Probability of 10-12% return on Nifty over 12 months: Mahesh Patil

He says, the political uncertainty in Europe will also drive markets in the short term

MAHESH PATIL, co-chief investment officer, Aditya Birla Sun Life Asset Management Co, spoke to Ashley Coutinho on the economy and the share market. Edited excerpts:

What is the outlook for the year ahead?

In the short term, (stock) market participants would be keen to see how the inflation-interest rate dynamics play out. Brent crude oil's price was close to $80/bbl before coming off and it is important to see how the government reacts to managing the price at the pump. The monsoon is expected to be normal this year, which should give much relief to the rural economy. In a couple of weeks after their meeting, Saudi Arabia and Russia are expected to ease production cuts, which could keep crude prices under check. The political uncertainty in Europe will also drive markets in the short term.

Over a slightly longer term, the trade spat between the US and its trading partners, rate hikes from the US Federal Reserve and the increase in global crude oil prices are factors to watch. Though there are some macro headwinds, the micro news as indicated in the commentary on companies is improving. All told, the probability of 10-12 per cent return on the Nifty (benchmark index on the National Stock Exchange) over the next 12 months is high.

Some believe the markets are factoring in a (Prime Minister Narendra Modi) victory in next year's general election. Do you see a reversal in flows if this is proved wrong?

The markets are currently not factoring any scenario of the 2019 general election; it is too early to do that. It is interesting that in the past four elections, which had both positive and negative surprises, returns made from the markets six months before and after the election results were significantly positive. For the markets,continuity of the economic agenda is important. As we have seen for the past two decades, though governments changed, economic reforms have taken place. In the short term, there could be an impact, pricing in the new information. At the current juncture, the economy is on the mend and earnings would recover, providing downside support in case the election results throw any surprises.

Do Indian equities look overvalued? What is your view on mid-caps and small-caps as investment bets?

On a trailing basis, the Nifty index is trading at a price to earnings ratio (P/E) of 22, a premium to the 10-year long-term average. Considering the earnings growth coming in FY19, the valuation becomes reasonable. Also, over the past 10 years, the proportion of non-cyclical stocks in the Nifty index moved up by 19 percentage points to 63 per cent, which demands giving higher valuation. There has been a reasonable correction in the mid and small-cap space, which could be used to start investing with at least a two to three-year time horizon. As growth comes back, they could start looking attractive.

What is your view on earnings growth?

The FY18 earnings season has ended with the Nifty index clocking single-digit growth. It is disappointing that yet another year ended with lower growth. Public sector banks, corporate banks, pharma, telecom and selective automobile companies have led to such low numbers. The growth in private banks and selective automobile companies was good. Metal companies also performed well. There were signs of recovery in FY19, clocking 17-18 per cent growth.

What are the global cues to watch?

The flip-flop of US President Donald Trump on implementation of tariffs on trading partners is making the markets jittery. The stance to force China to reduce the trade deficit with the US was re-affirmed by using a tweet, after a brief reprieve. Some of the countries exempted initially saw tariffs re-imposed on some of the imported metals.

Second, there is an expectation of six-seven rate hikes by the US Fed in the next two years. Though the Fed would be careful not to impact economic growth, there is a possibility of this if fiscal stimulus through tax cuts normalise. Third, the political uncertainty in Europe, especially in Italy, might lead to a risk-off due to fear of a break-up of the European Union.

As far as the crude oil impact is concerned, the oil producers benefit and consumers get impacted negatively. If it leads to higher inflation, leading to higher rates and a stronger dollar, the flows to emerging markets might get impacted.

Which sectors are you betting on?

Market share gain by private sector banks from public sector ones continues, which makes us continue our bullish view on the sector. We are positive on rural consumption, as is being corroborated by the commentary of companies in earnings conference calls. We are positive on some parts of the infrastructure space, where spending by the government continues.

We have a constructive view on the top three public sector banks. We are negative on the rest of the pack and do not advise bottom-fishing. There is a significant amount of capital required by these banks. This dilution leads to weaker return ratios even if they begin to grow.

Given the norms for categorisation and TRI (total returns index), will generating alpha (excess return of an investment relative to the return of a benchmark index) become difficult for fund managers?

The norms of categorisation leave immense scope to capture the market opportunities through sector allocation, stock selection and portfolio sizing to generate alpha. Future alpha could be lower than in previous years due to increased participation in the markets by various categories of investors through multiple vehicles.

If the comparison is against benchmark TRI, the alpha calculated would be lower. Hence, taking direct plans to calculate alpha against TRI might be appropriate. There might some confusion for the next few months but, beyond that, the categorisation helps investors to understand funds better. Their investment would be true to label across the funds and fund houses. It is useful for fund managers that the investment set is defined for themselves and their competitors.

Your message to investors?

Despite volatility, regular investments will pay off over a period of time. While a higher proportion of investment should be in large-caps, investing in mid-caps, especially after the recent correction (stock price fall), should be considered.