 "Abhinav Khanna")
The liquidity-driven rally in global markets has surprised investors, feels Abhinav Khanna, managing director and head of equity at Citi India. In conversation with Puneet Wadhwa, he says the US Federal Reserve might raise rates by 25 basis points by year-end. Edited excerpts:
Do you think the rally in the global equity markets has more steam left?
The rally has surprised most investors across developed and emerging markets (DMs and EMs). In our house view, we are looking at a minor upside from here on, around three per cent for the S&P 500 index (US) by mid-2017.
The global flows situation is fairly solid, despite intermittent setbacks like Brexit (UK voting to exit the European Union) or occasionally hawkish comments from some central banks, as well as political uncertainty in some countries. But, overall, central bank actions have been fairly co-ordinated. This liquidity flow has surprised everyone.
Do you see flows continuing into India?
We were surprised by seeing the huge flows into the Indian market but there have been other markets like Brazil, Indonesia and Thailand that have gone up much more than what India has. There has been an inflow-driven rally and at this point, we don't really have much idea as to whether the inflows will slow down. So, from a fundamental basis, we expect a small upside only (Sensex target 28,800), but ultimately the flows will be important to determine how much the markets can overshoot our fundamental index targets.
What factors are necessary to keep these flows coming into India?
These are EM flows. So, the India-specific situation can dictate these. We need the global central banks to continue comforting the market that they will be supportive of liquidity. This, hopefully, will guarantee that EM inflows remain strong, out of which India will get its own allocation. The bulk of ETF (exchange-traded fund) inflows that have come into India have been out of the EM allocation.
How much money has come in via the ETF route over the past few months into India?
According to reports, post Brexit, in the last two months, around $1.1 billion ETF buying has happened in India; and the bulk of this buying that has happened has been out of EM ETFs, which also have an India allocation. 90% of the year-to-date (YTD) inflows from ETFs have come post Brexit. So this just highlights the power of ETF flows and EM allocation money. We all were thinking that post Brexit, things would actually reverse and EMs may lose ground, investors may move to safe havens, the US may benefit at the expense of EMs. But simply by the power of the inflows, all our expectations have been belied.
Will this be true even if the US Fed were to raise rates?
It is tough to say that. The market is expecting around 25 basis point (bps) hike towards the year-end. Our expectation is 25 bps by the fourth quarter of the current calendar year and another 50 bps next year. If between now and December 2017 the hike is more than 75 bps, it might be negative for flows.
What are the key variables that are still in favour of India as an investment destination among foreign investors?
The domestic story in India is still very powerful. After talking to various investors, we feel people are looking at India as a market which offers growth. The chances of GDP and earnings growth accelerating are much higher than in other markets that investors are interested in.
That apart, the defensiveness of a lot of the sectors and companies in India also stands out. We have large, well-run companies where earnings are coming through. We also have seen a number of reforms happen recently, including the GST (goods and services tax) Bill. All this makes India stand out vs other markets. What is being expected is being delivered by the government.
The fiscal situation is also no major cause of worry. Over the past few years, we have started seeing the deficit situation improve; oil prices have been supportive too. We are well below the nervous levels we saw a few years ago as regards the current account. The currency (rupee) has been incredibly stable. All these factors make India stand out.
And, what are their key concerns?
A clear one is valuations, which are not cheap any more. In our study, the MSCI India index is trading at one standard deviation above the past 10-year mean valuation. So, valuations are not at a comfortable level now. Earnings expectations are already high, which is reflected in the high valuations. The concern is, what if the expectations are not met.
Do you think the implementation of the GST bill could get delayed beyond April 2017? How are the markets likely to react to this?
I think the government will try to ensure that the implementation does not get deferred. It is not an easy task, but even if it doesn’t happen by April 2017, the markets will not take this negatively. The biggest hurdle of getting it past the Rajya Sabha has been cleared.
What are your takeaways from the June quarter results? What are the expectations / projections for FY17 and FY18?
The first quarter, till now has been in-line with expectations. Around 80% of the BSE 100 companies have reported numbers, and the numbers are in-line with our expectation. . For the Sensex, we have 13% earnings growth expectation of FY17 and 16% for FY18.
What are the next triggers for the markets?
Investors are looking forward to some signs of a recovery in consumption. What we have seen till now is a slightly patchy recovery. But the view we get after talking to people is that the consumption recovery will happen before the investment recovery happens. For now, investors, in general, wish to play the domestic consumption stocks as opposed to capex cycle-related stocks.
By when do you see a recovery in capex cycle?
Capex cycle recovery may still be some time away, because the confidence of the corporates to put in more investment is missing. We are not seeing very high capacity utilisation levels across sectors. Historically, often the capex cycle has been kick-stared by the government, which is followed by private sector spending on capex. The government has done its bit, and now it is up to the private sector to catch up.
Which sectors are you overweight on?
The ones we are overweight on are financials, healthcare, utilities and cement. Financials is a great way to play investment and consumption. The leading private sector banks are amongst the best proxy for consumer sector. We also feel cement is the cleanest way to play the infrastructure theme where you can get good quality companies with clean balance-sheets, strong growth in volumes as well as firm pricing levels. Even though the valuations here are rich, we still like the cement sector.
There are some interesting stories in the healthcare space, where they have built a strong pipeline of products that will be launched over the next two – three years. YTD, this sector has also been an underperformer. So there is an opportunity after the recent underperformance. The government has done a lot for the utilities sector. The Ujjwal DISCOM Assurance Yojana (UDAY) has kick started a whole new phase in the Indian power sector, and the ripple effect on the Indian economy and on the financial system will manifest itself, in the long run.
Which sectors, according to you, will lead the next leg of market rally?
We clearly feel that the ones we are overweight on, should do well and lead the next leg of the rally. We are confident on financials, utilities, cement. While there have been some downgrades on the street in the healthcare sector, we feel confident and believe that over the next one year healthcare will outperform.
The mid-cap and the small-cap segments have seen a good run since the past few months? What are your views as regards these two spaces?
Within our coverage, there are select mid-caps that we like. We have not taken a blanket call on these segments here. One has to be stock specific.
What about metals?
We are underweight on the metal segment. Due to the global risk on. In general, metals have done well across the board. Commodity stocks have seen a good rally globally. So, a risk on combined with short covering, along with specific positive announcements for the sector in India has aided the rally. So due to the fact that the rally has not been completely fundamentals-driven, we feel that it is time to take some money off the table here.
Infosys - RBS development seems to have dented sentiment in the information technology sector? What is the road ahead?
IT is a sector where we have been cautious for some time. We have been cautious earlier because we felt the growth and margin outlook would clearly be weaker than before. The traditional IT services is not growing as fast as what it was 5 – 10 years ago. As the transition happens to new businesses like digital, mobility etc., Indian companies will need to reconfigure strategy, which they have begun to, yet more needs to be done.
We have seen that in the last couple of years where despite the big currency depreciation, the margins have either been flat or lower. So in such a scenario, we remained underweight on this sector. There is risk of more developments like the Infosys – RBS for the IT sector going ahead owing to Brexit. Currently, the budget spends for big clients of IT companies too are not growing at a healthy pace.
What about the auto sector?
We remain neutral here. The two-wheeler stocks have rallied a lot on expectation of monsoon, cut in rates, implementation of 7th Pay Commission recommendations. All this, we believe, is already factored into the prices. Within the rate sensitives, we are more comfortable with financials stocks than autos.
Will monetary policy be guided more by political compulsions?
There will be continuity in policy. We have a high degree of confidence here. Between now and March 2017, there can be a 25-50 bps cut in interest rates. However, we cannot forecast in which policy (review) this will happen.
There has been a debate of advancing the Union Budget by a month. What are your views on this?
This could be somewhat positive, though I don’t think this will change things, or the way work is done in a huge way. It does give more clarity at the beginning of the year. Simplification of processes and clarity on anything sooner in the year rather than later is generally welcome.
