Benign liquidity situation to support markets: Kalpen Parekh

Parekh says investors should temper their return expectations as interest rates have fallen over the past three years and valuations have stretched considerably

A benign liquidity situation along with a pick-up in earnings, both globally and locally, will continue to support markets despite above-average valuations, says Kalpen Parekh, president, DSP BlackRock Mutual Fund. Parekh tells Ashley Coutinho in an interview, that investors should temper their return expectations as interest rates have fallen over the past three years and valuations have stretched considerably. Edited excerpts:

What is your outlook for the market? 

While Indian equities have performed well (up about 23 per cent this year), they are not an outlier as they have underperformed the broader EM (emerging markets) index. Hence, we believe this is a global phenomenon and not India-specific. A benign liquidity situation along with a pick-up in earnings, both globally and locally, will continue to support markets in the near to medium term despite above-average valuations. Markets will focus on the Gujarat election, which may cause volatility. Internationally, the focus would be on crude oil, geopolitics, and commentary from the US Fed chair. 

We continue to remain bullish over the long term, driven by factors like favourable demographics, shift from the unorganised to organised sector, low interest rates, increase in consumption, recovery in global growth (boosting India’s exports), and pent-up earnings growth. Most importantly, the reforms announced over the past three years will start bearing fruit. We believe that markets are a reflection of the economy and hence, India’s GDP has the potential to grow substantially from here on. Assuming average market cap-to-GDP ratio, markets would do well over the next 5-10 years.

How concerned are you about market valuations at this stage?  

The markets are above averages, but certainly not at a high when you look at ratios like market cap to GDP and corporate profit to GDP. From a near-term (less than one year) perspective, investors should be cautious as markets have rallied significantly this year and there could be a chance of a pullback for reasons which are unknown. We are constructive on sectors like autos, cement, banks, oil-marketing companies, and gas utilities. We are wary of telecom, FMCG, and health care. 

What are your earnings expectations for FY18 and FY19? When do you see a revival in the capex growth cycle? 

After almost three years of subdued earnings growth of just about 0.6 per cent CAGR, we expect corporate earnings (Sensex) to grow at 8-10 per cent in FY18 and 15-18 per cent in FY19.  This could be driven by banks, oil-marketing companies, metals, and domestic cyclicals in general. As far as capex is concerned, capacity utilisation across sectors and companies is still around 70 per cent, which means we need demand to pick up before the private sector adds capacity (capex). The thumb rule is, at 80-85 per cent capacity utilisation, companies start adding capacities to address future demand. We, therefore, believe that capex in the private sector is still 12-16 months away unless there is a sharp pick-up in domestic and export demand. However, the government continues to focus on infrastructure which will help boost investments and also lead to job creation. As far as infrastructure is concerned, we are still building for the past, which means that even with significant infrastructure expansion, there is still a lot of catch-up required. From a 3-5 year perspective, infrastructure is certainly a good place to invest into.

What is your reading of the recent upgrade by rating agency Moody’s and the government’s initiative to recapitalise banks? 

The upgrade is an acknowledgement of India’s efforts to push through key reforms while keeping the fiscal deficit in order. A rating upgrade is generally followed by higher portfolio inflows as many funds are mandated to invest only in securities above a certain benchmark. We believe this development will lead to further inflows and support the rupee further. 

The move to recapitalise state-owned banks is a step in the right direction. It enables PSU banks to make adequate provisions for stressed assets and will also free up growth capital enhancing lending capacity – especially to micro, small and medium enterprises, and priority sectors. However, credit growth is also a function of demand, not just the supply side (bank recapitalisation). So, if the end-user demand (like private sector capex) doesn’t improve, banks may be willing to lend, but may not find avenues to lend to. 

What is your advice to investors at this point in time? 

Every growth cycle sees new investors coming in with high expectations. Investor should temper their expectations as interest rates have fallen over the past three years and valuations have stretched considerably. We would do well to moderate return expectations from both equity and debt. While equity fund returns are not predictable for a 3-5 year horizon, they have beaten other asset classes over longer time frames. So, invest in equity with a 10-year horizon. Equity returns are lumpy and cyclical, so don’t extrapolate last three years’ returns to future returns. Use debt funds for investment horizons lower than three to five years. It’s not easy to accept fluctuations when markets turn volatile. One can also consider balanced funds or active asset allocation funds, which shift between equity and debt depending on which asset class is more attractive.