It doesn't seem bubble-like situation is getting created: Vineet Bhatnagar

The earnings cycle has largely bottomed out, with huge impending potential growth ahead, he added

The developing geopolitical situation between the US and North Korea took a toll on the markets, with the benchmark indices slipping around five per cent last week. Vineet Bhatnagar, managing director and chief executive officer, PhillipCapital (India), tells Puneet Wadhwa it is advisable for investors to not initiate new incremental long positions for now. Edited excerpts:
 
What's your advice to investors now given the geopolitical situation?
Equity markets almost always shed gains even at hostile verbal exchanges that hint of growing conflict. This week has seen escalation. It might be advisable for investors to not initiate new incremental long positions. However, a swift resolution in the situation could present a good opportunity to build longs in high conviction ideas, as a short-term bottom could get established as geopolitical tension recedes.
 
Are global markets nearing a bubble?
On an empirical assessment, the markets do seem to be approaching high valuations. The world is trading at 22x on a cyclically adjusted price to equity or PE (CAPE) ratio, with the largest market, the US, trading at a lofty 28x and India at 21x CAPE. For growth economies, 21 times might still be defensible. While the ratio is high and has been fuelled by inflows into equity markets, it might not be bubble valuations as yet. There does not seem to be any irrational exuberance.
For India, the earnings cycle has largely bottomed out, with huge impending potential growth ahead. Inflation globally is very much in a manageable range and other asset classes are still subdued. So, it does not seem a bubble-like situation is getting created.
 
Could this liquidity tap run dry soon?
Liquidity globally is tricky because it is dictated more by central bankers. However, Indian markets are more dictated by consistent retail inflow. After a prolonged period, we are finally seeing equity is being accepted as an asset class by domestic retail investors, where a certain portion of their savings is getting allocated to equities. Systematic investment plans (SIP) in equities provide cyclically adjusted returns, and the returns are better than all other asset classes. This means SIPs will continue and liquidity for Indian markets is more likely to be stable in the medium term.

How is the current stock market rally – in India and globally – different from the ones we saw earlier?

The earlier rally of 2004-2008 was fuelled by the investment cycle while the present cycle is fuelled by consumption. This rally seems to be more sustainable as this one is fuelled more by domestic liquidity than foreign money. Domestic flows are more sticky in nature and do not impact the currency and in general insulate from global shocks. This provides a lot more stability to the local rally.

 
Why aren’t we seeing any ‘sell’ calls in India despite the run-up and absence of a meaningful earnings recovery?
Earnings recovery seems the biggest risk to the present rally. Eventually, earnings have to back the growth in asset prices. We are witnessing decent growth in earnings and the recovery cycle is playing out but it is yet to catch up with stock price growth. The indications are getting stronger for the cycle to pick-up but if it does not, there will be challenges.
It is also difficult to put a ‘sell’ (call) on the market at this juncture, when we are witnessing the earnings cycle turning, the macro environment becoming favourable, cost of funding declining and, more importantly, a very stable political environment.
 
Are you concerned about valuations?
These are stretched in some pockets like consumer goods, mid- and small-caps. On the other hand, the market is undervalued in areas like information technology (IT), pharmaceuticals and telecom. I would be worried about mid- and small-caps, as many stocks have become substantially large from the market capitalisation point of view, and their ability to deliver earnings on a sustainable basis to justify current valuations is questionable.
 
How are foreign clients viewing India as an investment destination?
They view India as expensive but are still keen to invest and many remain overweight on India. There now are new types of investors who are getting more interested in India. One example is activist hedge funds which are drawing up strategic plans for India. That space has tremendous scope and we might soon see activity there. If such hedge funds start succeeding in India, the markets could see further re-rating.
 
Your top calls in this market?
Our top buys are ICICI Bank, Divi’s Labs, Tata Steel, Bharti Airtel, Idea Cellular and Reliance Industries. Top sells are in IT and Lupin. Our contrarian picks are from the telecom space.

What are your earnings estimates for FY18 and FY19?

Our earnings estimate for Nifty are Rs 525 and Rs 600 for FY18 and FY19, respectively. Capex cycle should pick in a year’s time led by housing. Commodities like steel, copper are likely to do well because of various global reasons. We have been quite bullish on metals and mining space and have been recommending to buy the commodity plays even at current prices.