 "Sampath Reddy")
In a conversation, Sampath Reddy, Chief Investment Officer, Bajaj Allianz Life Insurance Company talks to Vishal Chhabria on what is driving the recent rally in markets, why retail participation is missing, why Q2 earnings were slightly better and the likely impact of QE tapering amongst other issues. Edited excerpts:
The current run-up in the market lacks breath and participation. How do you view this rally?
The recent rally in equity market was like a spring ball that went down sharply in August - September, when the US Fed hinted that they will commence the withdrawal of the Quantitative Easing (QE) sometime soon. But, post the Fed meeting in September as well as the 10-day shut-down and debt deadlock in the US, emerging markets rallied sharply as the spectre of tapering got pushed further.
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Contrary to expectations, the July-September quarter earnings have been good. From the data perspective, it was a poor quarter in terms of growth with high interest rates and tight liquidity. Hence, expectations were low, and second quarter numbers were better than expectation, which was a pleasant surprise and contributed to the market rally.
Given that the October rally was unexpected, most of the domestic investors were left out and many were also booking gains on their holdings. Even if we look at our company, every time the market crosses levels of 20,000 on the Sensex, redemptions increase sharply.
FII money is said to be smart money, and the way it is flowing in, it seems they are reading into something which perhaps the locals are not. Your thoughts?
FII money will be smart money from the global liquidity perspective, because they understand the global money flow much better than local investors, whereas locals are more bottom-up investors. Domestics understand the companies better and they know the demand and cost profiles, whereas FII’s are very good macro investors. So far the global liquidity seems to be on the benign side, and that has translated into incremental flows moving towards emerging markets. But it would be interesting to see, when the trend reverses and how it reverses. If and when there is any belief that QE taper is going to begin to happen and that the US Fed will taper a little bit in January, then you will see the flows coming down and the markets correcting quite a bit. So, that is a key thing to watch.
How long or to what extent do you think the markets will continue to rise?
From the long term perspective, we are very positive on the Indian market, especially if you look at the last 5 to 6 years wherein equity returns have been nil while companies have invested in their own businesses, grown bigger, become more efficient, gained market share, etc. So, significant amount of time correction has happened and valuations are attractive. But from the near term, the way the market rallied so much during September-October it is perplexing, and implying as though things are improving right away. But even if you buy now, in the next 2-3 years, you would still make good returns. If market corrects 4-5% from the top, it should be a great time to buy.
You mentioned, recent earnings have been slightly better. But it has been driven more by cost cutting rather than demand.
Yes, most of the reason for profit growth was cost cutting, because corporates were in the denial mode since the last one, one and a half years, in terms of a recovery. But over the last 4-6 months, they are beginning to feel the pinch and are cutting down costs very severely, which has helped profit growth to a large extent.
Given that demand environment still remains weak and there is a limit to cost cutting, what kind of trend do you expect going ahead in earnings?
In the December or even March quarter, you will not see any major uptick in earnings growth. In this remaining 3 to 6 months period, the market will consolidate and hopefully inflation pressures will ease, and that will bring down the overall interest rates and slowly growth will pick up. The bottom line is we need to get into the investing mode, as the cycle should begin to start. It has been declining for more than 3 to 4 years, so enough time has gone and, once the corporates start investing you will see recovery. That phase is about 6 months ahead (post elections).
For now, are you seeing any kind of green shoots in the economy?
No, not yet. If at all something was to happen it should be on the export side. Export-driven companies may begin to show some better performance, but otherwise, in the general capital equipment and infrastructure investment side, nothing yet.
This market rally is also partly due to the Modi factor. How do you read this? What is the risk involved here or are the markets over optimistic?
It is very difficult to say which party will come to power. At the moment it looks like a coalition, but irrespective of who comes to power, there should be stability and most of the current policy related paralysis should be out of the window. But, yes, the market is very optimistic about Narendra Modi coming to power. My view is that, irrespective of the outcome of the elections, we should see things improving six months from now.
How do you see the liquidity flows moving when QE tapering starts, and the impact on the markets?
Most likely markets will correct sometime in the start of CY14 when we believe that the tapering will begin, as that will actually lead to some reversal in the risk flows. And this time round, if there are serious outflows by the FII’s, markets can collapse, because, there would not be many buyers. And, even for the rupee, let’s say if $2-4 billion is taken out by FIIs, the markets will collapse and the currency will also start weakening. In the recent sell-off in the currency, the government tried to control the rapid depreciation and they implemented a number of short term measures with limited success to prevent the currency from weakening. If it happens again, it will be very difficult for the government to do anything to prevent it and that’s a big risk, I would say.
