After the rout, the markets have recovered. But does the recovery rest on a shaky foundation?
The equity markets have corrected in February due to two developments—one was domestic and the other was global. The domestic factor was the introduction of long-term capital gains tax on equity and equity-oriented schemes of 10%. This changes the future realizable return for investors—both domestic and foreign—and market participants are adjusting to it.
The global factor was the sharp increase in bond yields across markets, particularly in the US. This has caused volatility to go up and some of the ETFs (exchange-traded funds) betting on continued lower volatility went belly up, increasing volatility further in the markets. As cost of capital increases, global investors would have to cut positions in risk assets to rebalance their portfolios.
Both these factors are not fully priced in. Hence, one could see further volatility in future. However, the downside of this correction would be limited due to a strong macro environment and corporate earnings momentum.
Do you think that an organic improvement in corporate earnings will dispel such fears and make the markets hot again? How comfortable are you on the market valuations?
The downside protection for the markets would come from improved corporate earnings. After the dual impact of demonetisation and GST (goods and services tax), corporate earnings in the third quarter of this fiscal have been good. Among Nifty 50 companies who declared results so far, more than two-third of the companies have beaten or have been in line with expectations. We expect the Nifty 50 companies to grow their EPS (earnings per share) by 10% in FY18 and 19% in FY19. More importantly, the earnings growth will be broad based across sectors.
On trailing P/E (current market price to EPS, or earnings per share, ratio) ratio basis, market valuation looks on the expensive side. The markets could adjust through a correction or side-ways movement due to new tax changes and increasing bond yields. Meanwhile, the corporate earnings growth could come through, making the markets attractive again. This adjustment could happen over the next few months.
There are concerns that the Nifty is in bubble territory. What is your take?
The Nifty is nowhere near bubble territory. It is expensive as it has run up ahead of fundamentals, but it is not highly expensive. Let us take the comparison with 2008 where the markets have seen the previous bubble.
Only the trailing price to earnings (P/E) ratio of current markets match with that of the 2008 period. The price-to-book (P/B) ratio is 45% below, price to sales (P/S) ratio is 30% below, dividend yield is 40% above, market capitalization to GDP is 30% below 2008 levels. The return on equity (RoE) is at 14%, which is less than half of 2008 level. The economic activity as measured by growth in Index of Industrial Production across eight core industries, as well as credit offtake, are anaemic in single-digit numbers. These were clocking double-digit growth rate at the previous peak. We are currently at the bottom of the earnings cycle as they have been flat for the past three years, whereas the earnings growth was greater than 20% in 2008. In a bull market, almost all sectors would be buzzing, which is not the case today.
As volatility returns to markets, are you concerned that the risk-averse middle-class in India who caused quite a rally in the country’s stock market in 2017 will stay for the long run? The context of the question is many of these new investors have really tasted volatility yet.
The rally in 2017 was a global one in which India has also participated. It was not just India specific. It is true that many investors entered the equity markets directly or through mutual funds in the previous year. It is also true that the volatility in the markets have been at a multi-year low and these new investors have not experienced volatility.
One big segment that entered the equity markets was the traditional fixed deposit saver segment.
As the fixed deposit rates went low, this segment started investing in low-volatility hybrid products like balanced, equity savings and dynamic equity allocation funds. The investors of this segment may get impacted by both—volatility and introduction of DDT (dividend distribution tax). There could be some churn that could be seen among them in the near term.
The other investors who have entered the markets last year came primarily through the SIP (systematic investment plan) route. This segment would look through the volatility and could invest over long periods of time.
The investors today are much more mature and aware. This is thanks to the media, investor education programmes of AMFI (Association of Mutual Funds in India) and financial services fraternity—advisors, distributors, employees, etc.Unless the markets fall is big for some reason, or if outlook on equities changes, these traditional and SIP investors would be with their equity investments for long.
Green shoots visible in private capex—we’ve heard this phrase for several quarters now—what makes it different this time around? When will we see full-fledged private capex come back?
India has been facing a twin-balance sheet problem. It is stressed at the bank level and also at the corporate level. This is reversing. With RBI (Reserve Bank of India) focusing on easing the logjam of NPAs (non-performing assets) through resolution via NCLT (National Company Law Tribunal) and recapitalization of public sector banks by the government, we should see balance sheet repair at the bank level. The recapitalization is Rs2.1 trillion out of which 25-30% could be used as growth capital.
At the company level also, the balance sheets are getting repaired. The government intervention by increasing customs duties across sectors—like steel, electronics, agri products etc.—has helped domestic companies come back to profitability. The BSE 500 companies ex of financials are seeing lowest leverage in six years and highest free cash flow in over a decade. This would allow them to turn the lever when they decide to add capacities. With the buoyant equity markets, the companies are raising equity capital to decrease debt and fund growth.
The capacity utilization is at 72% currently. Due to consumption and export engines of GDP growth picking up, it’s only a matter of time when capacity utilization picks up and necessitates putting in new capacity. It is already happening in sectors such as steel, oil and gas, paper and automobiles. It would take around 1-2 years for it to become broad based.
What makes you confident that rural recovery will gather pace in 2018? Sluggish wage growth, lower crop planting, fluctuating prices paint a dismal picture for farmers and the agriculture sector, and data indicates that rural distress is only worsening.
The rural revival is evident currently and rural growth as a theme would be a long-term structural one. The government is working with farmers at various levels. It is trying to solve the twin problem of the farmer which is the uncertainty of crop and uncertainty of price.
The former is resolved by reducing dependency on monsoon and increasing land under irrigation. The issuance of soil health cards, advising suitable crops and teaching modern techniques for higher throughput are other measures. Now with Jan-Dhan accounts in place, the funding needs of the farmer are increasingly being met. The target of institutional credit to agriculture sector has been increased by 10% to Rs11 trillion in FY19.
The latter is being tackled by formulating MSP (minimum support price) at 50% above the production cost. The deficit in realizing the MSP at the market place will be compensated by the government. All agricultural markets are getting connected through e-NAM (Electronic National Agricultural Market), which would help in price discovery. The 22,000 rural haats (temporary markets) are being upgraded to Gramin Agricultural Markets (GrAMs) so that farmers can sell directly to the consumer in retail and wholesale. There are incentives provided for setting up of food processing units.
With an effort to double farmers’ income, the government has initiated steps to increase non-farm income. There is support for dairy, poultry, fisheries and aquaculture.
Improvement in connectivity through the building of roads and regular supply of electricity improves the output of farmers and business in rural areas.
The affordable housing scheme is also working well in rural areas where people are taking advantage of the government sponsorship for constructing new houses or interest subvention for buying new houses. The target for mudra loans, given to small enterprises, has been increased by 23% to Rs3 trillion in FY19.
Overall, the rural sector is turning out to be a long term structural play from equity market point of view.
When do you see the outlook for information technology (IT), pharma and cement improve?
The Indian IT sector is looking up albeit moderately. Due to growth especially in the US, more spending could happen in IT. The Indian companies are adapting to undertake digital projects. This should bring volume growth back. However, the issues on pricing by clients and lack of clarity on immigration remains. Currency is trickily poised, but a depreciation should help companies’ bottom line. The stated policy of dividend payout and buyback helps in protecting the down side.
The pharma sector has a few more quarters to go before normalcy returns. On the negative side are, one—the pricing in the US remains under stress, and second—faster pace of approval for products by US FDA (Food and Drug Administration). On the positive side—first, the approval of facilities and removal of import alerts on them by FDA is coming through, and second—pricing pressure in the domestic market from the regulator, NPPA (National Pharmaceutical Pricing Authority), is behind.
The cement sector is poised well due to focus of government on infrastructure spending and affordable housing. If private capex improves as envisaged, it would benefit the sector. Investors could expect to see volume growth coming through due to a pick-up in economy and pricing power to improve as capacity utilization picks up.