Market cap to GDP indicates no sign of overheating: S Krishna Kumar

The main risk for Indian equities is delayed earnings growth, says S Krishna Kumar

Our market cap to gross domestic product (GDP) ratio stands at 77 per cent, well below some of the developed markets that are trading above 100 per cent, says S Krishna Kumar, chief investment officer of equity at Sundaram Mutual. In an interview with Ashley Coutinho, he says the main risk for Indian equities is delayed earnings growth. Edited excerpts:
 
The markets are near their all-time highs. Is there some correction around the corner? What are the likely triggers and risks for the markets from here on?
 
Over the last few months, Indian markets have brought out inherent resilience. The markets have digested well all the negative news, such as Brexit, Donald Trump’s surprise win and demonetisation. Though the markets are touching higher levels every day, they are trading only slightly above their mean levels. The Sensex and Nifty are around 18 times one-year forward earnings and mid-cap indices at 19-20 times. Soon, investors will start rolling over into discounting FY19e earnings.  Factoring earnings growth at this inflection stage, the numbers should look even better. Our market cap to GDP stands at 77 per cent, indicating no signs of overheating compared to developed markets that are trading at higher than 100 per cent. That ratio had touched a peak of 150 per cent during the last bull run for the Indian markets. GST implementation, capex push by the government, clean-up of bank books and corporate earnings growth are the triggers. The main risk would be delayed earnings growth, apart from the global concerns around US Fed rate hikes, euro scepticism and China.

 

What are the global cues to watch out for in 2017?
 
Brexit was a big event the markets witnessed in 2016 that gave a realistic sense of populism and protectionism. As Britain prepares to trigger Article 50 and exit the European Union in March 2017, more clarity is likely to emerge, and the markets are set to readjust their expectations. Moving beyond Brexit, in the eurozone, one can see developments that range from populist to Euro sceptic. Populism in itself is not as concerning a development as Euro scepticism. Moving to the US, the Trump presidency is one to be closely monitored. The Trump presidency appears to be a shift to a non-linear approach that becomes difficult to predict. While he has started acting on some of his proposals, it is still too early to comment on the outcome of a Trump presidency. The pace and the number of Fed rate hikes would also depend on the playout of the Trump presidency. Moving to Asia, China still lingers on the sidelines. A leadership transition is expected to take place during the last quarter of 2017. This would be key for the markets to reassess their expectations on Chinese growth.

 
FPIs have come back to the market after a heavy bout of selling in the last quarter of 2016. How do you see FPIs allocating money to Indian markets in 2017?
 
Indian markets have seen DII (domestic institutional investor) money flow dominate FPI (foreign portfolio investment) flows for some time now. This appears to be an indication of a structural change that could persist. In this context, one can say the Indian markets appear to have a reduced dependence on FII money flow. Within the EM pack, MSCI India trades at a decent premium to other emerging markets. We believe this is justified given our superior RoE and growth prospects. Fundamentally, we are in much better shape when compared to our peers. Given the revival of the macro cycle, improving fundamentals and a possible spurt in corporate earnings, India should get more than a fair share of FPI allocations.

 
How do you see the year for emerging markets?
 
From the markets' standpoint, 2017 is likely to be the year of the fiscal with most governments acknowledging the need to create demand through fiscal spending. This increases the probability of DM (developed market) growth in the eyes of the markets. Nevertheless, the EM (emerging market) differentiation story structurally remains in place from the pure growth differentials it offers over DMs. The investing pie will get larger and EM equity flows should hold up. There is a lot of catch up EMs can do versus their DM peers, and they have all the room to do so, given their better fundamentals and growth prospects.

 
What are your estimates for corporate earnings for FY18 and FY19?
 
Earnings growth surprised us on the negative in the last two years, it is probably right to expect that the surprise on the upside is round the corner. This will result in a flurry of earnings upgrades soon. With respect to the mid-cap and small-cap segment, while there may not be any further broad re-rating, earnings growth trajectory could be far sharper than larger companies. In terms of the portfolios that we offer, earnings growth is comfortable in high double-digit growth with an earnings CAGR of about 26-27 per cent, compared to about 15 per cent for Nifty.

 
Which sectors you are optimistic about?
 
We continue to be bullish on a few themes that should emerge stronger over the next few years. The financial inclusion theme, which is much broader than traditional banking, is a structural one. Demonetisation has accelerated the access to banking for the rural poor while clearly opening up new business opportunities. NBFCs, SFBs tapping the underserved and new areas like consumer durable financing, home furnishing, professional loans, cash EMI, rural banking, life style financing, wealth management and insurance are beneficiaries.
 
The consumer discretionary theme is across auto, entertainment, lifestyle, affordable luxury and garments and should continue its growth trajectory. This will be supported by rising incomes, aspirations, retail credit and demographics. Government reforms is another which is gaining strength. Across sectors like energy, infra rural and logistics, we see structural corrections enabling sustainable growth.