Risk-reward is unfavourable for equities in the near-term: Abhay Laijawala

Interview with managing director and head of research, Deutsche Equities India

The recent geopolitical events have kept a check on the runaway market rally seen thus far in calendar year 2017 (CY17). ABHAY LAIJAWALA, managing director and head of research, Deutsche Equities India tells Puneet Wadhwa that his December 2017 target for the S&P BSE Sensex is 29,000. Purely from a return perspective, he expects mid-caps to fare better as compared to the large-caps. Edited excerpts:

How big a threat is the developing geopolitical situation in North Korea to the stability in global financial markets?

It's a risk that is low probability but also one that can't be overlooked. As a consequence, we see equity markets reacting negatively when the war of words intensifies and then react again once the threat seems to have blown over.

We may - unfortunately - see this trend continue given the significance of the event. Risk assets will sell off and safe havens will move up, as and when the situation appears to be intensifying. Over the last few years, the handling geopolitical issues has been encouraging though. We hope that an amicable consensus is arrived at soon.

Is it a good time to buy?

If the market decline is significant, one should buy on dips. In the near-term, the risk-reward is unfavourable for Indian equities. Market is facing headwinds from an accelerated cuts in earnings estimates, elevated valuations and huge issuance pipeline ahead. Monetary policy normalisations in developed economies is also a risk.

What is the outlook for foreign flows into India?

Foreign institutional investors (FII) were sellers of equities across key emerging markets in August. In India, the amount was relatively higher (around $2 billion). Besides the general risk aversion, India specific concerns were disappointing quarterly earnings, Doklam standoff and elevated valuations.

While India's macro-economic fundamentals stay robust, aggregate demand has been weak and earnings growth lacklustre. The recent quarter saw actual earnings come in below expectations, as well. Coupled with the elevated valuations, we see a high possibility that the threshold of investor patience may be getting stretched.

We expect FII inflows to turn volatile until there is clarity on geopolitical risks, tightening global liquidity and a resumption in earnings growth. Any macro data-point suggesting that the visibility of earnings growth resumption is improving can emerge as a very strong catalyst for Indian markets.

What are the key risks to the global financial markets from here on?

Key risk to global financial markets include normalisation in developed economies' monetary policy, especially the US Federal Reserve (US Fed) and the European Central Bank (ECB); geo-political situation; commodity prices and Chinese growth momentum, next year. Sustainability of Chinese Government's policy stimuli next year would be interesting as this would have broader ramifications on commodity prices and global growth outlook.

Should one be focussing on the large-cap segment or the mid-and small-cap basket over the next one year?

While the risk-reward appears favourable for large-caps as compared to the mid-caps, a recovering growth and improving risk appetite environment generally bodes well for stocks in the mid-caps basket. Only from a return perspective, we'd expect mid-caps to yields better return. Also the composition of index is such that defensive sectors like IT Services have higher weights in large-cap indices versus mid-caps.

What are your calendar year 2017 (CY17) and March 2018-end targets for the Sensex/Nifty?

Our December 2017 S&P BSE Sensex target is 29,000. We expect cyclicals to lead the next leg of market rally. Our preferred sectors are consumer discretionary, private banks, Energy (of which a large segment of our preference is oil marketing companies), materials and industrials. Contrarian play - IT Services.

We prefer sectors with earnings visibility or scope of earnings revival. Within the manufacturing space - we like auto, cement, oil refineries and select capital goods companies.

What are your estimates for FY18 and FY19 earnings?

We expect Sensex / Nifty earnings growth of 16 per cent for current fiscal and 21 per cent over next fiscal. GST implementation has been largely non-disruptive and should help higher growth and earnings momentum next fiscal.

Is the information technology sector out of the woods? What's your advice to investors in this space? And Infosys?

We have an overweight stance on IT Services sector in our model portfolio. Sector's relative valuation is attractive with MSCI India IT services now trading at a level last seen in 2008-2009, relative to MSCI India. Companies have been adopting to the new business environment. IT Services is a matured sector now are we're unlikely to get same growth momentum and profitability as last decade. Next decade will offer new challenges and newer opportunities.