Equity valuations are no longer undemanding: Harshad Patwardhan

Markets may deliver higher-than-historical long-term average returns over the next few years, says Harshad Patwardhan, chief investment officer-equities, Edelweiss Asset Management. He tells Ashley Coutinho that earnings growth might surprise the Street going forward as the economy accelerates from its current nominal levels. Edited excerpts: 

What is your outlook for the market? 

Over the next few years, markets might deliver higher-than-historical long-term average returns. This will likely be driven by earnings growth, which might surprise the Street as the economy accelerates from its current low nominal levels. We will not like to hazard a guess about the short term as markets tend to be unpredictable in the near term, often overreacting to noise. This might also prove counterproductive for long-term wealth creation.

How concerned are you about market valuations at this stage? 

It is true that equity valuations are no longer undemanding. However, valuations have to be seen in the context of where we are in the growth cycle. When you consider the fact that we are perhaps at the bottom of the earnings growth cycle for corporate India, with ROEs having declined steeply over the last decade and likely heading up, valuations are not as excessive as they appear. We are currently overweight on industrials, cement and consumer discretionary and underweight on pharma, IT and consumer staples.

What are your earnings expectations for FY18 and FY19? 

Over the next couple of years, we expect earnings growth to be in the mid-teens at the aggregate (index) levels. At the portfolio level this number is much higher. While there are already early signs of a capex revival, we expect more evidence to emerge over the next few quarters.

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

While we do not know many details, the recapitalisation of state-owned banks should eventually lead to an improvement in their ability and willingness to lend just as demand for credit picks up as the economy revives. In our view, actions of rating agencies are generally seen as lagging rather than leading indicators by equity market participants.

What are the global cues to watch out for?

The most important variable to keep an eye on is the global crude oil price. The sustained change in oil price levels can have a significant bearing on the economic and market narrative. Normalisation of monetary policy in the US is being done because the US economy has been doing well with unemployment rates heading down. So we do not expect any significant negative fallout for Indian markets. Most other global developments might have only a temporary impact on Indian markets. In any case, recent history shows that market participants are generally not good at predicting geopolitical events and their impact on the markets. Also, the over-analysis of low probability events often leads to action paralysis with attendant opportunity cost.

MF investment into equities crossed the Rs 1 lakh crore mark in 2017. Are fund houses facing a problem of plenty?

We are not facing any issues, but it is possible that the larger mid- and small-cap funds might struggle to stick to the mandate while also maintaining adequate liquidity in their portfolios.

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

Asset allocation is a function of variables, such as risk appetite, investment objectives, and personal circumstances. In my view, it is best to seek the advice of a competent financial advisor while determining asset allocation. We expect equity as an asset class to perform well over the medium to long term. Given the low level of equity allocation in the overall household balance sheet, individuals are more likely to be under-exposed to this asset class than over-exposed.

What are your thoughts on Sebi’s move to categorise MF schemes? 

This will bring clarity both for investors as well as their financial advisors and reduce the chances of misselling. We do not see any challenge in complying with these measures.