Mumbai: After the Goldman Sachs scare, the markets recovered well to close last week on a stable footing, with the Nifty back at 5,300 points. But with Greece still on the brink, will the markets be able to cope with continued uncertainty on the global front?
Pankaj Vaish, managing director and head of equities at Nomura Financial Advisory and Securities (India) Pvt. Ltd, says the crisis should not be a major problem for the Indian markets. R. Sukumar, managing director and chief investment officer, Asian equities, Franklin Templeton Investments, too, feels that the markets’ ability to withstand some minor bad news and volatility is much higher today than it was two years back. Edited excerpts:
Has the Goldman Sachs scare been digested by the markets or is it too early to say that?
Increased volatility: Nomura Financial Advisory’s Pankaj Vaish (left) and Franklin Templeton Investments’ R. Sukumar.
Vaish: I think, especially for the Indian market, it should not have been huge anyway. Goldman Sachs has come back very strongly with the statement and some defence with what they think are exaggerated charges... The political climate is difficult enough that this investigation will probably go on, but given the quality of management there, I am sure they feel very good that they are on strong grounds.
So if it is not bad enough for the US financial market, I do not think it should be, at all, a problem for the Indian market. This is not a wide thing, this is a very specific transaction that they are talking about. So I do not think that in itself should be a major problem for the Indian market.
Are you surprised at the resilience of global markets because they panic for a day—it happened with Greece, then Goldman Sachs and before that with Dubai—and then they manage to just bounce back? Is it just too much liquidity or is it that these events by themselves are not big enough to threaten the trend that we have been in?
Sukumar: I think it is both. Liquidity is obviously pretty high and that’s ensuring that the markets are fairly resilient. Also, people went through bad news in the last two years, so the ability to withstand some minor bad news and volatility is much higher today after undergoing all that we went through in the last two years.
So it’s a combination of both.
Cyclically, we are seeing recovery in most parts of the world, though there are concerns that the growth itself is not going to be as strong as it used to be before 2007, especially in the Western world. But from a short-term point of view, the markets do not have to be correlated to economic growth.
How do you gauge risk appetite? Is it smacking of complacency to you, the way markets are dealing with these kind of events, or do you think it is well-founded—the kind of risk appetite that is on now?
Vaish: I get a little bit torn between G-7 (Group of Seven) markets and the Indian market. So I would agree with you that in the US market, if I was still sitting in New York today, I would have been a little more concerned and circumspect about the various things that are going on. Goldman is just one; there is still the issue of Greece, although I think that is now being played out many times, so may be that is well digested.
There is some talk of housing going through second round of negative numbers. So there are plenty of things to be concerned about there.
In the US, there is very strong sentiment in terms of VIX (volatility index) being very low, and you can see call options on Citigroup (Inc.) have been purchased pretty much like a lottery ticket effectively. In India, on the other hand, I don’t think there is massive exuberance.
In the last three months, I have spoken to 50 clients and 90% of them were neutral to slightly negative. I know the money is still coming in. So I don’t get a sense of people being massively long, massively exuberant, and you see that. The price action is not crazy until two days ago, you tend to get corrections, you get a 5-6% and then the bids keep coming in.
Another place to look at it is in FX (foreign exchange) forward. In FX forward, you don’t see the kind of discounts that we used to see in 2007. So you would see forwards, rupee trading at a premium. This time you don’t see that. So I don’t see too many signs of wild exuberance. I think many people have been circumspect about the rally and yet get forced into it because they don’t want to underperform like the last two years.
Would you agree with that point that while there are concerns about elevated valuations, this time there is no sense of euphoria yet in the market?
Sukumar: I agree. For the broad market, I don’t think there is euphoria. Looking at a general valuation, I don’t think they are as aggressively priced as was the case in 2007. But at the same time we have to keep in mind that many companies have to raise capital. I think it is going to be a supply of stock more than what we have seen in the past and that would probably induce the second round of flight to quality. I think it has already started and I think we will probably see that process continue. So I think that is probably going to be one of the trends in the next few quarters.
Given what you just said, would you expect the index to remain more or less range-bound, but the broader market has a better chance of outperforming?
Sukumar: The mid-caps have been doing phenomenally well in the last two-three quarters in terms of numbers reported, which is understandable because the earnings volatility of mid-cap companies is higher; when there is a recovery in the economy, they will do pretty well. Also, the stocks have done well. But we have to keep in mind that the valuation of mid-cap companies are expanded much faster compared to larger companies and also quality-wise; the average quality among large-caps is better than the average quality among mid-caps. So, on (a) fundamental basis, it’s very hard to justify continued outperformance of mid-cap companies. But if local liquidity is very strong, it would help mid-caps do better for some more time.
How are you calling the market for the rest of 2010?
Vaish: Our view coming into the calendar year was probably like mid-teens return kind of a year, perhaps in the first part just marking time based on Reserve Bank of India (RBI) tightening... When we did our conference at the end of January, we were making that point that we thought rates were too low and they should have started. So I think they (RBI) were slightly late, but I am very happy that they have begun and they seem to be very thoughtful and deliberative about how they are going about it. So that is very reassuring.
For foreign institutional investors (FIIs), the two big things tend to be inflation and deficit. I think everybody agrees that growth is very strong in India and will probably remain so for 10 years. But it’s the macro stuff that scares FII investors. So the fact that the finance minister did a very good job as we spoke on the Budget day and also the central bank has begun tightening is reassuring on both fronts. So our view is that now the plateaus keep rising for the market. We will stick to mid-teen return for the year.
Sector-wise, we feel that now State Bank of India and ICICI Bank (should) perform; the rate-sensitive should now start doing well. Some of these banks that had underperformed last year and also some real estate like Unitech (Ltd) which our analysts like a lot. So we thought interest rate-sensitive (stocks) now make sense.
How are you positioned in the interest rate-sensitive stocks, particularly banks, in the context of the rate environment that we are in?
Sukumar: Banks, we are looking at the quality of franchise; we are not trying to time the interest rate cycle as far as the banks are concerned. PSU (public sector unit) banks, we are less confident about sustained profitability because there is some chance that the portfolio quality might deteriorate over a period of time and would require increased provisioning. So we are looking at banks which have strong franchises and can continue to grow both the balance sheet as well as the net interest margins. So, we had quite a bit of exposure to some of the private sector banks.
Do you see inflation as a big threat to the Indian market through the course of 2010 or do you think RBI will be successful in taming any kind of a spike there?
Sukumar: RBI has credibility, so we should generally be more confident. But having said that, it is a huge problem. It was initially the food prices, but I think the capacity utilization is increasing across sectors, which means that in many sectors the pricing power will increase—that is not good for prices. So I think there is a threat that the inflation might spread.
In markets like the US, increasing interest rates can bring down consumption because individuals are leveraged. With increase in interest rates, I think there will be less propensity to borrow and consume. But here the retail people, who are spending, are not necessarily leveraged and the companies that want to put up capacity have to go to the banks and borrow. So increasing interest rates might not help (in) increasing new capacities.
So it is very tough to say how RBI should act in the face of increasing inflation. But I think we will have to see how it plays out; I think we are not out of the woods, though the credibility of RBI should give us some comfort.
We were talking about inflation, does it worry you that in the middle of 2010, we could have some kind of a spike which the stock market might get terribly worried about, or you are confident that now that the process has started, it will be dealt with?
Vaish: I think that worry is always there, particularly because we didn’t come off a lot during the slowdown. Cyclically, the one thing that should have helped is that if you go through a slowdown then CPI (Consumer Price Index) should have at least come down to 8-9% or gone through 8% but it just didn’t happen. That is why we were puzzled as to why RBI was delaying tightening.
Do you think the monsoon assumes even greater importance this year or you think the market might be able to deal with it even if it is a second consecutive sub-par monsoon?
Sukumar: The risks are going to be very high if we have a second consecutive sub-par monsoon. The food prices can continue to be strong and I think that would be a very scary situation. I don’t think they can afford that. I think that failure of second monsoon is definitely going to test the nerves of the market.