 "Nilesh Shah")
With the US Federal Reserve (US Fed) keeping the doors open for a rate rise in December, Nilesh Shah, managing director, Kotak Mahindra Asset Management, tells Puneet Wadhwa the quantum and pace of the rise will be far more calibrated and moderate this time around. Six to eight rises of 25 basis points (bps) each are already factored into the US and Indian yields, he says, and suggests that the volatility caused by the rate-rise issue is a great opportunity to buy stocks from a long-term perspective. Edited excerpts:
Are the global financial markets factoring in a rate hike by the US Federal Reserve (US Fed)?
The fear that the market is expressing is how much will the US fed rate rise? My guess is that six to eight hikes of 25 basis points (bps) each is already factored into the US as well as Indian yields. It does not appear that the US Fed will revert to its historical average of 10 to 12 hikes in a row. The quantum and pace of the hike will be far more calibrated and moderate.
While we have to keep a watch on the Fed rate hike, it should not be more than what is priced in by the markets. In some sense, the hike will be more beneficial to India over medium-to-long term rather than negative in the short-term, but we do have to live with market volatility. When the dust settles, one will realise that all the volatility caused by the US Fed rate issue was a great opportunity to buy.
How long do you expect the upbeat scenario to last across global equity markets?
The US Fed is seeking to normalise their monetary policy, while there is a counter current in the European Union (EU), China, Japan and India who are seeking to ease the money supply in their respective systems. And it’s not that US is going to harden liquidity, it wants to raise the interest rate for the future incremental liquidity flow in their banking system. So per se, the backlog of easy liquidity is likely to remain to drive asset prices from time to time. Individual equity markets may now increasingly align with their domestic performance trends rather than be taken in with the macro liquidity tide.
In the Indian context, should one use this opportunity to exit?
From Indian viewpoint, it is a time to buy, and buy for long term. Indians have been selling equity since 1994 when FIIs (foreign institutional investors) were allowed to invest. Now, retail ownership of equity has been left at eight per cent of market capitalisation. Domestic Investors are now allocating more money to equity than in the past. Indian markets are on a strong wicket with top down macros better than most peers, and bottom-up stock picking rewarding risk takers with earnings and valuation rebound.
What’s your view on the foreign institutional flows for the remainder of FY16?
The last FIIs selling was led by exchange traded funds (ETFs) and sovereign funds. But this trend may change. Emerging markets have underperformed developed markets over the last five years due to dollar strengthening. India stands out like an oasis in a desert among emerging markets (EMs). Flows by long-only funds in listed market and private equity funds in unlisted market gives comfort that India will get differentiated among its peers in months to come. Falling fiscal deficit and current account deficit, falling inflation, improving growth, stable currency and fair equity valuation should give comfort to investors.
What about other issues like an unfavourable outcome if Assembly elections in Bihar that could play a spoilsport as regards the reforms?
The absence of broad political consensus for taking the reform momentum forward is keeping many disconcerted. For that reason, the delays in the GST rollout, and reforms in land and labour would be a concern.
Another could be the geo-political shocks. This may lead to reallocation of capital towards subsidies or in creating a high cushion for risk absorption; thus inordinately widening the now tamed fiscal and/or current account deficit. Mounting losses and NPAs in the public sector banks and utilities could also cause expenditure of political capital and keep government pre-occupied from the more essential process of reform.
Could the pick-up in earnings get delayed given the recent turmoil in global markets?
While global market volatility impacts the performance of Indian equity markets largely due to portfolio flows, by and large, the earnings trajectory for the companies in India are determined by the underlying domestic trends in terms of growth. With commodity prices having declined and expected to remain soft, some of the companies (which use the commodities as raw material) have benefited due to improvement in costs and hence margins. Global market volatility also could have a bearing on the movement of the rupee. While the depreciation of the rupee is by and large positive for export oriented sectors, the relationship is not a linear one.
How has the September quarter results season played out thus far according to you? Do you think that the markets are factoring in any disappointment/ negative surprises?
The expectations going into the Q2 FY16 earnings season were by and large muted for most sectors — partly due to the festive season having been pushed out to the third quarter and also a reflection of poor monsoons.
While most technology companies have reported healthy revenue growth numbers quarter-on-quarter (in USD terms), there is evidence of margins pressure despite the rupee depreciation given higher competitive intensity and changing nature of the business. Among banks, private sector retail banks continued to show healthy trends with loan growth remaining significantly higher than industry average and asset quality remaining largely stable. For banks with a larger exposure to corporate sector loans, there has been evidence of some deterioration in asset quality.
By which quarter, going ahead, do you expect the overall slowdown in global economy to get adequately reflected in corporate India’s financials?
Corporate India’s earnings growth is largely reflective of domestic demand factors. We expect that domestic demand growth has bottomed out and would show improvement going ahead. Earnings growth in H2FY16 is likely to show improvement partly on a lower base as well as due to pick up in domestic demand trends.
The impact of the slowdown in global economy is limited to companies that are export oriented, for example technology and pharmaceutical companies. While any significant slowdown in the global economy from current expectations would impact such companies, at present the slower global growth outlook is to a great extent reflected in expectations for the companies in these sectors.
What are your sector and stock preferences amid all this?
Large-cap stocks have underperformed mid-caps in the last 12–18 months. The valuation difference between large-cap and mid-cap now favours large-cap stocks. Superior returns will be generated by bottom-up stock selection as quality stocks are likely to be rerated on lack of new issuances.
Private sector banks and non-banking financial companies (NBFCs) should outperform on interest rate cuts and increased financial savings. Domestic cyclicals like cements should outperform on improving spending by the government on the infrastructure sector. Urban consumption like white goods, automobiles and affordable housing should also outperform the market on pay revisions to government employees.
Mutual funds have been net investors in the Indian equity markets since the last 17 months. Equity folios, too, have seen a rise. What is the road ahead?
Now, there are 80 lakh Indians that are doing Systematic Investment Plan (SIP) every year; they are getting roughly Rs 30,000 crore every year into equity mutual funds. This trend is only likely to accelerate as the word of mouth spreads about SIP experience. The government has also liberalised PF investment norms to enable further retail participation in equity market. We expect more than Rs 900,000 crore to come into the equity market over next five years between Mutual Funds, Insurance Companies, Banks and Provident Funds exceeding the potential supply of papers from government divestment and retail selling.
