While being cautiously optimistic on the outlook for global and Indian equity markets as we head into 2013, Punita Kumar Sinha, managing partner, Pacific Paradigm Advisors tells Puneet Wadhwa in an interview that within the emerging markets, China may get more FII flows as compared to India. In the Indian context, she believes that equity markets have limited room to re-rate on fundamentals but sentiment could drive market performance. Edited excerpts:
What is your assessment of how the markets could pan out in 2013? Do the current levels and valuations factor in the possibility of a solution, even if temporary, to the US fiscal cliff issue and the developments across the euro-zone?
It is difficult to say if the current valuations are factoring in this. The valuations in the euro-zone are reasonably attractive. While on one hand you have the continued problems across the euro-zone, there could be a positive outcome on the fiscal cliff issue in the US.
The US government is aggressively working towards reaching a solution, and I think a compromise will be reached although it is hard see that happening before January 2013. This should provide some relief to the US equity markets. The Euro-zone, however, will continue to be in a volatile situation.
As regards valuations of the Indian markets, we are already at PE multiples which are only slightly below their 10-year averages. So, re-rating in terms of fundamentals appears unlikely. But because the overall sentiment is positive given the Government’s reform drive and the upcoming Union Budget in February, the markets could move up from here on. This up move will not be due to the fundamentals, but will likely be sentiment driven.
Where do you see the Indian markets one year from now?
I don’t think based on fundamentals, the markets will move up beyond the earnings growth, which is around 12 – 15%. If there is no re-rating, this is the return one can expect in normal circumstance. However, if there are any positive developments in terms of reforms or the Union Budget, the markets will react accordingly.
What, in your opinion, does 2013 hold for global flows into Emerging Markets (EMs), especially India? Can they better what we have seen in 2012? What could be the possible deterrents to these flows?
I think flows to the EMs will continue. I feel that as an asset class, the EMs could see more flows next year. But I doubt that India will get more/large chunk of these flows. There are other regions within the EM that are more attractively valued, particularly China which has started to outperform India in the last couple of months.
This trend may continue for a while, especially if the news flow on the macro-economic front remains positive. So, while India may get flows, China may get more flows in the EM region as compared to India.
There are expectations that the central banks across the globe will continue to pump in enough funds, which in turn, will drive the demand for risky assets. Would you agree? Do you see fundamentals catching up anytime soon?
The demand for risky assets will remain good in the next year. If you look at various asset classes, fixed income segment in the developed world, particularly the US, has had several good years. At this point, to expect significantly good returns from fixed income versus equities does not seem very likely. Thus, equities are likely to do better than fixed income although in India, fixed income markets could still do well.
Within equities, when you have a situation where global conditions are better than what they have been in 2012, investors will buy into risky assets because they perceive that the growth outlook and the valuations are quite decent and attractive at the current juncture. It is not that the investors want to take more risk with their money, but they believe that EM is a good place to be in for future growth.
Given all this, what are you advising your clients at the current juncture?
We feel that EM and Asian equities should continue to do well for the next several years because there is sustainable growth in a number of these countries. Equities in general are a better place to be in the developed world versus fixed income. In the Indian context, the fixed income segment could actually still do fairly well besides the equity segment.
When do you see the Reserve Bank of India (RBI) easing rates?
Economic growth has slowed down and that should help the RBI to take a decision on rates. Inflation, however, remains sticky. While the central bank will focus on inflation, they are also keeping a tab on the growth rates. I think that the rates will head down next year for sure. I wouldn’t like to hazard a guess about the quantum of rate cut, but the overall trend now will remain down.
Do you think RBI is little behind the curve compared to government in supporting growth? Are the growth rates projected and targeted by government attainable, or will the overall growth figure come in lower?
The overall economic growth in 2013 could be between 5– 6%. The investment cycle has not picked up significantly yet for growth to be above six%.
Is there any striking fact that you would like to highlight based on how equities have performed across the globe in 2012?
If you look at what has outperformed this year, there has been a sector effect globally. If you look at both US and India, despite both the countries having very different economies and having vastly different headwinds and challenges, investors have seen returns from the consumer discretionary and the financial sectors in both these countries.
On the other hand, information technology, energy and materials’ sectors have underperformed in both the countries. Consumer discretionary sector, I feel, could keep doing well in India in 2013. Energy and materials, which also fall under the cyclicals’ bucket, could perhaps start looking up if the economic conditions improve.
What is your view on the banking and pharmaceutical spaces in the light of the recent policy measures and the valuations these stocks are available at?
There are opportunities in the banking space, but one has to be stock specific. Financials, in India, have been the best performing sector across Asia – up nearly 45% year-to-date (YTD), comparing very favorably to anywhere in the world. While the sector may continue to do well as we go along, the returns may not be as spectacular as seen in 2012.
Pharma again is a very stock specific story. Over the last couple of years, a number of Indian companies have benefitted from the drugs going off patent in the US. So, these returns will taper off and the sector as a whole will see stock specific action.
What about the cyclicals?
In terms of valuations if you look at cyclical versus defensives, cyclicals have been trading at a significant discount on P/BV (price-to-book value) basis, which is more than the historic average discount. From 2005 – 07, the valuation discount of cyclicals to the defensives was a lot less than now. Therefore, as the economy recovers, cyclicals still have room to outperform the defensives.
So, what’s the big story in terms of sectors for 2013?
Indian market has a number of stories / themes that can continue to do well. Banking, albeit stock specific is one theme; cyclicals is another. Select mid-cap consumer names should do well and they already form a part of a core portfolio.
The valuation of large-cap stocks currently stands at a forward P/E of around 13.5 times versus 14.6 times, which is their 10-year average. On the other hand, valuation of the small/mid-caps, the 10-year historic P/E average is around 10.6 times and they are trading at a forward P/E of around 10.1 times currently. Thus, both the large and the mid-cap segments are at somewhat similar valuation discounts versus their history, and returns will be very stock specific.
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