After the sharp fall, the market recovery – even though partial – has been swift. Mahesh Nandurkar, executive director and India Strategist at CLSA talks to Puneet Wadhwa ahead of their 21st India Forum on his interpretation of how the markets have played out over the past few months, the road ahead and his sector preferences in this backdrop. Edited excerpts:
What is your interpretation of how the markets have played out over a couple of months?
The market movement was quite sharp, but it did not come across as a surprise. We had been cautious about the market for the past few months. The primary concerns that we had, apart from the valuations, included the rising interest rate environment and other macro indicators. The correction, to some extent, brings valuations down to more reasonable levels. That said, they are still not in the 'value buying' zone.
So, what is the comfort zone you are looking at in terms of valuations?
As things stand today, Nifty50's current price-to-earnings (P/E) multiple is higher than the 10-year historical average. Valuations in the other emerging markets are now trading below their historical averages. One of the reasons why India still has that premium is the inflow we continue to see from the local investors into the equity mutual funds. This has been a key support for the markets. So long this sustains, the market premium will continue. If you look at the flow trend over the last few months, the extent of inflow has come down. The key worry from here on is how these flows sustain. The comfort zone for the market will be a 5 – 10 per cent below the current levels.
How does India look within the emerging markets (EMs)?
Though the valuations have become more reasonable than before but still not in the comfort zone, I would not term the market as a whole a 'buy on dips'. While there are certain segments that are looking better, there is more downside risk for the markets as compared to an upside potential right now.
Your outlook for foreign institutional investor (FII) flows?
FII flows have generally been weak in India for the last few years. A lot of this has to do with the global trends and FIIs have favoured developed markets (DMs) over the emerging markets (EMs). As regards India, it was big overweight for foreign investors within EMs. Within the EMs, investors have cut exposure to India given valuation concerns and the macro picture (oil prices staying at an elevated level that impact India much more). Though oil prices have softened, it is too early to say concerns on this front are over. The rising interest rate environment and the political uncertainty ahead of the upcoming state and general elections is also playing on the minds of investors. In this backdrop, the FII flows are not likely to pick-up anytime soon.
Have the developments shaken the confidence of retail investors as well?
Over the past few years, we have seen financialisation of savings. That trend has peaked out. From here on, the risk to the retail flows into the local equities is more on the downside. Yes, the retail flows have weakened but at an absolute level, it still remains robust. This will be one of the key factors to watch out for and will remain a key risk for the markets. How long the quantum of such flows can sustain is the key question.
How do you see the oil prices, bond yields and US Federal Reserve (US Fed) policy action play out over the next few months?
Bond yields in the US have been well above 3 per cent now since quite a while. There are expectations that the US Fed will continue on its rate hike path over the next 6 – 12 months. Back home, there are fiscal-related concerns. The GST (goods and services tax) collections have been way short of where they need to be to meet the government’s budget. We expect that on a full-year basis, the GST collection shortfall will be around Rs 1 trillion, which is a large gap to bridge. This will continue to put pressure on the fiscal, bond yields and the general interest rate scenario in the country. While the yields and oil prices have softened over the past few weeks, this respite is temporary. The interest rates are likely to move up by 25 – 50 basis points (bps) and the markets are not pricing in all this yet.
Do you think the next wave of selling can come in post an adverse state election outcome?
Local investors will be more sensitive to political developments. One must recollect that the big change in the local investor sentiment was visible in the monthly numbers (investment via mutual funds) starting May 2014, which coincided with the outcome of general elections. If the state election results were to raise doubts in the minds of investors about the political certainty going forward, it will impact flows into equities. Of the four states going into polls in December 2018, markets can still digest a loss in one state for the Bharatiya Janata Party (BJP). A loss in two or more will see an adverse sentimental impact.
Your overweight and underweight sectors?
We stay quite defensive in our choice of sectors. There is more downside risk to the rupee and so to that extent, we like the export-oriented sectors like IT services and pharma. The consumption segment, especially the rural consumption space looks good. This is where the government action will be ahead of the elections. We also have a long-term structurally positive view on the housing market recovery as well. From that perspective, we like property developers and large housing finance companies (HFCs). There has been a steady improvement in corporate-oriented banks where the gross non-performing asset (NPA) ratios have been coming down over the last two quarters. So, selectively corporate banks are also looking attractive. Telecom, cement & materials, non-bank finance companies (NBFCs) are our underweight sectors.
Can you elaborate as regards NBFCs?
Our house view is that the interest rates will go up going ahead. This will be incrementally negative for the wholesale-funded institutions like the NBFCs. Banks that have been losing market share to NBFCs over the past two-three years is now set to change. Therefore, we prefer private sector banks which will be relative beneficiaries over the NBFC segment.
What does this then mean for the corporate earnings over the next few quarters?
For the financial year 2018 – 19 (FY19), our earnings growth estimates have been coming down. The September 2018 quarter (Q2FY19) results were disappointing where we saw estimates getting revised downwards across the board. For FY19, the earnings growth for Nifty50 is likely to come in around 10 per cent. We are much more optimistic for the financial year 2019 – 20 (FY20) and project over 20 per cent earnings growth.
Where is this sudden spike in growth in FY20 coming from?
It is primarily coming from corporate banking space and select companies outside of this sector. In FY19, banks have raised their provisioning levels. To that extent, the credit cost is still very high. For FY20, the credit and the provisioning costs will reduce significantly with some of these corporate banks reporting doubling or even tripling of earnings growth year-on-year (y-o-y) basis. If these two sets are excluded, for the rest of our coverage universe, the earnings growth should be around FY19 levels.
How will the market react, should the RBI governor resign?
Differences in opinion between the government and a central bank have been a global phenomenon and India is no exception. Even in the past, we have witnessed some differences between the RBI and the government. Going by reports, the rift seems to have widened now. That said, there are rules and regulations that cover the behaviour and functions of the RBI, as per the RBI Act. To that extent, we have visibility on the RBI rate actions going forward. Any form of instability in the RBI can be a source of discomfort, especially for the foreign investors as the RBI clearly stands out as one of central banks across the EMs where investors have a lot of faith.