Given the macroeconomic headwinds, markets are in for further downsides, believes Anish Damania, head (institutional equity), Emkay Global Financial Services. In an interview with Vishal Chhabria and Sheetal Agarwal, he talks about the outlook for earnings and key sectors to invest in, in current markets. Edited excerpts:
What is your outlook for markets?
Right now, we are not positive on markets. Headwinds exist ahead in terms of slowdown in earnings, high inflation and interest rates. The government is not tackling supply-side issues to ease pressure on inflation and, hence, interest rates are rising to curb demand. Higher interest rates would eventually mean a slowdown in demand, causing a vicious downward spiral. Notably, the impact of a slowing gross domestic product (GDP) on the earnings growth is much compounded as we go ahead. So, when you look at a GDP growth rate of probably 7-7.2 per cent in 2011-12 and a similar or less number in 2012-13, we can expect more downgrades in earnings forecasts for 2012-13. Other triggers are that investment decisions continue to be on hold or cut and there exists a lot of uncertainty on the political front. The government’s borrowing continues to remain high. So, interest rates would remain high even if the Reserve Bank of India wants to reverse. Liquidity will remain tight and this is not good news for the market. So, even if I were to ignore global events, there are enough headwinds in the Indian economy and earnings to be factored in prices. I still think the earnings yield will be less than seven per cent. But the risk-free bond yield is around nine per cent. Given the uncertainties in growth, there is a likelihood of earnings yields tending towards bond yields over the next few months. This means either bond yields have to fall or markets have to go down. My sense is markets will go down to match earnings. We believe markets can go down to 15,000 levels.
What’s your view on the September quarter numbers and the road ahead?
We have begun to see some moderation due to high interest rates, lower availability of iron ore, short supply of coal and probably electricity, as well. This, in turn, is affecting production. However, on the consumption side, the demand slowdown is not yet pronounced, though just beginning to be felt. Some companies are seeing some moderation in demand in case of discretionary consumers, but that’s about it. On the operational front, wages are moving up, interest and raw material costs are going up and companies are not able to pass on the entire cost increase. So, we are seeing a continuous deterioration in margins. To add to that, the rupee depreciation is hurting margins further.
While some banks are reporting good numbers, others are witnessing higher-than-expected growth in non-performing assets. I think almost all capital goods companies are reporting poor order inflows. Auto companies have witnessed good earnings growth. Cement companies have done reasonably well because the earnings growth has started taking place. We are looking at seven-eight per cent earnings growth for 2011-12 across most companies and 10-15 per cent earnings growth for 2012-13, where we believe a scope exists for a downgrade.
What non-monetary steps do you think are the need of the hour?
Increasing the excise duty. Given the strong consumption demand, this should boost the government’s revenues. It will add to inflation, but will improve the fiscal deficit scenario. The only way we can do well is by inviting as much investment possible into the country through incentivisation. You have to attack the supply-side bottlenecks.
What theme are you following while investing in markets?
We are still betting on defensives like auto, fast moving consumer goods and technology. Those companies are generating cash and have earnings visibility. We can see a one-and-a-half year outperformance by defensive companies. We are bearish on banks, capital goods and some asset heavy companies in the infrastructure space.
What could be the next sunrise sector?
Agri-inputs is a sector which will continue to do well structurally. So, I like fertilisers and pesticides companies such as Coromandel Fertilisers and Rallis.
Equities have underperformed bonds in the last two-three years. Is the trend sustainable?
Right now, it’s more sustainable. If at all interest rates fall, bonds will appreciate. Till the growth environment is fudgy, bonds will outperform equities. We expect bonds to outperform equities for another four quarters at least.
What’s your view on foreign institutional investor (FII) flow?
Right now, FIIs would rather invest in the US markets because, bond yields there are at zero levels and you get decent stocks at decent dividend yields. If growth in India is suspect, then they will not invest because dividend yields are far lower than those in other markets. This is why developed markets are outperforming India. If earnings growth revives, FIIs will return.