 "We expect over 30% returns in two years: Mahesh Nandurkar")
The markets saw a knee-jerk reaction to the Bihar election outcome on Monday. Mahesh Nandurkar, executive director and India strategist at CLSA, in an exclusive interview with Puneet Wadhwa ahead of the 18th CLSA India Forum from November 16 to 18, says the kind of optimism that existed on the new government about a year ago has come down significantly. Going ahead, he believes, the market returns will be dependent on capital expenditure cycle recovery, which is a slow and steady process. Edited excerpts:
Well, it depends on how the Bharatiya Janata Party (BJP) interprets this defeat — whether it thinks not enough was done on the developmental side, or the defeat is seen as just a mismatch on the mathematical electoral equation, etc. But by and large, I do believe it should serve as a mild mid-course correction for the government’s policies. It should ideally make the government help accelerate the delivery of its services in an improved manner — for 24x7 power and housing for all, among other things. There will be more concrete steps on sectors like agriculture and education. I do expect that.
I think the kind of optimism that existed on the new government about a year ago has come down significantly. People, including foreign investors, understand that it is not easy to change the direction for a large economy like India in a hurry, or to put in place reforms in a hurry. Investors understand that there are other problems like those related to the Upper House (Rajya Sabha). There are several things that need to be done to improve the banking sector and power distribution side. I, therefore, believe the global investor community is now looking at things as they come, and not necessarily give large benefits of doubt to the government like before, say a year ago.
What are your targets for the Sensex and Nifty for the next 12-24 months?
We expect over 30 per cent returns for the market over a two-year period. This, however, could be back-ended. This means the returns will not be around 15 per cent each year, but perhaps around 10-12 per cent in the first year, and 15 per cent-plus in the second year.
The market returns will be dependent on the capex cycle recovery, which is a slow and steady process. It will take time and I don’t see a big capex recovery until the second half of 2016-17. So, in that sense, the returns in the first year will be less than 15 per cent.
FII inflows will be a function of two things. Firstly, what is happening in India, and secondly, what is happening elsewhere across the globe. It looks like we are on the verge of seeing the first rate increase by the US Federal Reserve and more such increases will take place going forward in the next one to two years.
Our expectation is that the flows into emerging markets, in general, will get impacted. The US-based fund inflow will decelerate. As a result, the overall pool of money that is available will shrink. We have already seen that happening this year itself. The year has not been great in terms of FII flows into India. So, I believe a similar trend should continue. I expect $10-15 billion net inflow by a one-year view. We feel the domestic investors will continue to be more dominant than foreign ones.
What is your analysis of the corporate earnings so far? By which quarter do you think the global economic slowdown will get fully reflected into the financials?
The corporate earnings season so far has been weak this financial year. We have been seeing earnings downgrades for a little over three years now. I think the downgrade cycle still continues. We have been seeing for the past few months that there is a one per cent cut in earnings estimates every month. So, in the past six months, estimates have been lowered by six per cent.
Going ahead, the pace of the earnings revisions should come down, but there will still be earnings revisions on the downside. On an absolute year-on-year (y-o-y) basis, however, the third and the fourth quarters of the current financial year (2015-16) are likely to be much better than the first half of the year. This is because the third and the fourth quarters of 2014-15 were significantly weak. But that apart, I think the economy as a whole is also about the pace of a slow recovery. So, that should also begin to be visible in the corporate number going ahead.
Which sectors in your opinion will lead the recovery?
I think the recovery should be visible across several sectors. We have already seen margin-led improvement being visible in automobiles, consumer staples and media sectors. The revenue growth in general, however, continues to remain under pressure because of the fact that we have entered into a phase of low inflation which has a negative impact on the revenue growth.
Going forward, therefore, I think the slow economic recovery should be visible more in the sectors that have been linked to the domestic economy. I think we should begin to see some slow improvement in cement, automobile, banking and capital goods sectors. It should be a domestic-led recovery. The pace of recovery, as I said, will be slow, but the domestic sectors should drive that.
Is it time to look at policy-driven sectors like telecom, power, aviation, infrastructure and real estate, or do investors still stand a chance of losing money here over the next couple of years?
If one takes a two-year view, the big story for the Indian markets will be that of a capex cycle recovery. So, all the capex-driven sectors — infrastructure asset owners, equipment providers and the service providers like capital goods companies, financiers like the infrastructure sector financiers, banks (more of corporate lenders and not necessarily the retail lenders) will do well. Retail banks like HDFC Bank and IndusInd Bank are not much geared toward the capex cycle recovery, but many others are — both on the public and private sector sides. They should gain from the capex cycle recovery. These sectors, and cement too, should do well over the next two years.
But one must note that the capex cycle recovery will be slow, and will be back-ended. So, in the near term, we continue to focus on companies where we see more visibility on earnings. In a three- to six-month horizon, I do expect more earnings downgrades to take place. In that context, I would like to be with the sectors that have greater resilience towards the earnings — like the retail financials, and autos (four-wheeler), where we have been seeing strong demand trend — as they will be safer bets. Information technology remains one of our favourites.
Do you think the market reaction to the Bihar election outcome is overdone?
The indices were down around two per cent intra-day, which doesn't seem to be an over-reaction to the outcome. I feel that the two per cent fall was a subdued reaction and is in-line with what we were expecting.
Will the outcome now see the government pushing the stalled reform process with a renewed vigour?Well, it depends on how the Bharatiya Janata Party (BJP) interprets this defeat — whether it thinks not enough was done on the developmental side, or the defeat is seen as just a mismatch on the mathematical electoral equation, etc. But by and large, I do believe it should serve as a mild mid-course correction for the government’s policies. It should ideally make the government help accelerate the delivery of its services in an improved manner — for 24x7 power and housing for all, among other things. There will be more concrete steps on sectors like agriculture and education. I do expect that.
Also Read: What the market expects from Modi govt after Bihar verdict
Do you think the ‘Modi impact’ on markets has now completely worn off? How do you expect the markets to react to a few more sessions of logjam in Parliament?I think the kind of optimism that existed on the new government about a year ago has come down significantly. People, including foreign investors, understand that it is not easy to change the direction for a large economy like India in a hurry, or to put in place reforms in a hurry. Investors understand that there are other problems like those related to the Upper House (Rajya Sabha). There are several things that need to be done to improve the banking sector and power distribution side. I, therefore, believe the global investor community is now looking at things as they come, and not necessarily give large benefits of doubt to the government like before, say a year ago.
What are your targets for the Sensex and Nifty for the next 12-24 months?
We expect over 30 per cent returns for the market over a two-year period. This, however, could be back-ended. This means the returns will not be around 15 per cent each year, but perhaps around 10-12 per cent in the first year, and 15 per cent-plus in the second year.
The market returns will be dependent on the capex cycle recovery, which is a slow and steady process. It will take time and I don’t see a big capex recovery until the second half of 2016-17. So, in that sense, the returns in the first year will be less than 15 per cent.
Also Read: Expect strong returns in new Samvat
Foreign investors have put around $3.4 billion in the Indian capital markets in October, the highest in seven months. Do you expect this trend to continue over the next year? Or could this reverse?FII inflows will be a function of two things. Firstly, what is happening in India, and secondly, what is happening elsewhere across the globe. It looks like we are on the verge of seeing the first rate increase by the US Federal Reserve and more such increases will take place going forward in the next one to two years.
Our expectation is that the flows into emerging markets, in general, will get impacted. The US-based fund inflow will decelerate. As a result, the overall pool of money that is available will shrink. We have already seen that happening this year itself. The year has not been great in terms of FII flows into India. So, I believe a similar trend should continue. I expect $10-15 billion net inflow by a one-year view. We feel the domestic investors will continue to be more dominant than foreign ones.
What is your analysis of the corporate earnings so far? By which quarter do you think the global economic slowdown will get fully reflected into the financials?
The corporate earnings season so far has been weak this financial year. We have been seeing earnings downgrades for a little over three years now. I think the downgrade cycle still continues. We have been seeing for the past few months that there is a one per cent cut in earnings estimates every month. So, in the past six months, estimates have been lowered by six per cent.
Going ahead, the pace of the earnings revisions should come down, but there will still be earnings revisions on the downside. On an absolute year-on-year (y-o-y) basis, however, the third and the fourth quarters of the current financial year (2015-16) are likely to be much better than the first half of the year. This is because the third and the fourth quarters of 2014-15 were significantly weak. But that apart, I think the economy as a whole is also about the pace of a slow recovery. So, that should also begin to be visible in the corporate number going ahead.
Which sectors in your opinion will lead the recovery?
I think the recovery should be visible across several sectors. We have already seen margin-led improvement being visible in automobiles, consumer staples and media sectors. The revenue growth in general, however, continues to remain under pressure because of the fact that we have entered into a phase of low inflation which has a negative impact on the revenue growth.
Going forward, therefore, I think the slow economic recovery should be visible more in the sectors that have been linked to the domestic economy. I think we should begin to see some slow improvement in cement, automobile, banking and capital goods sectors. It should be a domestic-led recovery. The pace of recovery, as I said, will be slow, but the domestic sectors should drive that.
Is it time to look at policy-driven sectors like telecom, power, aviation, infrastructure and real estate, or do investors still stand a chance of losing money here over the next couple of years?
If one takes a two-year view, the big story for the Indian markets will be that of a capex cycle recovery. So, all the capex-driven sectors — infrastructure asset owners, equipment providers and the service providers like capital goods companies, financiers like the infrastructure sector financiers, banks (more of corporate lenders and not necessarily the retail lenders) will do well. Retail banks like HDFC Bank and IndusInd Bank are not much geared toward the capex cycle recovery, but many others are — both on the public and private sector sides. They should gain from the capex cycle recovery. These sectors, and cement too, should do well over the next two years.
But one must note that the capex cycle recovery will be slow, and will be back-ended. So, in the near term, we continue to focus on companies where we see more visibility on earnings. In a three- to six-month horizon, I do expect more earnings downgrades to take place. In that context, I would like to be with the sectors that have greater resilience towards the earnings — like the retail financials, and autos (four-wheeler), where we have been seeing strong demand trend — as they will be safer bets. Information technology remains one of our favourites.