There is a real risk of a significant market correction: Saurabh Mukherjea

Interview with Saurabh Mukherjea, chief executive officer, Ambit Capital

With the markets rallying to all-time highs, SAURABH MUKHERJEA, chief executive officer, Ambit Capital tells Puneet Wadhwa if investors wish compound returns from their portfolio, they need to buy high quality stocks and leave these untouched for a decade. Edited excerpts:

What is your outlook for the markets over the next six to 12 months?

At 18 times the (estimated) forward earnings, the market appears to be overvalued but not radically so. If double-digit earnings growth were to fructify in FY18, the current overvaluation could sustain. Our fear is that, as in the past four years, earnings growth for the S&P BSE Sensex will again be in single digits.

What are the possible risks?

There is a real risk of a significant market correction which could take place on the back of a specific event, say, a large non-bank lender struggles to repay its NCDs (non-convertible debentures). I am not an expert on global events but, as all of us know, political risks (Trump, Brexit, Syria, North Korea) abound. And, it is not clear how long stock markets globally can continue rallying in the face of such risks.

How do you see fund flows — foreign and domestic — in this backdrop?

As Indian investors abandon land and real estate as an asset class for the purpose of saving, we are likely to see strong retail (from non-wealthy individuals) inflows into the stock and bond markets for several years to come — although from quarter to quarter, such flows might show volatility as retail investors deal with their own cycles of greed and fear.

What’s your advice to investors now?

Investors who want to or need to make money from the market over a one-year to three-year horizon should avoid the market at this stage. Ambit’s analysts have repeatedly shown that entry-level valuations do not have a bearing on your portfolio’s returns, provided your investment horizon is longer than three years. Those who need to make money over a sub-three-year horizon should, instead, consider a diversified mixture of gold, short-term government bonds and equities. Such a portfolio tends to give nine to 12 per cent (annual) return, even if equity markets are under pressure. 

Where do you find valuation comfort in these markets?

The sector we worry about the most is financial services. Valuations here appear stretched and the fundamentals are increasingly fragile. On the other hand, the abandonment of frontline information technology (IT) stocks, some of which are clearly saying that they will return vast amounts of cash to investors, and well known pharma stocks, which have successfully dealt with their FDA (US regulator) issues, has clearly created pockets of opportunity in these sectors.

What about mid- and small-caps?

If the market is overvalued, then small-cap and mid-cap stocks are even more so. Investors who are sensitive to one-year and three-year horizons need to constrain their exposure to such names. On the other hand, if, like me, you are focused on compounding your portfolio over five to 10 years, you need to buy a group of high quality stocks (several of which will be small-cap and mid-cap ones) and then leave your portfolio untouched for a decade.

How has the March quarter results season been thus far for you?

The March quarter results are underwhelming. With the exception of three large private banks and three large cement entities, every other company of note has reported tepid to disappointing results. Barring passenger vehicles (and financing of these), it is hard to find any other segment of the economy with positive momentum. In this context, the elevated valuations in the market are worrisome.

Is India Inc prepared for the goods and services tax (GST)?

I don’t think anybody or any company can truly prepare properly for GST, beyond implementing the relevant systems and processes. Nobody that I have met can fully comprehend the impact of GST on working capital cycles and pricing. Clearly, the compliance burden will be felt far more keenly by small and medium enterprises (SMEs) which don’t have large finance and IT teams to deal with a scale of this magnitude. 

Within SMEs, I worry most about those who don’t fully declare their income. Such companies will come under the taxman’s scanner in the post-GST era. I am not sure how long such companies will survive in that era. As and when this type of SMEs die, larger companies will eat their market share and then, possibly, hike prices.

How should one play the infrastructure and real estate themes in the backdrop of the Real Estate (Regulation and Development) Act?

I am not an expert on the RERA but as different ministers have repeatedly said, RERA will be used to crack down on benami property. The intensity of this crack down will determine whether the much required correction in land and residential real estate prices in big cities fructifies. Expensive real estate and a broken banking system are real impediments to economic progress. I am hopeful that the NDA will tackle at least one of these problems before the start focusing on the spate of assembly elections next year.