America Merrill Lynch, tells Puneet Wadhwa that the pain in Indian equities is just starting. Foreign portfolio investors’ (FPI) money, he says, will not come in any big way till June 2019. Edited excerpts:

The fall from the peak levels has been quite sharp. From a year’s perspective, are these losses recoverable?

The losses have been sharp – perhaps sharper than what most people anticipated. But the sell-offs are always like that. My personal view is that these losses are not recoverable over a year’s time. One needs to understand the important events that can impact markets over the next one year. Besides the global factors, elections in India – state and general – are key. State elections (in November-December) are crucial and the outcome will give us important cues/indicators leading up to the general elections scheduled in May 2019. In the light of these uncertainties, it is hard to expect the markets to recover all these losses. We expect the Nifty50 index at 9,200 levels a year from now. Our December 2018 S&P BSE Sensex forecast is 32,000.

Is this a correction within the bull-run that started a few years ago or is it something deeper?

The ‘India structural story’ is still intact. The drivers and institutions put in place by the government over the last two-three years are not broken. That said, the markets are not likely to go up in a straight line. India is not insulated from global markets and one needs to be cognizant of the risks, valuations and at what price is one buying stocks. 

Are the valuations compelling enough to start cherry picking?

It is quite tempting to start cherry picking given the sharp drop in select stocks. It’s not just the large-caps, but the mid-caps too have been beaten down badly. Though the levels are tempting, one should wait for now. The headline valuation of the market has come off meaningfully. We are down from 19x (peak levels) to around 16.5x now. The average has been close to 15.5x. While the valuations are nearing long-term average, on a relative basis, India’s premium to the rest of emerging markets (EMs) is still elevated. Valuation of mid-caps is still at a significant premium to the large-caps. While headline valuations are not compelling enough, within sectors there are a few opportunities.

Do you think, the next wave of selling can come in post an adverse state election outcome?

That’s for sure. An adverse out from state polls would trigger another round of selling. Politics aside, one also needs to keep a tab on domestic flows. The only real support for the market in the last few months has been domestic flows. The foreigners have generally been sellers through the year and in case of a fall from the current levels, the domestic flows will dry up. And should the global allocation to EMs drop, there is no reason to believe India won’t be impacted. 

So, how does India look within the EM pack?

India’s premium to the EMs is still elevated. However, within the EM pack, one can argue that India has been always been a stand-out structural story and is less dependent on external factors. That said, oil is the biggest worry. But despite that, the ‘domestic story’ is still intact. Though we have had a stable government with benign macro for the last few years, both these counts would now see uncertainty. The other EMs, too, are plagued by similar issues like currency weakness, pressure on current and fiscal situation etc. Going forward, India will trade in-line with other EMs. That is a function of global asset allocation by foreign investors, rather than allocation only to India.

Would you blame the recent correction more on fear factor creeping in or is there genuinely something wrong with the fundamentals?

What happened in the non-bank finance companies (NBFC) space was triggered by the developments at IL&FS and led to an element of fear. The correction in NBFCs was sharp because the valuations were exorbitant -- some NBFCs were trading at 5x book and 30x earnings. The domestic and foreign money was sitting in just a handful of NBFC stocks. As the panic spread, investors unwound their positions.

How long do you think this phase of market correction will last?

The correction is likely to last for a considerable time. That’s because we still haven’t seen any real panic from institutional investors. While the FPIs have sold, it is still not a panic-like situation. Some of the tourist money may have gone out of the system, but the large long-term players are still invested. Once we see a panic set in from their side due to some reason – domestic or any external factor, that’s when we can say the correction will come to an end. It is too soon to say that when or whether the panic will set in. Once the redemptions begin in the mutual funds, that’s when the real panic will set in and the market bottom will be in sight.

Are the FIIs / FPIs looking to get in at some point?

This is difficult to predict. The pain in the equities is just beginning to set in now. The FPI money will not come in to India in any meaningful way till June 2019. Globally, there have been outflows from equities as an asset class and this is not stopping anytime soon. There will be a shift into safer havens. With the US Federal Reserve continuing to tighten, the debt flows and flows into the EMs will also be impacted. There is generally a risk-off phase among investors and they now prefer to stay away from the EMs. These are difficult times for asset managers; they are finding it tough to find avenues to deploy money. 

So, which asset class then will attract money over the next one year?

Given where we are right now, flows into debt segment should pick up. With the regulator’s stance of ‘calibrated tightening’ and financial stability, the risk reward is better for debt over equity in India. 

How do you see the US Fed and the Reserve Bank of India responding to the developments over the next 6 – 12 months?

The RBI has made it clear that it is unlikely to cut rates. They will monitor the situation with oil, rupee and target inflation. If the oil feeds into inflation, then we do expect the RBI to hike rates. The US Fed, too, will continue on its tightening path and I don’t think they will deviate from this. 

How do you see the bond markets playing out in the US over the next six - 12 months and how will it impact fund flows into EMs and India? Is that another risk Indian equities haven’t priced in yet?

Definitely, a big factor is impacting flows into EMs and hence India – we’ve seen massive redemptions from bonds and with the Fed determined to tighten, these outflows could continue. The risk for India is yet to play out and therefore, this risk has not been priced-in for Indian equities.

Are the markets prepared for a higher current account deficit and widening fiscal deficit?

The markets are nervous because of oil and the rupee. For the markets, it really comes down to how oil prices play out. Our global view is oil hitting $95 per barrel by June 2019. The market is not factoring oil prices to reach that level yet, or the rupee breaching the 75 mark. A breach can trigger a further correction in the markets.

What does this then mean for the corporate earnings over the next few quarters?

The corporate earnings will get reset. We had a great tailwind for 18 months. Street estimates are still elevated and we expect downgrades to accelerate. Our expectation is for a 12 per cent earnings increase for the S&P BSE Sensex. The street, however, still expects this to be around 16 – 17 per cent mark. If our thesis on oil and the rupee plays out, there will be downgrades in what the street is expecting. 

Your sector preferences?

We still advise client to stick to strong franchise retail banks and the rural theme. Whatever is happening currently in the NBFC space, there is a natural shift to high deposit collecting banks that have a robust funding franchise. They may regain some of the market share lost to these NBFCs. Going into an election year, the rural theme should also do well. People have found a safe haven in the information technology segment given the rupee’s slide. However, in case of a further slide, the rupee depreciation benefits stop accruing to the IT companies. Over the last one year, the incremental money was getting allocated to pharma and IT sectors. So these sectors are crowded. That, too, is being partially unwound now. But, for now, investors should definitely stay away from the mid-and small-caps.