Return of the DIIs is not priced into the market yet, says Elara Capital MD

The near 8 per cent rally in the frontline benchmarks thus far in calendar year 2019 (CY19) has mostly been fuelled by foreign flows. HARENDRA KUMAR, managing director for institutional equities, at Elara Capital tells Nikita Vashisht that post the election outcome later this month, market will start to price in a continuation of policies and a strong recovery of the earnings cycle, which will be the bedrock of new bull-run. Edited excerpts:

After a sharp rally since March, do you now expect the markets to consolidate over the next couple of quarters?
 

The current market up move should not be seen as a rally, but more as a re-bound or risk-on after the poll debacle of the current incumbent government in Rajasthan and Madhya Pradesh state elections. The bull trend will gain strength after the poll results in the event of a favourable outcome for the incumbent government. Market will price in a continuation of policies and a strong recovery of the earnings cycle, which will be the bedrock of new bull-run.

Elara expects 40 per cent upside in the markets over the next 15 months. Isn't that too optimistic considering the sluggishness in the economy?

History is testimony that such moves are not impossible. Let’s lay out the underlying dynamic that will lay the foundation for such a big move. Firstly, the re-rating is bound to occur as market re-prices the re-turn of macro and political certainty. Secondly, a strong 20 per cent earnings CAGR (compounded annual growth rate) for the Nifty50 companies over the next three years, which is sizeable for any market. Typically, where there is such confluence of events, FIIs (foreign institutional investors) price in a strong view on the rupee, which drives flows on the short-term. Thirdly, trade war fears are between US and China are mellowing, which will be a tailwind to the markets.

What are your underweights at the current juncture? Any contrarian bets?

There is more pain in the auto sector. It continues to be over-owned and that is where the risk is. We believe that the cyclical top is made but not the bottom and more downside is likely over the next two quarters. We think public sector (PSU) banks, cement and real estate sectors could see interest returning.

Do you see the pace of flows to equities pick up once the election-related nervousness is over? What about domestic (DII) flows?

DIIs have been sceptical of the current rally and have preferred to be on the sidelines. They are happy to wait for the outcome before re-positioning their bets. Their ears are closer to the ground and they are still keeping an eye on the soft macro numbers and are not swayed so much by the political noise. The return of the DIIs and strong inflows is not priced into the market yet, which buttresses are point that there will be some chasing into the market rally.

What are your estimates for corporate earnings for FY20? Can the spike in oil prices again push back the recovery / pick up in earnings growth?

Around 20 per cent for the Nifty is a consensus view for the market. Oil prices have not been a big variable for the Nifty earnings, as there are cancelling effects between weaker earnings for a few and gains on a weaker rupee for exporting companies. Moderate inflation is good for the markets as it works on the nominal earnings. Risks only emerge when some thresholds are broken – say above $90, for which we are under-prepared. That kind of risk, however, is non-existent today.