A clear mandate to Narendra Modi–led National Democratic Alliance (NDA) for the second time in a row lifted the S&P BSE Sensex and the Nifty50 to 40,000 and 12,000 levels, respectively for the first time ever. JITENDRA GOHIL, head of India equity research, Credit Suisse Wealth Management tells Puneet Wadhwa that before the new government takes up any major reforms such as in land and labour, we expect that the regulators and the government to address the liquidity issues with respect to NBFCs. Edited excerpts:
What is your reaction to the poll outcome and how the markets have played out today and post the exit poll verdict?
Our markets have underperformed global peers year-to-date (YTD) and we needed a reason to rally and catch up rally was long overdue; with Bharatiya Janata Party’s (BJP's) strong performance, positive sentiments could lift the overall market into an overvalued territory, which may not sustain. Currently, the Nifty Index is trading at a 12-month forward blended price-to-earnings (PE) of 18.4 times, which is at a premium to 10-year and 5-year average of 15.5 and 16.5, respectively.
While this premium is warranted given low interests rate environment in the global markets, if the Nifty trades close to 20 times, we would recommend trimming exposure to equities and being more defensive. Clear BJP win will also trigger more buying interest for retail investors, which could offer good exit opportunities in overvalued stocks and re-orient portfolios.
What do you expect from the new government in terms of policy changes and reforms?
Let me be clear here. Reforms are good from a long-term perspective, but it has a slowdown impact in the near-to-medium term. While reforms make India structurally more attractive, there could be negative repercussions on growth and earnings that can hurt markets in the near-term. Before any major reforms such as in land and labour, we expect that the regulators and the government to address the liquidity issues with respect to non-bank finance companies (NBFCs). Moreover, the government will have to quickly address rural distress as we can't afford to let the slowdown in consumption for long. There is also an expectation to help accelerate credit offtake by recapitalising the banks to help bridged the void created by distressed NBFCs.
What’s your view on the mid-and small-cap segments? Can they outperform the large-caps in calendar year 2019 (CY19)?
For the past few months, we have been recommending mid-caps selectively. We think there is a good buying opportunity in mid-cap space. The valuation for midcaps has already corrected and now stands at 20 per cent discount to the large-cap peers. This offers a good buying opportunity. With expectations of higher flows by retail participants and overcrowded trades in a few large-cap stocks, the risk on rally will help overall mid-caps in the near to medium term, in our view.
How comfortable are you with the overall market valuation at this stage?
Valuation is stretched for Indian equities right now but if you look at the global markets, the valuations have gone up YTD for almost all markets. The US Fed was supposed to be tightening in 2019, but there is expectation of rate cut; and hence the flows into the emerging markets will keep the valuation elevated. As I mentioned earlier, if the valuation goes into euphoric zone i.e. close to 20 times or more, we will be concerned and will think of advising investors to book profits in Indian equities.
Financials have led the poll-outcome rally – both after the exit polls and the actual outcome. How should investors approach this segment now?
We still think financials will continue to do well. Lower interest rate environment will benefit and continuation of the government policies will bring some confidence. Banks with good deposit franchise and NBFCs with strong parent backing will relatively outperform markets as they have good opportunity to gain market share. We aren't still very positive about the whole distressed NBFCs space and are recommending staying away.
Infrastructure has been one of the key focus areas of the NDA government in its first term. Do you think it will remain in focus over the next five years as well?
The NDA government benefitted due to sharp fall in oil prices when they came to power and partly this helped them to spend more on infrastructure sector. While most the spending happens outside budget and by states, there isn’t enough headroom for the central government to spend aggressively, especially when the urgent need is to first fix the consumption slowdown first. Private participating is also limited. Having said that, we don't deny that speculations could lift the sector in the near-term, eventually the order flows and execution will determine overall performance.
As per the BJP's manifesto, their focus will continue to remain on infrastructure which is positive. However, from a stock market and return perspective, the infrastructure stocks have done poorly over the past five years, the initial rally fizzled out especially after the funding stressed emerged. In the road construction segment, awarding activities were solid but execution lagged expectations due to funding stress. Overall if you look at the BSE Infrastructure Index, it has delivered CAGR of just 6 per cent versus Nifty of about 11-12 per cent over the past five years.
What are your expectations from the full Budget of the new government? Do you see chances of a fiscal slippage and how will the markets react to such a development?
We do not expect much from the budget as the government doesn’t have enough headroom. While the tax collection has seen improvement in the recent months, it is still below expectations. Market is already factoring in some fiscal slippages and slightly higher borrowing from the government. However, the RBI is also aggressive with open market operations (OMOs) to absorb additional supplied from the government which is helping yields to stabilise. There will also be some state elections in coming months, like in Maharashtra. Hence, whoever forms the government will have to act fast on their promises made in manifestos, in our view.
It is important to note that what steps the government will take to improve GST and direct tax collections. There is an urgent need to take steps to curb GST tax leakages. Overall, the growth outlook is slowing and hence this could also impact tax collection forecast for FY20.
What are your top overweight and underweight sectors?
We are recommending to re-orienting portfolio towards stocks that could benefit from domestic growth revival in that cement and other structural stories like Chemicals are favoured. Low-cost housing should be the focus area of the government and hence cement should see demand improvement, in our view. We also like some niche mid-cap IT players where we are recommending building exposure. Consumption, including autos, we are negative on. However, if the monsoon is reasonably good – current forecast is below normal monsoon – consumer stocks will back again in focus. In autos, there could be some tactical buying opportunity in the later part of the year when we can see some pre-buying before emission norm changes from April 2020. In terms of policies, we believe financial inclusion is going to be the long-term structural themes and hence financials that cater to low and mid-income group could see strong performance over the next few years.