 "Global markets unlikely to remain upbeat for long: Tirthankar Patnaik")
Markets across the globe have rallied over the past few weeks, as the US Federal Reserve (US Fed) kept interest rates unchanged in its September policy review. Tirthankar Patnaik, India Strategist at Japan-based Mizuho Bank, tells Puneet Wadhwa that the euphoria might not last long. He does not expect the September quarter results of India Inc to spring any negative surprises and says India remains an attractive investment destination for global investors. Edited excerpts:
The recent rally in the markets has been on the hope that the US Fed could defer the hike, given the employment data. What are your views?
We believe there is a high possibility of the US Fed's interest rate hike to be delayed to the next year, as weak employment data and continued growth concerns in the emerging market (EM) space would keep the US economy under pressure. While the Fed is on track to meet both its mandated guidelines (unemployment and inflation), there is increasing awareness of EM-DM (developed markets) contagion. The Fed is unlikely to take any rate action before it sees growth stabilising, not only in the US but also on a global level.
Global markets have rebounded after the deferred rate action by the US Fed in September but this scenario is unlikely to sustain for long, as major challenges to the global growth and trade remain. The slowdown in China is likely to stretch through 2016, and the US Fed's inaction on rates has not provided the signal markets needed on the US recovery.
India's macro fundamentals are strong, especially among EM peers, with over seven per cent annual growth, Indian markets continue to remain an attractive investment destination for global investors, and they have been joined by local players in the past two quarters.
Do you expect more bad news from China over the next six – 12 months? If so, what? What is the likely policy response from the Chinese authorities?
China’s quarterly (y-o-y) growth has averaged 9.2% since 2000, but has steadily dropped to a 7% trajectory over the last 10 quarters. We believe growth in China would go down to 5.5%-6% levels over the next two years, as the Chinese economy struggles to adjust from in an investment-driven high growth trajectory to a steadier consumption-focussed one. This transition would almost certainly result in continual mini crises, ranging from wealth management, real estate, local Governments to equity markets. PBoC also needs to take a call on the eventual long-term trajectory of the yuan. Apart from this, we would not rule out fiscal expansion from the Chinese Government.
What is your expectation from the September quarter results of India Inc?
We believe these are unlikely to spring many surprises this time around. Overall, revenue growth is likely to remain muted, with resource sources (cement, mining, metals and energy) likely to underperform, given the downward trend visible in commodities. Realisations are likely to remain weak, with dwindling margin support. Revenue growth for the broader universe is likely to be flat at best on a year-on-year basis versus around five per cent in the first quarter of FY16. Pharma, information technology (IT) and power sectors are likely to do well. Metals, cement and energy are likely to disappoint.
The sharp upward move in the markets post the 50 basis points move by RBI (Reserve Bank of India) has progressively moved the tolerance for negative surprises in the second quarter results. While analyst estimates are getting more realistic and reflective of an extended recovery, we believe there is limited room for disappointments with the Nifty at 8,200 levels.
Do you think the pick-up in earnings could get delayed, given the recent turmoil in global markets?
Increased volatility in global markets, thanks to growth concerns in China, (International Monetary Fund expects 6.8 per cent growth in 2015) has begun to reflect in analyst downgrades of global and regional growth estimates for 2015 and 2016. While India remains a largely domestic player, with a recovering macro environment, a weaker outlook for global GDP and trade does not bode well for its growth in general, and exports in particular.
We believe this adjustment to a lower China growth trajectory would play out over the next year and a half and, therefore, do not expect a commensurate adjustment in a hurry. While consumption remains resilient and would benefit from cheaper cost of funds, resources are likely to remain under a significant overhang of low realisations, low capacity utilisation and high leverage.
What about other issues like an unfavourable outcome if Assembly elections in Bihar that could play spoilsport as regards the reforms?
Opinion poll bodes an NDA (National Democratic Alliance) victory in the Bihar elections, and consensus expectations reflect this as well. While the brute majority in the Lower House precludes any issues with governance in the event of an unexpected setback, the washout of the Monsoon Session does pose questions on the reform trajectory.
The NDA's long-term strategy would naturally be to veer towards a majority in the Upper House through regional assembly wins, so Bihar with 16/233 seats in the Rajya Sabha is an important milestone to cross. The reform process would not be derailed, but would definitely get delayed with an unfavourable result in Bihar.
Do you see the pace of foreign institutional inflows slowing in the second half of 2015?
We have consistently maintained that India's current pre-eminent position among EMs does not preclude investor apathy in the event of a global risk-off. Capital outflows are likely to intensify on incremental negative news from China, even as Fed uncertainty remains an overhang. We believe favourable interest levels with foreign institutional investors (leading to a rebound in flows) might be insufficient to ward-off a concerted sell-off across EMs.
Could the mid-and small-caps outperform their larger peers in the second half of 2015?
In the near-term, small and mid-caps managed to outperform narrow market large-cap index like NIFTY, given their limited resource exposure, but we do not see this trend continuing if the global macro overhang worsens. We would expect small and mid-cap indices to underperform the NIFTY in 2015.
What are your sector and stock preferences amid all this?
With expectations of a gradual macro recovery ahead, we believe cyclical sectors like automobiles, construction/infra and capital goods would be preferred over a medium-to-long term horizon. However, the pace of the recovery necessitates having adequate defensive representation in portfolios as well. Financials should benefit the most, but continue to be saddled with fragile asset quality. In the near term, global-dependent sectors (pharma and IT) should continue to benefit from the overhang on the rupee.
The recent rally in the markets has been on the hope that the US Fed could defer the hike, given the employment data. What are your views?
We believe there is a high possibility of the US Fed's interest rate hike to be delayed to the next year, as weak employment data and continued growth concerns in the emerging market (EM) space would keep the US economy under pressure. While the Fed is on track to meet both its mandated guidelines (unemployment and inflation), there is increasing awareness of EM-DM (developed markets) contagion. The Fed is unlikely to take any rate action before it sees growth stabilising, not only in the US but also on a global level.
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How long do you expect the upbeat scenario to last across global equity markets? In the Indian context, should one use this opportunity to exit?
Global markets have rebounded after the deferred rate action by the US Fed in September but this scenario is unlikely to sustain for long, as major challenges to the global growth and trade remain. The slowdown in China is likely to stretch through 2016, and the US Fed's inaction on rates has not provided the signal markets needed on the US recovery.
India's macro fundamentals are strong, especially among EM peers, with over seven per cent annual growth, Indian markets continue to remain an attractive investment destination for global investors, and they have been joined by local players in the past two quarters.
Do you expect more bad news from China over the next six – 12 months? If so, what? What is the likely policy response from the Chinese authorities?
China’s quarterly (y-o-y) growth has averaged 9.2% since 2000, but has steadily dropped to a 7% trajectory over the last 10 quarters. We believe growth in China would go down to 5.5%-6% levels over the next two years, as the Chinese economy struggles to adjust from in an investment-driven high growth trajectory to a steadier consumption-focussed one. This transition would almost certainly result in continual mini crises, ranging from wealth management, real estate, local Governments to equity markets. PBoC also needs to take a call on the eventual long-term trajectory of the yuan. Apart from this, we would not rule out fiscal expansion from the Chinese Government.
What is your expectation from the September quarter results of India Inc?
We believe these are unlikely to spring many surprises this time around. Overall, revenue growth is likely to remain muted, with resource sources (cement, mining, metals and energy) likely to underperform, given the downward trend visible in commodities. Realisations are likely to remain weak, with dwindling margin support. Revenue growth for the broader universe is likely to be flat at best on a year-on-year basis versus around five per cent in the first quarter of FY16. Pharma, information technology (IT) and power sectors are likely to do well. Metals, cement and energy are likely to disappoint.
The sharp upward move in the markets post the 50 basis points move by RBI (Reserve Bank of India) has progressively moved the tolerance for negative surprises in the second quarter results. While analyst estimates are getting more realistic and reflective of an extended recovery, we believe there is limited room for disappointments with the Nifty at 8,200 levels.
Do you think the pick-up in earnings could get delayed, given the recent turmoil in global markets?
Increased volatility in global markets, thanks to growth concerns in China, (International Monetary Fund expects 6.8 per cent growth in 2015) has begun to reflect in analyst downgrades of global and regional growth estimates for 2015 and 2016. While India remains a largely domestic player, with a recovering macro environment, a weaker outlook for global GDP and trade does not bode well for its growth in general, and exports in particular.
We believe this adjustment to a lower China growth trajectory would play out over the next year and a half and, therefore, do not expect a commensurate adjustment in a hurry. While consumption remains resilient and would benefit from cheaper cost of funds, resources are likely to remain under a significant overhang of low realisations, low capacity utilisation and high leverage.
What about other issues like an unfavourable outcome if Assembly elections in Bihar that could play spoilsport as regards the reforms?
Opinion poll bodes an NDA (National Democratic Alliance) victory in the Bihar elections, and consensus expectations reflect this as well. While the brute majority in the Lower House precludes any issues with governance in the event of an unexpected setback, the washout of the Monsoon Session does pose questions on the reform trajectory.
The NDA's long-term strategy would naturally be to veer towards a majority in the Upper House through regional assembly wins, so Bihar with 16/233 seats in the Rajya Sabha is an important milestone to cross. The reform process would not be derailed, but would definitely get delayed with an unfavourable result in Bihar.
Do you see the pace of foreign institutional inflows slowing in the second half of 2015?
We have consistently maintained that India's current pre-eminent position among EMs does not preclude investor apathy in the event of a global risk-off. Capital outflows are likely to intensify on incremental negative news from China, even as Fed uncertainty remains an overhang. We believe favourable interest levels with foreign institutional investors (leading to a rebound in flows) might be insufficient to ward-off a concerted sell-off across EMs.
Could the mid-and small-caps outperform their larger peers in the second half of 2015?
In the near-term, small and mid-caps managed to outperform narrow market large-cap index like NIFTY, given their limited resource exposure, but we do not see this trend continuing if the global macro overhang worsens. We would expect small and mid-cap indices to underperform the NIFTY in 2015.
What are your sector and stock preferences amid all this?
With expectations of a gradual macro recovery ahead, we believe cyclical sectors like automobiles, construction/infra and capital goods would be preferred over a medium-to-long term horizon. However, the pace of the recovery necessitates having adequate defensive representation in portfolios as well. Financials should benefit the most, but continue to be saddled with fragile asset quality. In the near term, global-dependent sectors (pharma and IT) should continue to benefit from the overhang on the rupee.