Valuations are not cheap but not stretched either: Sharekhan CEO

GST and Demonetisation will benefit business and economy in long run, he added

Stock market sentiment towards India could be dented if the much-awaited revival in corporate earnings does not materialise in the coming quarters, Jaideep Arora, chief executive officer at broking house Sharekhan, tells Ashley Coutinho. Edited excerpts:

What is your market outlook for 2017? Given the run-up so far, have the chances of a steep correction increased?

The benchmark indices, Sensex and Nifty, have given returns in line with the rally in the MSCI Emerging Markets Index. It has been more of a global rally and India has got its fair share of foreign inflow during the past seven months. Given the returns and the growing concerns related to expectation of the central bankers in developed markets curtailing easy liquidity, the equity markets globally could see some volatility.

From India's perspective, sentiment could be dented if the much awaited revival in corporate earnings does not materialise in the coming quarters. Thus, it is advisable for investors to invest systematically in carefully selected stocks and keep some powder dry to take advantage of corrections or pullbacks.

Are you concerned about valuations at this stage, particularly with regard to mid-cap and small-cap stocks?

Valuations are not cheap anymore. The Sensex trades at 18-18.5 times its one-year forward consensus earnings estimate, at a premium of 10-15 per cent to its long-term average PE (price to earnings) multiples. Having said this, it is important to note that the valuations are still comfortable on some of the other top-down macro parameters, like the ratio of market capitalisation to gross domestic product. At 0.8-0.85 times, this is way below the lofty valuation of 1.2 times and largely around long-term average multiples. Similarly, Sensex valuations are not too stretched on a price-to-book value at 2.5 times the one-year forward estimates, in line with the long-term average.

More important, valuation multiples are a function of the cost of capital. Given the low interest rates in India and low inflationary expectations, the PE multiples do tend to expand and can sustain at premium valuations.

In the case of mid- and small-cap companies, it is not right to paint these with the same brush, as it is a vast basket of companies with different business dynamics. There are pockets of companies that do appear expensive (largely in the consumption space) but at the same time, there still exists money-making opportunities on a bottom-up stock picking basis.

What are the key triggers for the market?

Domestically, corporate results and management commentary on pick-up in demand would be watched keenly by investors. On the policy front, the Street is hoping for the Reserve Bank to cut interest rates in its policy review meet (this week), as inflation remains benign.

Globally, any announcement by the US Federal Reserve to shrink its bloated balance sheet and/or a similar response by other central bankers to protect their currencies could cause some volatility in the markets globally. Emerging markets tend to be more volatile and could see foreign money outflow if risk aversion rises globally.

What are your expectations for earnings growth in FY18 and FY19?

The consensus is pencilling in a compounded annual growth rate of close to 15-16 per cent over the next two years (FY17-19), largely based on normalisation of earnings of banks (lower provisions and growth on low base), improving margins of global commodity companies (stable steel and energy prices) and pick-up in domestic consumer demand, post the initial hiccups faced during implementation of the Goods and Services Tax (GST).

Has the government has done enough on reforms?

The government has taken two significant reform measures through demonetisation and GST to curb the parallel economy and boost the formal or organised sector. These measures could lead to some near-term pain but are expected to significantly improve the overall economic growth and bring more transparency in governance and businesses.

Passage of the Insolvency and Bankruptcy Bill and the measures initiated to resolve 50 large troubled accounts (of banks) are steps in the right direction. However, the clean-up of bank balance sheets is a humongous task, given the scale of non-performing assets and the infusion of fresh capital required to sustain the banks.