Given the favourable macros and better growth prospects compared to other emerging markets, India is expected to command a premium valuation, says Rajat Jain, chief investment officer, Principal PNB Asset Management Company Private Limited. In an interview with Ashley Coutinho, he says stock-picking has become difficult but there are still good opportunities in the mid-cap space. Excerpts:
Where are the markets headed?
We are positive from a two-three years' perspective but slightly cautious in the near term, given the sharp-run up since March and concerns around the US election outcome and US Federal Reserve (central bank) rate increase possibility. Domestically, the decision on goods and services tax (GST or unified sales tax) rates and rollout would also be sentimentally important. The results for Q2FY17 announced till now have not been too encouraging and there is a possibility of some cut in estimates for the rest of the year. With earnings (net profit) growth yet to meaningfully pick up, some caution in the near term seems justified, but we remain optimistic about FY18 seeing mid-teens to high-teens earnings (net profit) growth.
Sensex valuation at 16.5 times its FY18 earnings (net profit) estimate is neither very expensive nor cheap. But given the favourable macros and better growth prospects compared to other emerging markets, we expect India to command a valuation premium. It is much more challenging to identify new opportunities, but if one takes a two-three years' view, there still are good opportunities in the mid-cap space, especially domestic-oriented businesses. Rural recovery, construction, and railways, among others, are themes better played through mid-cap stocks. We believe earnings (net profit) growth for domestic-oriented mid-cap stocks could outpace that of large-cap stocks and that drives our thesis that over the next three years or so, despite spells of high volatility, mid-cap returns could be better than those of large-cap stocks.
How do you see fund flows into emerging markets such as India over the next 6 to 12 months?
There are expectations that emerging markets' growth would be better than growth in developed markets. In that context, we expect flows in emerging markets, and thus India to remain positive. There may be some volatility in flows in the near term given important events globally but we expect the trend to remain positive. Flows to India would be driven by expectations of favourable macros and structural reforms such as GST leading to better growth prospects.
How do you see the July-September net profit panning out?
We expect it to be better than that of June quarter but still not good enough to drive any significant earnings (net profit) upgrade. In fact, there could be slight downgrades to current year estimates. The key would be the net profit outlook for the second half of FY17, seen as much better than that for first half; thus it will drive mid-teens net profit growth in FY18. The results announced so far have been slightly disappointing not only in information technology but also in volume growth for some agrochemical and consumer discretionary companies.
Mutual funds have remained net buyers of stocks. Will the trend continue?
Given the low ownership of stocks in India and low interest rates, we expect inflows to continue. Mutual funds have performed well over the past few years and that provides an additional tailwind.
We are living in a world of negative interest rates. Earlier this year, noted fund manager Bill Gross said yields were the lowest in 500 years of recorded history. What is the road ahead for the global bond market?
In some sense, that has been a big catalyst for the stock markets globally. From a long-term perspective, negative rates are not sustainable, but predicting them in the short run is difficult.
A large part of the fall seems to be behind us, though rates may remain low for some more time. There is a growing opinion that interest rates have played their part and the focus would have to shift from monetary policy to fiscal policy to drive sustainable recovery in major global economies.
Where are the markets headed?
We are positive from a two-three years' perspective but slightly cautious in the near term, given the sharp-run up since March and concerns around the US election outcome and US Federal Reserve (central bank) rate increase possibility. Domestically, the decision on goods and services tax (GST or unified sales tax) rates and rollout would also be sentimentally important. The results for Q2FY17 announced till now have not been too encouraging and there is a possibility of some cut in estimates for the rest of the year. With earnings (net profit) growth yet to meaningfully pick up, some caution in the near term seems justified, but we remain optimistic about FY18 seeing mid-teens to high-teens earnings (net profit) growth.
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Your take on valuations? Has it become more difficult for fund managers to spot opportunities, particularly in the mid-cap space given the rich valuations?
Sensex valuation at 16.5 times its FY18 earnings (net profit) estimate is neither very expensive nor cheap. But given the favourable macros and better growth prospects compared to other emerging markets, we expect India to command a valuation premium. It is much more challenging to identify new opportunities, but if one takes a two-three years' view, there still are good opportunities in the mid-cap space, especially domestic-oriented businesses. Rural recovery, construction, and railways, among others, are themes better played through mid-cap stocks. We believe earnings (net profit) growth for domestic-oriented mid-cap stocks could outpace that of large-cap stocks and that drives our thesis that over the next three years or so, despite spells of high volatility, mid-cap returns could be better than those of large-cap stocks.
How do you see fund flows into emerging markets such as India over the next 6 to 12 months?
There are expectations that emerging markets' growth would be better than growth in developed markets. In that context, we expect flows in emerging markets, and thus India to remain positive. There may be some volatility in flows in the near term given important events globally but we expect the trend to remain positive. Flows to India would be driven by expectations of favourable macros and structural reforms such as GST leading to better growth prospects.
How do you see the July-September net profit panning out?
We expect it to be better than that of June quarter but still not good enough to drive any significant earnings (net profit) upgrade. In fact, there could be slight downgrades to current year estimates. The key would be the net profit outlook for the second half of FY17, seen as much better than that for first half; thus it will drive mid-teens net profit growth in FY18. The results announced so far have been slightly disappointing not only in information technology but also in volume growth for some agrochemical and consumer discretionary companies.
Mutual funds have remained net buyers of stocks. Will the trend continue?
Given the low ownership of stocks in India and low interest rates, we expect inflows to continue. Mutual funds have performed well over the past few years and that provides an additional tailwind.
We are living in a world of negative interest rates. Earlier this year, noted fund manager Bill Gross said yields were the lowest in 500 years of recorded history. What is the road ahead for the global bond market?
In some sense, that has been a big catalyst for the stock markets globally. From a long-term perspective, negative rates are not sustainable, but predicting them in the short run is difficult.
A large part of the fall seems to be behind us, though rates may remain low for some more time. There is a growing opinion that interest rates have played their part and the focus would have to shift from monetary policy to fiscal policy to drive sustainable recovery in major global economies.