Markets face 7-8% downside amid global uncertainty: Tirthankar Patnaik

Interview with India Strategist at Mizuho Bank

 

These are testing times for investors who wade through uncertainty, owing to developments in Greece, a sharp fall in Chinese markets and the imminent rise in interest rates by the US Federal Reserve (US Fed). Tirthankar Patnaik, India strategist at Japan-based Mizuho Bank that had assets of nearly $1.64 trillion in 2014, tells Puneet Wadhwa that he expects the Nifty to trade in a range of 8,500–9,500 over the medium term and prefers cyclicals over defensives in a medium-to-long term India model portfolio. Edited excerpts:

How do you see the developments with Greece impacting global financial markets? To what extent is India insulated ?

We believe global markets are yet to price in the full impact of a Greek stand-off, as our base case remains that of a solution, but a crisis situation cannot be ruled out. With India's macro much better now than in mid-2013 (taper tantrum) or in 2012 (Greek crisis) or in 2011 (US downgrade), any downturn in global macro sentiments would hurt capital flows and, therefore, rupee and the markets. Indian markets face seven to eight per cent incremental downside amidst this global uncertainty.

Markets have failed to cling on to higher levels, of late. Have investors come to terms with the fact that fundamentals will take time to improve?

One year and +13 per cent rally in the markets (by May 2015) into the new government, investors are gradually coming around to the fact that a macro recovery remains quite unlike that of a market recovery and would take time to play out, even as India's external (rupee, balance of payments, current account deficit) metrics remain in check. Its growth fundaments (7.3 per cent in FY14, 7.5 per cent in FY15E) remain weak.

As credit growth remains in early double digits and earnings in single digits, investors are finding India to be a long haul, even as it continues to outpace EM (emerging markets) peers. We believe lower cost of funds and improving world economy and a decisive government would continue to play in India's favour and therefore, remain committed to the long–term growth story. Markets are likely to reflect this in the medium-term.

What is the broad trading range for the markets from a near-to-medium term perspective and what are the key triggers and risks?

We expect the Nifty to trade in a band of 7,800–8,500 over the near-term and 8,500–9,500 over the medium-term. The key triggers that would instrumental in favouring a bull market would be a favourable monsoon season, recovering GDP (gross domestic product) reflected in reviving earnings, cheaper cost of funds with external indicators remaining well under control, fiscal prudence playing through and a reviving global economy.

However, key risks to our expectations remain that of the Grexit (Greece exit) playing out, market volatility around the first few hikes by the US Fed or the Chinese markets, and the government not meeting investor expectations.

How do you see key macro indicators panning out over the next few quarters? How do you see these factors impacting corporate earnings in FY16 and FY17?

We see near-term depreciation of the rupee led by uncertainty on the US Fed's interest rate hike and overhang of the Greek debt crisis. On inflation, we expect it to rise till August 2015, after which the high base effect wears off and inflation is likely to stabilise in a five-six per cent range for the rest of the financial year.

The Reserve Bank of India is likely to maintain a pause on rates for the rest of this year, and we foresee the next rate cut in the January–March 2016 quarter, depending on the monsoons, inflation trend and US Fed's decision on interest rate hike.

The monsoons have been good and this would benefit farm incomes amidst a modest MSP (minimum support price) hike. With macro recovery underway, we believe company fundamentals should also improve and expect corporate earnings to increase by 12–13 per cent in FY16 and 15–16 per cent in FY17.

Going by the IIP numbers, there has been a consistent improvement in the capital goods segment. How should investors play this theme now?

The capital goods index in the IIP basket is contingent on finished products and, therefore, remains susceptible to near and mid-term volatility. Overall, capacity utilisation in the system continues to lag long-term averages. Together, weak aggregate demand and high cost of funds, we believe a capex recovery in India is unlikely to be front-ended and remains dependent on fiscal spending. Mid-cap infrastructure remains saddled with leverage and is unlikely to surprise on earnings.
 

What is your view on rate sensitive sectors? Would you prefer allocation to defensive plays instead at the current levels? Why? What are your top picks in the sectors mentioned above?

We remain positive on a gradually tapering cost of funds in India over the next two years, as the RBI gets to grip on the country's inflation trajectory. Lower interest rates would be positive for India's investment story and also on discretionary consumption. We therefore prefer cyclicals over defensives in a medium to long-term India model portfolio. At current levels, with rupee depreciation, we prefer global over local defensives (but not mid-caps).

Securities and Exchange Board of India (Sebi) recently relaxed listing norms for start-ups. Do you think that there is appetite among retail investors for such issues given that investing in a start-up even for institutional investors is a risky proposition?

Sebi's relaxed norms for start-ups have brought them closer to global standards and reflect the market regulators comfort on this funding channel. Despite the evident risks associated, we believe well packaged and marketed issues will have appetite, for both institutional as well as retail investors.

Mid-caps and Small-cap segments have also hogged the limelight given the sharp swing in these stocks. Is it a good time to accumulate and which would be your top picks with a 12-month perspective?

Mid-and small-caps, selectively chosen, have historically provided the highest returns in a long-term bull market - the operating word here being selective. Given the gradual pace of recovery, unfortunately, quality mid-caps no longer have significant upside from a valuations perspective. While the argument for small and mid-caps remains persuasive we believe macro overhang over the next two quarters remains a concern in this category.