A narrow bull mkt does not give much comfort: First Global's Shankar Sharma

Sharma expects earnings growth in FY20 to be in low single digits

High oil prices and the possibility of corporate earnings growth not coming through are the two biggest risks to the Indian equity story, Shankar Sharma, vice-chairman and joint managing director at First Global, tells Puneet Wadhwa. He expects earnings growth in FY20 to be in low single digits. Edited excerpts:

Are current market levels sustainable irrespective of the outcome of the ongoing general election?

The market rally, at least in the large-caps, is based on very average fundamentals in terms of corporate earnings. Only a handful of stocks have been driving the markets higher. Typically, this does not sustain for very long. While the markets can still run up — narrow bull-markets can run for a while — such rallies do not generally end well.

A bull market, in order to run hard, needs two things — low interest rates and good earnings growth. While on the first parameter, we have a very dovish Reserve Bank of India (RBI), which is a good sign as far as the equity markets are concerned. Earnings growth, however, remains worrisome. We have waited for nearly 20 quarters for an earnings revival. It's been easier to spot the Yeti (footprints), than this animal called earnings growth. If anything, earlier contributors to the earnings growth such as autos have started to get into a de-growth mode. So, a narrow bull-market does not give a lot of comfort.

Do you see a sharp correction in case the current dispensation does not come back to power?

Historically, the markets have had no real love for any party. The markets are a very promiscuous bed fellow. In 2004 when the Bharatiya Janata Party (BJP) did not come to power, the markets slipped for a few days and then delivered the best bull-market we have seen in 25 years with compounding of around 55 per cent for three–four years. In 2009, when the Indian National Congress (Congress)/United Progressive Alliance (UPA) came to power with better numbers and a far stronger coalition, the markets surged 20 per cent. However, the story was quite different when their tenure was nearing an end. That said, I don’t pay much attention to what the markets’ immidiate reaction is to the change in government. Even if the same government comes back to power, the markets would eventually look past it. This is much like the Budget, which is a much-touted event. The reality is that what the market does that day is forgotten in a few days. 

What would you expect from the new government in terms of policy and reform agenda for the next five years?

If the same government returns, then one can expect the same set of policies or sameness to policies. This is true for companies, as well, when you have the same management running the show, which will replicate the same or similar policies till they are at the helm. That’s the way human being work — we rarely break from our own track record. If one needs a dramatic break, then one needs to change. If the government changes, one can expect a different set of policies and strategies at play. From a market perspective, it is all relative. At different points in time, the market will treat the same set of facts differently.

Consensus estimates peg the earnings growth in FY20 at around 20 per cent. What are your views?

20 per cent is a nice number, but unfortunately we have never met this consensus estimate since the past few years. My sense is that FY20 earnings will remain weak with a downward bias, as the core economy is not doing well. The consumption, too, has been slowing down and it is getting reflected in the auto sales/demand figures. Autos represent a kind of economic growth, which is consumption-driven. When that starts to go into a de-growth mode, then one needs to question whether a big pillar of economic growth, which is consumption, is itself now sputtering. 

The capex and the industrial production parts of the economy are already hugging the zero line. The capex part is nothing to write home about. So, if the consumption starts to slow, whatever little growth in corporate earnings we have seen is also at risk. Earnings growth in FY20 will be in low single digits.

The Sensex has returned around 9 per cent every year on a compounded basis since May 2014 when Narendra Modi took over as prime minister. How do the next five years look?

The Sensex returns have been way below their long–term trend in the last five years, which is around 15–16 per cent. The main reason for that is very poor corporate fundamentals and lack of earnings growth. Unless that changes, I don’t think the overall market-return figure can be substantially improved. The markets may chug along at these (return) rates. From a two-month perspective, however, the return can be higher, but it will average out over a five-year period. 

The big factor, as I said, is corporate earnings. If they remain at the current levels, the five-year return will not be too high.

So if earnings growth does not come through, do you expect the markets to correct in the second-half of 2019?

The markets are not cheap at the current levels. To sustain these multiples, 5–8 per cent growth in earnings will not be enough. This needs a very strong fuel. Market correction should not come as a surprise. That said, the global equity environment is very, very benign. Once that tailwind exists, India will perform in line with the other emerging markets (EMs). For now, let’s not get worried about how Indian equities will perform as world equities are in a sweet spot, and that will cover a lot of domestic headwinds.

Where can investors park their money for the next 12–18 months?

I like the small-cap segment. They had a terrible 2018 but had run up a lot in the preceding four years. Post the correction, several companies are looking good. A lot of stocks in this space have good dividend yield and are looking cheap. This is the segment which will be a surprise element as regards returns in 2019 and beyond. I do not like large-caps as they are too expensive.

Broadly, the markets remain good and should wade their way through the election-related uncertainty. Investors need to find companies in the small-cap space that are in single-digit multiples and have healthy cash flows. Small-caps are really the place to be in and I strongly believe that.

Aviation has seen a lot of developments since the past few weeks. What’s your reading of the situation and how should investors position themselves here?

The developments have been positive for the existing players. That said, the developments have also put into question the larger thing that India at all can afford a full-service airline or whether it becomes purely a low-cost carrier model. Full-service carriers such as Air India and Jet Airways have struggled. 

Should one allocate higher to defensives?

Given the rupee, which looks weak, exporters look good. Therefore, the information technology (IT) sector does look attractive. Also, given the fact that oil does appear to be headed north, we are looking at a very, very weak rupee. 

What about banks and non-banking financial companies (NBFCs)?

I don’t like either. Barring some opportunistic ones like IndusInd Bank, I don’t like banking as an industry. NBFCs I like even less so. What banks don’t want to do themselves, they let the NBFCs do it. Everyone has a great three–four years in the NBFC business. There is a big asset liability mismatch (ALM). They are lending to the riskiest sectors in the industry -- i.e. the real estate and promoters. In the housing finance segment, companies do not get much spread. One needs low cost deposits in order to do low cost lending in housing finance. It is an over-crowded segment.