Earnings trajectory for mid-caps remains strong: BNP Paribas' Anand Shah

The global monetary and economic policies such as the US Federal Reserve monetary policy is a key factor, says Shah

While lower crude oil prices and a strong rupee are positives, uncertainties abound in the form of elections, US-China trade war and a possible rate hike pause by the US Fed. However, Anand Shah, deputy CEO and head of investments, BNP Paribas Asset Management, tells Jash Kriplani that he is confident that things should settle down in the second half of 2019. Edited excerpts:

Where do see the markets headed in 2019?

We believe that earnings will be positive, but we need to be cognizant of the fact that the first half of 2019 could see several headwinds from macro events, keeping the markets volatile. Be it the US Fed's decision on rate hikes, trade wars or the domestic general election. Once all the uncertainties are behind us, the second half is expected to be driven by earnings and there could be some good news for the market. We believe that 2019 will be more constructive, but the first half will be more driven by news and events rather than fundamentals.

Which macro factors will impact the markets the most?

We believe there are four key ones which we will have to watch closely. The global monetary and economic policies such as the US Federal Reserve monetary policy is a key factor. The focus will mainly be on the pace at which rates are being hiked (two rate hikes indicated as per the latest Fed meeting outcome) and the pace of balance-sheet unwind. Then any escalation of the US-China trade war could have a bearing on large as well as related smaller economies, hurting their competitiveness, capital allocation, resources and economies of scale. Crude oil price is another important macro, which could stabilise this year owing to production cuts by Opec and slowing growth in global demand. Besides these, the upcoming general election is another key event to watch out for.

How will easing crude oil prices and a stronger rupee impact us?

The strengthening of the rupee is because of the macro environment and not the other way around. The sudden, significant correction in crude price in November and December is positive. The softer food inflation continues to keep the domestic inflation benign. We continue to see a soft bias towards food prices, which have been sort of an Achilles heel for Indian inflation for many years in the past. On the other side, farm loan waivers have significantly dented state finances. 

Are mid-caps looking attractive at current valuations? 

From a broader perspective, we have had underperformance of mid-caps as compared to large caps and to that extent, valuations have been reasonable. Second, the tailwinds of economic recovery led by consumption continue to benefit smaller and mid-sized companies more than large-sized companies in terms of earnings growth. Earnings growth trajectory remains strong in the mid-cap segment. Combination of higher earnings growth and more reasonable valuations makes us believe that mid-caps are fairly priced and the risk-reward is favourable.

Though valuations have come down, do you see further de-rating? 

The biggest and most positive aspect of Indian markets has been earnings recovery, which has come after three-four years of sluggish earnings growth. We are talking of the corporate earnings to gross domestic product (GDP) being at a multi-year low after sharply correcting from 6.8 per cent to as low as 3 per cent of GDP. More than the absolute price-to-earnings multiples -- market cap to GDP and price to book – seem to indicate that the markets are reasonably priced and to that extent the scope of de-rating is minimal. However, if we have more shocks on the macro side in the form of higher crude price or a big-bang reform that hurts the near-term earnings growth, there could be de-rating.

How do you see FIIs behaving towards Indian markets in 2019?

India is set to witness strong earnings growth for FY20. The increase in earnings growth appears achievable as the implementation of tough economic reforms such as good and services tax (GST) is behind us. This should structurally benefit the organised sectors. Longer-term growth outlook and demographics look strong for emerging markets (EMs). India is likely to be among the fastest-growing EMs. We believe a stable government formation in 2019, coupled with an earnings recovery can lead to an increase in FII flows into India. The US Fed has indicated two more rate hikes in 2019 as against expectations of three hikes. As a result, FIIs may look at emerging markets more seriously in 2019.

Which sectors are you bullish on?

We are more focused on domestic consumption stories that are business-to-consumer (B2C) businesses. Among financials, we are finding some value in the B2C NBFCs, which were quite expensive earlier. Among others, we expect consumer staples space to benefit from the rural consumption recovery and consumer discretionary to benefit due to GST and pickup in urban spending. We are finding more opportunities in earnings growth stories on the domestic side of the market and that is where we are focusing. Cement is another focus area.