Improvement in global economic growth should drive markets: Nandurkar

Investors need to strike balance between valuations & growth outlook, says CLSA executive director

With markets seeing a healthy run-up since their December 2016 low, Mahesh Nandurkar, executive director and India Strategist at CLSA, the Hong Kong-based investment and brokerage entity, tells Puneet Wadhwa investors need to strike a balance between valuations and the growth outlook. As a contra theme, one could look at the information technology sector, he says. Edited excerpts:

How do you see the global financial markets in 2017?

We clearly believe that the global growth outlook is steadily improving, thanks to the improvement in the growth outlook in the United States (US). We are clearly seeing this improving outlook to some extent getting factored into the stock prices already. In that context, I do see that for a long period of time where the markets were moving up more on account of monetary stimulus by global central banks, the key driver will shift to fiscal stimulus. Hopefully, this should have a much better and direct impact on the global growth outlook, and this is what we are seeing right now. 

On the negative side, the monetary stimulus will get slowly unwound, and we have already seen a couple of rate hikes in the US and more will happen in CY17. These are the two key factors that one needs to keep a tab on, besides developments elsewhere, such as European elections in key states.

Having said that, we continue to believe that the improvement in global economic growth should be the dominant factor that will drive markets. It would also mean that the emerging markets and economies will also get the beneficial impact of the overall improvement in economic growth.

What is the general mood among foreign institutional investors (FIIs) on India as an investment destination after demonetisation and the Budget proposals? 

The foreign investor sentiment is getting impacted by global developments more than local ones. Looking specifically at India, investors have to strike a balance between valuations and the growth outlook. Earlier, India was among the bright stars, given the gross domestic product (GDP) growth potential. This started changing over calendar year 2016 (CY16). The other competing economies are catching up. The growth delta was favouring India, but is not doing so anymore. 

Second, a lot of investors who were overweight on India for most of CY15/16 have been gradually changing their stance. In this backdrop, money has shifted away from India into the other EMs. The demonetisation-led slowing in the near term probably gave one more excuse to pull out of Indian markets.

Having said that, I think the investor positioning on India has come down to a small overweight rather being aggressively overweight – what it was 12 months ago. From the Budget proposals’ viewpoint, the clarity on taxes as regards foreign institutional and portfolio investors is a relief. 

How do valuations look at this stage?

Indian markets are trading at 17.5 times the one-year forward earnings, around a 10 per cent premium to the historical average. Though the valuation is at a premium, the point is that the Indian economy is at a cyclical low, especially when you look at corporate earnings. So, a slight premium in the price-earnings (PE) multiple on the earnings base, which is depressed, is not a bad deal. We still believe that over the next one year, the Nifty50 (benchmark index on the National Stock Exchange) should deliver close to 10 per cent (total) return, including dividends.

What are your estimates for corporate earnings in FY18 and FY19? 

We expect earnings growth of 13-15 per cent for FY18. FY19 is some time away and we do not wish to make any guesses. We did reduce the estimates for (the years ending) March ’17 and March ’18 after the demonetisation announcement by four percentage points. To that extent, there was no change in growth estimates for FY18 because both the March ’17 and March ’18 estimates have been reduced. Having said that, the December quarter results have been better than expected, barring a few. Since then, we have revised our earnings estimates marginally. 

Which sectors surprised positively and which were the laggards?

Those that surprised positively included private banks, consumers, automobiles and cement. The negatives came from pharmaceuticals and telecom, where there were earnings downgrades. We also saw downgrades for public sector banks. The information technology (IT) sector was mixed.

We remain overweight on consumer discretionary (including automobiles and media), and banks and financials, mostly the private sector ones. We are also overweight on global commodities, which includes metals and petrochemicals.

The mid-cap segment has seen a healthy run up since its recent low in December. Is there still money to be made here, or do you prefer the large-cap basket?

From a top-down perspective, valuations in the large-cap segment appear more attractive. However, select mid-caps can still outperform as the earnings growth would actually be quite strong. 

Is IT a good contrarian play from a 12 – 24 month perspective? What about the pharmaceutical stocks?

We are also watching the IT space keenly. We do note that there are concerns, on the visa-related issues, at the same time, a lot of the issue are getting reflected into the stock prices. The key positives that we take a note of is the improvement in the US growth. If that happens, it is good for the Indian IT companies because large sectors like the financials and the US retail are reasonably large clients of Indian IT vendors. We also derive comfort in the current valuation of IT stocks. I think if one wants to play a contra theme, IT is one of the good option even as compared to stocks in the pharma sector.

Index of industrial production (IIP) contracted 0.4% in December with capital goods declining 3%. How do you extrapolate that to the road ahead for the capital goods companies?

For a reasonably long time now, the IIP number has not really been correlated with the performance of the companies in the listed space. For the listed players, some part of the business also comes from abroad. On an overall basis, we do not draw one-to-one comparison and correlation between the two. Having said that, we do not see any signs of capex revival anytime soon. To that extent, we continue to maintain underweight on the capital goods and the industrial sectors.

How do you see the Reserve Bank of India (RBI) responding to the global and domestic developments in terms of cutting rates and managing the rupee in CY17?

The RBI has made its position clear in the last monetary policy review. They have changed their stance from accommodative to neutral, which basically gives out a message that the probability of rate cuts in the remainder of CY17 is now very low. Though one can’t rule out a cut, but the possibility has reduced considerably. The rupee has behaved well over the past few months as compared to the other emerging market currencies. This is even when there was a huge redemption of non-resident (NRI) deposits. All this goes to show the underlying strength in the economy. Now that the RBI has signalled for no more cuts of any reasonable size, the rupee outlook has improved a bit. I don’t see a significant depreciation in the rupee even if we assume three more hikes by the US Federal Reserve (US Fed) in CY17. The maximum it can depreciate is maybe 3 – 4% over the next 12 months.