Q1 of CY19 will be a good time to buy, says Macquarie's Sandeep Bhatia

Despite a sharp fall from the peak, SANDEEP BHATIA, managing director, head of equity India, commodities and global markets at Macquarie, tells Puneet Wadhwa that there could still be a 5–8 per cent downside risk for the market from the current levels. Edited excerpts: 

Are concerns regarding the markets and non-banking finance companies (NBFCs) overdone?

I don’t think so. A certain amount of correction was required as the markets were trading at very high multiples and needed a reason to correct. The reason was provided by the fund crunch in the NBFC segment. There is clearly pressure on them (NBFCs) now to see whether this lending has not flown to sectors and areas where they find it difficult to recover money. While the correction started with NBFCs, it is spreading to other parts of the markets like the consumer and auto stocks.

Does that derail India's growth story?

This by itself cannot derail India's growth story. The market correction is giving an opportunity to investors—if it deepens further—to buy. The underlying growth story in terms of consumption remains intact. Maybe, it is slightly slower than what most people anticipated, but consumption is picking up. 

What are your expectations for corporate earnings?

On a year-on-year (y-o-y) basis, earnings growth will still be strong, especially for the banks given last year’s low base. For businesses that have not been as badly hit as the banks, top-line growth will be stronger. There will, however, be pressure on margins. We had a very benign cost pressure environment, partly because how food prices have behaved and helped keep consumer price inflation (CPI) in check. For the next couple of months, there could be some pressure if crude oil prices rise further. Earnings growth for the indices in the financial year 2018–19 and 2019–20 will be around 18–20 per cent. 

Where do you see the rupee and crude oil over the next few months?

One needs to take the expectations for these two with a large pinch of salt. That's because most analysts are following the spot price. The rupee is through with the much-needed correction. We had a stable rupee for the last four years. If we take an inflation differential of three per cent, the 12 per cent currency correction was necessary. The rupee is now at a level where it should be in terms of purchasing power and inflation differential versus the US. On the other hand, the spike in crude oil prices could put pressure on the currency. That said, the required correction (on a fundamental basis) is already done.

Are the markets pricing in the possibility of higher bond yields going ahead?

Well, the real thing to watch out for is how the US treasury yields play out. The consensus is that they will go from 3.25 per cent now to 4 per cent. In this backdrop, bond yields in India also need to be watched as they are likely to go up. To that extent, price-to-equity (PE) multiples and discounting rates of companies will get adjusted. The markets are not factoring in all this right now. 

What has been you investing strategy in CY18 and in the recent correction?

We have talked about defensives all through this year and they have done well. What we are now suggesting is investors look at cyclicals. Growth rates will pick up and this segment should do well in this backdrop. Large construction and EPC (engineering, procurement and construction) players, even private banks that have corrected, large information technology (IT) companies and select auto companies should do well over the next one year. In the Q1CY19, I would still opt for large-cap names, as there is still an election uncertainty in India.

How much importance the markets are attaching to the outcome of the upcoming state polls?

It depends what the outcome is. If the Bharatiya Janata Party (BJP) wins two states and one goes to the Congress, then we may not see much reaction. A big negative outcome, such as loss in three states for the BJP will be a damper. That said, state polls are not necessarily an indicator of what happens in the general election. What will surely trigger a negative reaction is if oil prices and bond yields in the US go up.

So,  should one avoid the marketsright now?

The market still has a downside (risk) of 5–8 per cent from the current levels. The broader market has corrected much more than the frontline indices. There is still some correction left in mid-caps. The first quarter of the next calendar year (Q1CY19) will be a good time to buy. 

How are you viewing the recent developments in the banking, NBFC segments?

The NPA (non-performing asset) problem in the banking sector has been identified and is being addressed. The governance, too, is improving. A lot of pain has already been taken care of. The Reserve Bank of India has also taken a lot of bold steps in the last quarter. The recent changes in the top management in the banks is a signal to the entire financial sector. The commercial paper (CP) norms are also likely to be tightened to avoid the asset-liability mismatch (ALM) on the NBFC side. Hence, the growth now will be on a much sounder footing than it was in the last 3-5 years. India has been subject to crony capitalism and the problem of favoured business groups has been addressed by the institutional mechanism now. The GDP (gross domestic product) growth will easily be above 7.2 per cent for the next two years.

How are foreign investors seeing developments in India?

They are concerned about the emerging market (EM) pack as a whole, including China, in the backdrop of interest rates in the US that are now rising after a decade. In case rates do continue to rise for a prolonged period, this will be a concern for the EMs. The US treasury rates can hit four per cent, however, if they go above this level, it will be a cause for concern for the EMs, including India. 

Disclaimer: Macquarie Capital Securities (India) Private Limited is a Sebi-registered research company, please visit the website at www.macquarie.com/disclosures for disclosures.