We seem at the cusp of earnings recovery, says Janakiraman R

One-off disturbances such as demonetisation and the goods and services tax (GST) have made it difficult to assess the true underlying earnings growth, says JANAKIRAMAN R, fund manager at Franklin Templeton Investments India. He tells Ashley Coutinho that 2018-19 earnings growth should benefit from the positive impact of reform measures. Edited excerpts:   

How is the current stock market rally, in India and globally, different from those we saw earlier?

A noteworthy aspect of this current rally is that earnings growth hasn’t caught up adequately with index growth. More, one-off disturbances like demonetisation and GST have made it difficult to assess the true underlying earnings growth. The existing negative output gap holds scope for the economy to attain better capacity utilisation levels. The continuing strength in consumption and aggressive plans by the government to boost investment in public infrastructure are other positives. Put together, these augur well for earnings growth. 

On the flip side, global liquidity has greatly increased after the prolonged quantitative easing and accommodative monetary stance adopted by most central banks post the global financial crisis. As major central banks prepare to move towards quantitative tightening, the shrinkage in global liquidity could disrupt the equity market rally.

Do Indian markets look overvalued? What about the mid-cap and small-cap segments?

The one-year forward consensus price-to-earnings for the Sensex is at 22 times, a modest premium to the long-period average. In this context, an investor should take note of the reduction in interest rate. Not only the current rate but the reduction in expectations about it over a longer time period. In addition, after having seen quite a few efficiency-oriented policy initiatives, we seem at the cusp of an earnings recovery. 

The mid-cap and small-cap segments have indeed become expensive over three years. There exist many pockets of very expensive valuation in these categories. A disciplined investment style and realistic return expectations are required. Also do not forget that in the light of improving domestic demand, this segment is likely to see stronger earnings growth.

How do you view the government’s bank recapitalisation programme? While the move is seen as a positive by several analysts, what are the potential drawbacks?
 

The government’s recent move to recapitalise public sector banks could help in tackling and fast-tracking of bad loan resolution. This, in turn, should aid private capital expenditure recovery and improvement in economic activity coming from productive utilisation of bad assets. The move could also help in lowering of lending cost, which in turn can revive the investment cycle and make the lending market more competitive. 

The potential drawbacks could include an impact of the interest component of the recapitalisation bonds on the fiscal deficit. Low investment demand in the system might result in no immediate revival of credit offtake in the economy. More, with this programme, there should be initiatives to improve governance at public sector banks. 

Your thoughts on Sebi’s (the markets regulator’s) move to reduce and consolidate the number of mutual fund schemes?
 

The move comes at an apt time, when investor interest in Indian MFs is strong and rising. With a large number of funds and multiple overlaps, it is only logical to define and demarcate categories, to facilitate the understanding of risks, comparison and selection of funds. Sebi has laid out a clear distinction with respect to asset allocation and investment strategy across open-ended schemes. This is expected to bring needed uniformity across similar types of schemes. Which, in turn, could standardise the peer set for evaluation by investors. 

What global cues do investors need to watch?

In the backdrop of mounting tension between North Korea and the US, continued lack of action from China to restrict its dealings with North Korea might result in the US imposing trade bans or tariffs on China. This could lead to aggressive dumping of its products by China into other markets, leading to disruption in many economies, including India’s. A Chinese credit crisis could lead to monetary tightening by its central bank, triggering a credit freeze. This could lead to a deflationary situation in major economies, starting with falls in commodity prices, financial markets and eventual fall in real demand from Chinese consumers. Balance sheet normalisation by the US Federal Reserve and the hawkish stance adopted by the European Central Bank could impact global liquidity and flows to emerging bond markets. The easy monetary stance of the Bank of Japan should alleviate the impact to some extent. In addition, steady improvement in aggregate demand in the US and Europe should mitigate the adverse impact from a rollback of quantitative easing.