"There is a disconnect between current market valuation vis-à-vis earnings" | Outlook Business
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Soumik Kar

Where the rich are investing 2016

"There is a disconnect between current market valuation vis-a-vis earnings"
Insights from India's leading private wealth advisors at Outlook Business’ 5th annual roundtable, Upper Crest - Part 1

N Mahalakshmi & V Keshavdev

L to R: Atinkumar Saha, head, wealth management, Deutsche Bank; Sandeep Das, MD, private banking, Standard Chartered (India); Atul Singh, CEO, Julius Baer India; Sharad Mohan, MD, retail bank, Citibank; Himanshu Bhagat, managing partner, IIFL Wealth Management and Rajesh Saluja, CEO, ASK Wealth Advisors

Outlook Business: Last year, the view in the room was optimism laced with a dash of caution. As it turns out, the environment today is far better than last year. Interest rates have come off, the economy is showing signs of revival, inflation is cooling down and we also had a good monsoon. So, are there any factors that can offset this recovery and have an impact across asset classes?

Himanshu bhagat managing partner, IIFL Wealth Management
Sandeep Das:
For the past three consecutive years, we have had high interest rates, poor monsoon, weak economic activity… all of which played out in a sequence. Today, we are looking at the reverse — better monsoon, easing interest rates. We expect another 25 basis points cut in December or in early 2017 and increased consumption led by the 7th Pay Commission. So, we are overweight equities and expect it to yield a good return in the coming year.

Outlook Business: Himanshu, is that your view as well and is there a specific trigger for equities to outperform, because usually you need one big push factor...

Himanshu Bhagat: We are bullish on equities as well. But, there is also a disconnect between the current market valuation vis-à-vis corporate earnings. Hence, any kind of a shock can trigger more volatility. I don’t think there is any one thing that will change the outlook, unless there is a dramatic change in the crude price as we have been a big beneficiary of the same. Apart from that, I don’t see any other event that can derail the momentum.

Rajesh Saluja: The one factor, probably, will be improved earnings which will play out from the third quarter. The transmission of lower interest rates and the impact of GST on branded consumer goods will also act as a kicker. In fact, compared with most other emerging markets, which have gained anywhere between 10% and 30%, we have hardly moved 7-8%. Even our P/E premium, within the MSCI global index, at one point, was the highest at 40-50%. Today, it is just 15-16%. So, optically we may look expensive, but there are very good opportunities both within the index and outside of it. So, our view is to stay invested in quality businesses where earnings growth is strong and these typically will be pharma, FMCG and the likes.

Sharad Mohan: We, too, are overweight equities. If you look around, all the variables which are internal to India are playing out really well. Our view is that financials, energy, and pharma will benefit the most, while IT and commodities will struggle. The big risks are external to India and have a lot to do with what happens in Europe, the Brexit fallout and the US elections. But given India’s underlying growth story, the impact of all these events will be transient.

Outlook Business: Atin, what’s your view on valuations?

Atinkumar Saha: As far as valuations are concerned, we believe it’s no longer cheap. We normally look at equities from an asset allocation perspective and that could vary based on the risk profile of our clients. From that perspective, we are neutral on equity with a positive bias in 2017. If you look at equity MFs from a long-term view, there is no reason why one needs to be skeptical. Returns for large and small-cap funds over a five-to-10-year period have ranged anywhere between 15% and 25%. In the near term, though, we are keeping an eye on corporate earnings, which continues to be sluggish. While the coming quarter will be marginally better than the previous, there is no reason to believe that the numbers will be great. We expect a better performance somewhere in the second half of 2017 with GST getting implemented and rural consumption playing out. The other area of concern is around private investment, which is yet to pick up. Government spending cannot make up for a weak private investment cycle.

Outlook Business: Where do you see the risk to earnings?

Atinkumar Saha Head (wealth management), Deutsche Bank

Saha: Right now we are only seeing demand in staples and discretionary, but nowhere else are we seeing increasing demand. Capacity utilisation is hovering around 70% and that number needs to get better. Utilisation levels have to be at 80-85% for India Inc to think of fresh capacity creation. So, we will continue to look at an overall muted earnings growth till such time that the investment cycle picks up and leads to fresh creation of assets.

Outlook Business: Rajesh, you spoke about earnings being the primary factor that will drive the market. Where does your bullishness stem from?

Saluja: Clearly, the private investment cycle is a good 18-20 months away, but I think the biggest investment is happening through the VIDS (Voluntary Income Disclosure Scheme) route. Look at it this way, the scheme is going to fetch the government a good 40,000 crore, which is a big boon. Also, not many have noticed and factored in their estimates, the subsidy and crop insurance by the government. $25 billion worth of crop has got insured and that means the government is trying to bring stability to rural income, which was always dependent on monsoon. By taking out that variable, the farmer, who was till now worried about the next monsoon and the need to save for a rainy day, will now have money to spend. Besides, the 7th Pay Commission, too, will come into play and have a spill-over effect. 

Outlook Business: But won’t it take time to play out...

Saha: ...there is another bottleneck which we need to be aware of and that is the inability of the banking industry to leverage on the macros. With NPAs of 800,000 crore, a chunk of bank credit is still stuck in cyclical companies. So, the private investment cycle taking off will also hinge on the easy availability of finance. But we are looking at some bit of a succour which was evident in Urjit Patel’s statement on bad loans. In that sense, banks and leveraged companies will have a little more space to re-engineer and make a fresh start.

Outlook Business: The non-transmission of lower rates is by design, as banks want better NIMs to cover the NPA pain. So, are we being presumptuous that because the RBI will be growth-driven, banks will also follow?

Atul Singh: Well, in terms of interest rate transmission, will corporates borrow because funds are available at 7% and invest it in building productive capacity? The answer is no. I think there’s far too much capacity in the system and, from a private sector perspective, merely reducing the interest rate will not kick-start the investment cycle anyway.

However, though the investment cycle has not recovered, the government is trying to keep the momentum going through defence, railways and infrastructure. The consumption story continues, thanks to the 7th Pay Commission, besides interest rates are already on the mend. We can always argue how much of it is getting transmitted or not. 

While the impact of monsoon on consumption might play out with a lot more certainty, the impact of reforms on the economy is, at best, going to be patchy. For example, the short-term pain of implementing GST itself will be massive. Assuming that it gets implemented on April 1st 2017, there will be massive de-stocking, inventory reduction by companies, which will actually take the steam off revenue growth.

This is Part One of Outlook Business' 5th annual private wealth roundtable, Upper Crest. You can read Part Two here and Part Three here.

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