Markets are not factoring in a bad monsoon: Centrum

Q&A with G Chokkalingam, ED and CIO, Centrum Wealth Management

Market participants have been mindful of the economic data at the domestic level and have fine-tuned their investment strategy accordingly. G Chokkalingam, executive director (ED) and chief investment officer (CIO), Centrum Wealth Management tells Puneet Wadhwa in an interview that as India heads closer to the general elections, foreign institutional investors (FIIs) are likely to remain fence sitters. The markets are in for a few shocks till December 2013, he adds. Edited excerpts:

Do you think that the Indian markets have priced in the worst as regards the domestic economic scenario is concerned?

I agree that the economy is in a bad shape – be it the current account deficit (CAD), slowdown in the FDI (foreign direct investments) inflows and in GDP (gross domestic product) growth, NRI remittances, or high leveraging of “new emerging industrial houses”.

While on one hand there is stress in the system, the valuations of the markets are appealing. Yes, the worst is already priced in both major indices and also in majority of the individual stocks. The Sensex at around 18,300 is quoting about 8% lower than October 2007 levels. As much as 40% of stocks from the public sector (PSU) space, MNC basket and the BSE 500 are quoting lower than their October 2007 levels. Sensex, on one-year forward earnings, is quoting little less than 11x, which is significantly lower than the long-term average of around 14x.  

What are the key risks to the markets at the current juncture?

The FIIs have brought in around $38 billion in the last 15 months. To me, that itself is a risk. So, if they decide to book even partial profits say $4 – 5 billion, ahead of the general elections, which I feel will happen only around January – February 2014, the markets may see a sharp fall.

I think that the markets are in for a few shocks till December 2013 and before the elections are announced. As we head closer to the elections, the FIIs are likely to remain fence sitters or will try taking away a small portion of their past investments, which will be a problem for the markets.

As things stand, monsoons are a major concern for the economy and the markets, which has not been priced in yet. The country does not have the appetite to withstand another drought, which will fuel inflation. In case the monsoon fails or is below normal, the Reserve Bank of India (RBI) will not be in a position to cut rates aggressively.

What is scaring the FIIs away?

Firstly, it is the widening current account deficit (CAD), which has largely been caused by the soaring import of gold. While scope for increasing the exports is limited (as it is largely an exogenous factor, dependent heavily on the global economy), ability to curtail the import of twin oils (crude oil and edible oil) is not possible at all in the short-to-medium term.  

Any move to curtail steep import of twin oils will lead to slow down in the industrial economy and steep jump in the domestic edible oil prices. Hence, the problem can be addressed effectively by controlling gold imports, where the government needs to take up further effective measures.

The second factor is the recent political realignment - the government is now forced to depend on certain regional parties which are in power at the State level. Reliance on parties not in power at the State level will reduce pressure on the fiscal demands.

How do you see the rupee panning out going ahead?

I firmly believe that the government has to address the gold import, which is the most disturbing factor as far as the fiscal situation and the Rupee are concerned. If this is addressed and the CAD is brought down to around 3.5% (of GDP), the rupee should be around 51 against the US Dollar (USD) by calendar year (CY) 2013 end. A failure to address this, however, could result in FII outflow and the rupee can even touch 57 – 58 levels by CY13-end.

Do you think that the developed markets will attract a big chunk of foreign institutional (FII) flows as compared to the emerging markets (EMs)?

I don’t think that a large chunk of money will flow in to the US and the developed world. Even at five% GDP growth, we are much better than some of the developed markets, and markets are already pricing it in. However, there can be few months where the FIIs allocate less to the emerging markets, including India; this will not become the basic / broad trend.

Attractive valuation of the overall markets, far more attractiveness of individual stocks and possible upgrades to both GDP growth and corporate earnings consequent to further reversal of interest rate cycle (which in turn is subject to progress of monsoon) will ensure that there is no serious run down in the investments of FIIs in the country.

In the worst case scenario, there could be anywhere $5 to $10 billion outflows from the FIIs by end of CY2013 – however, the overall adverse impact could be minimal since the domestic institutions – especially LIC – could provide support to the markets.  

Given all this, what has been your investment strategy?

We are advising our clients to allocate a maximum of 30 – 40% wealth into equity and an equal portion in debt (liquid funds). This is an ideal strategy to follow in case the world economy goes into a recessionary mode, which seems a remote possibility as things stand.

What about real estate as an asset class?

We are advising people who are over-exposed to real estate to cut exposure. Depending on location, the real estate sector has given a return of 100 – 300% over the last five years. I think there is a risk to the real estate prices over the next one – two years now.

On a pan-India basis, I expect the prices to correct at least 15 – 20% from the current levels as both wealth creation and income generation is not happening the way in which they were evolving from the stock markets, information technology (IT) and Telecom sectors during 2001–2007.

What are your expectations from the March 2013 quarter results season?

I don’t expect much change as compared to the December 2012 quarter. Private banks, pharmaceuticals, IT and fast moving consumer goods (FMCG) companies are likely to do well in relative terms. On the other hand, cement, telecom, automobiles, real estate and construction will be under stress.

What is the outlook for FY14 and FY15?

While Sensex earnings are expected to grow around 10% y-o-y in FY2013 and about 12% in FY2014. However, we can see a positive surprise in FY2015 with Sensex earnings growing more than 20% over FY2014 if forthcoming monsoon is really good in terms of its actual spread.

With global commodity prices including prices of crude oil already going down by over 10 – 15% y-o-y, good monsoon will bring down or at least control the prices of primary articles which in turn will lead to significant fall in both headline inflation and interest rates  in the system by end of FY2014. Consequently we will see the full benefits of fall in corporate financial costs and also sharp rise in aggregate demand in FY2015.

Do any stocks from the mid-cap space make it to your investment list?

In MNC space, one can look at Styrolution ABS (India), KSB Pumps, Clariant Chemicals and BASF. In the PSU pack, one can look NMDC, Engineers India (EIL). Balmer Lawrie Company and BHEL. In domestic private sector,  HIL Ltd (formerly Hyderabad Industries), Repro Systems, KCP Sugar, Surya Roshni, Indraprastha Medical, SOTL (Savita Oil Technologies) are the stocks worth investing in. We also like private sector banks like Karur Vysya Bank, South Indian Bank and City Union Bank. In the IT space, we like Hexaware and Polaris.

What about the large-caps?

From the large-cap space, I would recommend ITC, Reliance Industries, Cairn India, Hindustan Zinc and Lupin.

As per SIAM data, car sales have hit over a decadal low in the last financial year. What is the outlook for this space and are the stocks adequately reflecting the concerns? What about cement and capital goods counters?

I would suggest a hold on Bajaj Auto and Mahindra & Mahindra (M&M). However, I would not advise taking a fresh exposure in the auto space, except a few midcap stocks, like Autoline Industries, which are available at throwaway valuations. Overall, I do maintain a cautious view on the auto sector, which is also facing a lot of competition from the unlisted foreign players in India.

I would also stay away from the stocks of leveraged capital goods companies. One can, however, look at look at Siemens, Bhel and Larsen & Toubro. As regards cement, I think there will be a lot of stress given the current economic scenario and excess capacity.

Have you changed your views on the power space post the CERC’s stance on Adani Power and Tata Power?

I am still cautious about the power sector. Besides the general elections, there are some states as well that will face elections soon. In such a scenario, the government will not be able to pass on the entire tariff burden to the consumers. The problem regarding fuel supply is also adding to their woes.