With the government stepping on the reform pedal and the Reserve Bank of India (RBI) likely to cut rates, we expect a mild recovery in both the economy and earnings, says Jyotivardhan Jaipuria, managing director and head of research, Bank of America-Merrill Lynch in an interview with Puneet Wadhwa. Edited excerpts:
How upbeat are you as regards the performance of the Indian equity markets in 2013?
India has been one of the best performing markets in 2012 rising by around 25 per cent. We expect 2013 to be another year of positive performance. Our (Sensex) target is 21,750 and this is based on 14x one-year forward earnings.
We expect market returns more or less in-line with earnings growth. Our top-down FY14 Sensex EPS estimate is Rs 1,350 (bottom-up Rs 1, 400) which is around 12 per cent growth on FY13 EPS of Rs 1,200.
With the government stepping on the reform pedal and the Reserve Bank of India likely to cut rates, we expect a mild recovery in both the economy and earnings. Moreover, the bulk of earnings downgrade is behind us. However, the factor that could hold back the market is that expectations in the market are fairly elevated relative to a year ago and positioning is high. Moreover, supply of paper may keep the secondary market in check in the latter part of the year.
What about foreign institutional investor (FII) flows?
India was the highest recipient of FII flows among Asian peers. Two factors drove this – first is the easy liquidity globally with central banks following a loose monetary policy. Second, growth was a concern everywhere and India benefitted from fears of a China hard landing (which also hurt countries like Brazil and Russia where materials is a significant part of the market).
While we continue to be positive on flows to India, we must caution that the overweight on India by GEM funds is now at a five-year high. In case of a better environment in countries like China where the markets have under-performed and are significantly cheaper, we could see FII flows, at least relatively, turn to other markets.
What are your estimates for global growth, and especially in the BRIC region?
Our economists expect global growth to bottom at 3.2 per cent levels. The US could trade places with Europe as the world’s main problem, in our view. Emerging markets (EM) should continue to drive global growth. Growth in developed markets (DM) could slip to 0.9 per cent in 2013E from 1.2 per cent in 2012E. By contrast, EMs will likely grow at 5.3 per cent, up from 4.9 per cent this year, powered by a Chinese recovery.
In terms of growth, we expect India to be second only to China among the BRIC countries. In an absolute sense, global uncertainty could constrain India’s GDP (gross domestic product) growth to 6.5 per cent in FY14, below its 7.5 per cent growth potential.
Do you expect the Indian economy to fare better as we head deeper into 2013?
We expect 2013 to see a recovery in both GDP and earnings. However, the recovery will likely be milder than past recoveries given that we still expect the investment cycle to be slow. The GDP growth is expected to recover to 6.5 per cent in FY14 from the forecast growth of 5.5 per cent in FY13. We believe the recovery will be led by better agriculture crop and a pick-up in consumption as interest rates come down. However, the recovery will likely be weak as the investment cycle is unlikely to pick up.
What about the capex cycle? It hasn’t picked up.
Unfortunately, we still think capex by corporate India will be subdued. Our bottom-up analysis for companies we cover forecasts a negative growth in capex for FY13 and FY14. There are four reasons why we think the capex cycle will take time to recover – business confidence is still weak, the stress in the economy in terms of companies requiring re-structuring still remains at elevated levels, gearing is at elevated levels and the de-leveraging process needs to be completed before we see a sharp spell in capex, and regulatory reforms.
Can you suggest a few sectors / stocks that still make it to your investment list?
Our model portfolio, in spite of recent outperformance, continues to favour rate sensitive sectors at least till the Budget in February, 2013. We are overweight rate-sensitive sectors like autos, financials, real estate, telecom and pharmaceuticals.
What about the metal, consumer and information technology pack?
We believe global growth will continue to be the key risk to the markets in Q1CY13. However, the potential for improvement in the US post-Q113, stabilisation in Europe from H213 and a rebound in China in H213 could support metal prices in H213, in our view. We expect demand in China and the world (ex-China) to become more evenly balanced as China’s economy slows structurally.
As regards consumer staples, while earnings growth should remain strong, given the current valuations, we expect the sector to be a relative underperformer in a rate cut environment. Volume growth for organised players can hurt — especially for commodity-sensitive categories like soaps and detergents — as unorganised players increase competitive intensity given the softening in raw material costs.
Worse-than- expected economic challenges in Europe and subdued business environment in the US could impact business outlook and sentiment for the IT sector, in our view.
