High exposure to fixed income would be more prudent now

Valuations are not cheap anymore and the earnings season has been disappointing too.

May 28, 2013 5:38 IST | India Infoline News Service
This may not be the best time for equities, with stretched valuations and a correction looming over the horizon in the face of moderating consumption demand and decelerating GDP growth. Besides, the possible $12-15 billion worth of issuances lined up to meet Sebi’s minimum public shareholding norm and the PSU divestment target of over Rs. 30,000 crore could act as an overhang on markets.

Edited excerpts of my interview in Economic Times:  

The selloff in Japanese equity markets last week has raised questions about the stability of global markets. What are the risks of the global liquidity tap getting tighter, amid talks of US Federal Reserve withdrawing the stimulus?

The indication given by the US Fed that it will reduce asset purchases if the economy improves may have caused the selloff in Japan. Obviously, if the stimulus is withdrawn, it can affect the flow of money into emerging market equities. However, in my opinion, a withdrawal of liquidity support when unemployment is still high will not be risked. Many central bankers are committed to keeping interest rates low and have enforced cuts recently. I would say, in the near term, prospects look okay as far as liquidity flow into emerging markets is concerned. In the medium term, however, global economy faces a huge challenge from merely pushing the problem forward and not resolving it.

The RBI has said that it will take falling inflation numbers into account while making monetary policy decisions. Dalal Street has built hopes of one more interest rate cut in the next RBI policy meet on June 17. What is your assessment on the interest rate scenario?

While WPI’s large weightage of metals may have exaggerated the moderation in inflation, the ~150 basis points temperance in Consumer Price Index over the past two months is encouraging. This clearly suggests that a consumption slowdown is causing lower pricing power and thus lower inflation. With weak momentum in consumption expected in the coming quarters, inflation will trend lower. RBI is likely to oblige with another 25 basis points Repo cut in the next policy meet. Post that, it will watch for a correction in Current Account Deficit and monetary transmission of the cuts — which have only been 5-30 basis points — before more action. There could be an incremental 50-75 basis points rate cut from now to March 2014.

Despite $14.5 billion investment by FIIs so far this year, our markets have hardly moved. Many fund managers believe there is little room for markets to rally. What is your call?

The Indian market has outperformed other emerging markets in the past three months and valuations aren’t cheap anymore. GDP growth has been decelerating and moderating consumption is evident in declining retail store sales, depleting auto sales, subdued credit card usage and reduced domestic travel. Infrastructure is unlikely to pick up anytime soon due to land and financing issues. Private sector investment will be unresponsive as long as capacity utilisations are subdued and the deleveraging exercise is not completed. The likely $12-15 billion equity issuances in FY14 to meet regulatory requirement of minimum public shareholding and PSU disinvestment will act as an overhang on stock prices.

Fourth-quarter earnings from sectors such as capital goods, infrastructure and PSU banks have not been up to the mark. Do you think earnings slowdown has bottomed out?

My impression is that the quarterly result season has been mostly disappointing so far. Nearly half of the 180-odd companies covered by our research team have declared results and nearly half of them have disappointed. Sectors like capital goods, infrastructure, cement, utilities, energy and PSU banks have disappointed, while consumer, pharma, IT, telecom and private banks have generally done well. Broadly, earnings estimates for FY14 are still being cut, and I don’t expect an upgrade in the near term.

The debt levels of many infrastructure and real-estate companies are very high. How do you think companies can address this?

It’s no secret that investment sentiment is poor and has been deteriorating for the past 3-4 years. Companies mainly in infrastructure, metals, real estate and utility sectors have accumulated huge debt and this is unlikely to be serviced through operational cash flows alone. These companies will have to divest core and non-core assets to reduce their debt to manageable levels. They should be able to find buyers for these assets, provided their expectations are realistic and they are willing to take a haircut. Companies sitting on huge cash pile are in no hurry to deploy funds and would wait for things to improve on the ground.

Which are the big sectors you are currently overweight on? Are you betting on sectors linked to revival of the US economy?

Talking of sectors, pharma will gain from limited competition in the US generic business, strong domestic and emerging markets growth and sustained INR weakness. Information technology companies will capitalise on improving US economy and emerging stability in Europe. In banking, private sector banks will post relatively stronger earnings growth and balance sheet profiles.

What’s your big investment theme over the next one year?

Executive decision making has badly suffered in the past few years and we can be hopeful of a pickup in momentum post general elections. Interest rates are expected to decline sharply over the next one year, as inflation collapses and demand for capital recedes. A kick-start to the investment cycle and revival in consumption demand can be the next big theme, although still some time away.

What is your investment philosophy, how much exposure should one take in equities and debt right now?

An asset allocation approach is the best strategy. Historically, 90% of returns accruing to an investor are a function of asset allocation. Since these are not the best times for equities, investors should maintain a lower exposure, say 20% and gradually increase it in line with market correction. For now, high exposure to fixed income would be more prudent.

General elections are less than a year away; how do you expect markets to behave?

The ruling party will be on its toes, not just owing to general elections but also with upcoming state elections in Rajasthan, MP, Chhattisgarh and Delhi. Although the UPA government will try to push reforms, progress in the near term, on critical issues like land acquisition, mining and infra development is unlikely. From a stock market perspective, volatility will run high ahead of elections, but in our opinion, whatever the outcome; it will only help reset the system and kick-start the reform process once again.

In the near term, prospects look okay as far as liquidity flow into emerging markets is concerned. In the medium term, however, global economy faces a huge challenge from merely pushing the problem forward and not resolving it

The above article first appeared in the Economic Times on May 27, 2013

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