Fair value for market at least 15% below current levels: Saurabh Mukherjea

It will be great if the government approaches the first Budget and five out of five years of the second term with the same approach, says Saurabh Mukherjea, founder, Marcellus Investment Managers

With PM Narendra Modi receiving a stronger mandate for his second term, Saurabh Mukherjea, founder, Marcellus Investment Managers, elaborates on expectations from the new government and the markets, in a conversation with Hamsini Karthik. Edited excerpts:

What are your expectations from the new government and for the market?

Governments and markets are two different things. The question is whether democratically elected governments make a meaningful difference in the functioning of the economy. That said, in the first two years of the previous National Democratic Alliance (NDA) government, we saw the energy and resolve. It will be great if the government approaches the first Budget and five out of five years of the second term with the same approach. If the government shows its ability to tackle issues such as infusing fresh capital into the banking system and providing a social security safety net, the country will be in a better position. Indradanush 1, Indradanush 2 and so on seems to be an exercise of futility for the banking system. Instead of a piecemeal attempt every six months like Aayushman Bharat, Maha Pension and PM-KISAN and on an intermittent basis, farm loan waiver, it will be great to see a unified framework by the Centre for the social security net. Sums involved are modest and it’s a political vote winner. 

The market (S&P BSE Sensex) already seems to be factoring in a lot of these.  Do current valuations bring comfort to you?

My caution with regard to the broader market hasn’t found support elsewhere and my view remains that a majority of frontline companies in our country have questionable financials. It doesn’t support the valuations that the Nifty gives them. So, somewhere around 9,500 and 33,000 seems the fair value for the Nifty and the Sensex — a good 15 per cent below from where we are. In a post-election climate, there may be a relief rally. But, as we get into FY20, sober realities such as the precarious situation of the financial sector, difficult fiscal situation and weak job creation will hit and lead to the overall market levels being moderated. 

You’ve been vocal about potential troubles if global economies tighten their purses and trade wars continue?

The precarious nature of the market is that these factors are half factored and half not-factored for. Barring two or three non-banking financial companies (NBFCs), there are serious problems in the system. Wholesale market-funded lenders can’t pull through as they were borrowing short and lending long, up to 20 years for housing financiers. They were also lending to assets of adventurous quality. IL&FS in a way is a reality check for the whole construct and we are halfway through the reality check. In the remaining six months of the year, we will see the final chapter of the reality check unfold. We may end the year with a far smaller NBFC sector. As for trade wars, I don’t see that as a massive negative for Indian exporters. We may see China devalue its currency. A consequent rupee devaluation by itself is not a great problem. Where it is complicated is if it forces the RBI to tighten liquidity and thus compounds problems for NBFCs. 

Hopes are ripe for another rate cut…

I think the RBI needs to cut rates by 50 basis points to deal with the sheer extent of problems faced by the NBFC sector. But, that will not lead to a recovery in the economy — in terms of redemption in vehicle lending or capital expenditure. It will be nice to see how we adjust to a bank-led system as the four large private sector banks will be more profitable in this construct. Towards the end of this financial year, they’ll be able to take on some risk sheet and lend towards corporates. That will trigger a revival in capex.

What about earnings growth? It’s been absent for a while, making it tough to justify the valuations?

For the market as a whole, return on capital employed (ROCE) has traded downwards for the last 11–12 years and earnings growth missing for six years. So, the market or economy as a whole hasn’t been a healthy place to invest. Therefore, for investors, particularly the retail, investing in the Nifty or the large-cap stocks without reference to quality filters isn’t a good idea.  Even if valuations are near about the 10-year average, trailing price-earnings at 25–27 times is scary.