Abhay Laijawala, head of research, Deutsche Equities India, tells Puneet Wadhwa that market valuations are close to the levels from where positive returns become increasingly probable over a long-term horizon. Edited excerpts:
June is an important month for the global markets due to the Greek elections. Should investors brace themselves for a rough H2CY12 or is most of the bad news already factored in?
The outcome of the Greek elections is no doubt the most important variable influencing global risk appetite in the immediate term. While the jury is not yet in, a tail risk event in the form of exit of Greece from the European Union will be a blow to the risk appetite and will have a negative impact on all high beta asset classes.
Even though India’s equity market valuation suggests most negatives are factored in, they will not stay immune from any generic risk aversion, induced by Greece’s exit from the EU. We believe that if an extreme scenario does materialise, the authorities would have already devised an appropriate response to moderate the impact of any contagion.
Once the outcome on Greece is known and the many risks that investors fear have played out, the focus of the Indian markets will turn inward and be contingent upon progress on key reforms, an improvement in external account and the return of corporate confidence.
How high are the chances of a third round of quantitative easing (QE3) in the US, given the labour market and the unemployment data?
Global economic dataflow has worsened over the past few months — particularly the deterioration in the US economic data has come as a negative surprise for the market, even as a slowdown in China has already been discounted.
As per our US economics team, investors believe Chairman Bernanke, in the upcoming testimony to the Joint Economic Committee, is likely to indicate whether the Fed will embark on an extension of Operation Twist or undertake QE3. The consensus is for further easing.
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But, given that interest rates had been near all-time record lows, prior to the recent 'flight to quality' trade into treasuries, it is not clear if a few basis points reduction in yields would meaningfully stimulate economic activity, especially if it only serves to reinforce investors’ concerns about economic and financial fragility.
We are at a nine-year low in terms of the gross domestic product (GDP). The rupee depreciation has also been a serious concern and then there is the so-called 'policy paralysis'. How are you approaching India as an investment destination, given all this?
There has no doubt been a confluence of headwinds for the Indian economy over the past year-and-a-half. However, we believe the market has factored in most of the domestic woes and will now be increasingly driven by the global macro determinant in the near term, specially the way the euro zone crisis plays out.
The Sensex is currently trading at 12x one-year forward earnings, the lowest level in the current cycle (post the recovery witnessed after the credit crisis of 2008).We believe market valuations are close to the levels from where positive returns become increasingly probable over a long-term horizon.
While no further policy rate cuts from the Reserve Bank of India( RBI) is our central view, we are enthused by the sharp decline in global crude prices, which if sustained, will significantly ease current account concerns and could allow RBI to shift its overriding policy focus from containing inflation to stimulating growth.
While most of the negatives seem to be in the price, we still cannot envisage a scenario of a unidirectional rally in equity markets as the government needs to demonstrate strong resolve to ameliorate economic maladies.
Which sectors/themes/stocks in the Indian context are you overweight and underweight on?
We are currently overweight on the consumption theme, IT services and companies with strong balance sheet, earnings/cash flow visibility and lower risk of government interference. We are underweight on utilities and healthcare.
RBI seems to be fighting in vain to save the rupee from deteriorating further. How big a threat is the rupee to the economic recovery at this stage and how do the equity markets shape up, going ahead? Is the worst yet to come in terms of inflation, the rupee and the economic growth?
As with equity markets, we believe the sharp 20 per cent y-o-y INR depreciation is factoring most of the negatives from the Balance of Payment side, and hence, the downside from here seems limited. Also, the rupee is not alone as several other emerging market currencies have suffered similarly, reflecting the generic strength in the dollar.
If, at all, a sharply lower rupee could now begin to have a salubrious effect on India’s export competitiveness, while the negative effect on the payments side could be moderated by falling crude prices and a deliberate attempt by the government to slow down gold imports. There could be some near-term upside pressure on headline inflation, if the government decides to raise diesel prices.
We expect the equity market to be ranged within a band in the near term, with global developments dictating sharp movements, offering short-term alpha generating opportunities for nimble-footed investors. We have a year-end target of 18,000 for the Sensex.
What have you made of the earnings season, this time around? Do you expect more pressure on the corporate earnings in FY13 and FY14, given the economic headwinds?
The most noticeable feature being the top-line growth for the Sensex companies moderated after several quarters of over 20 per cent growth, which is in-line with the sharp economic slowdown witnessed during the quarter.
The consensus earnings cycle seem to have bottomed with little earnings downgrades over the past few months. Since April, we have witnessed only a 1.2 per cent cut in Sensex FY13 consensus earnings estimate, while for FY14 the consensus earnings revision has been positive. Counter-intuitively, weakness in the rupee will have a positive effect on the Sensex earnings, as 56 per cent of its revenues are derived from direct exports, foreign subsidiaries or dollar-denominated sales.