 "Neelkanth Mishra")
Neelkanth Mishra, managing director of equity research at Credit Suisse, the Zurich-headquartered financial services entity, shares his views with Puneet Wadhwa on the road ahead for markets and his sector preferences ahead of the crucial 'Brexit' vote. Edited excerpts:
How many hikes do you expect from the US Federal Reserve this financial year?
With the Federal Reserve dot-plot itself downshifting quite sharply in its June meeting, and global economic momentum unlikely to accelerate meaningfully from here, it's hard to expect more than one hike this year. Before this meeting, our US economists expected two. The Brexit vote next week can impact global markets as well as economic momentum, and that can change the outlook.
What's also interesting is the agreement last weekend (as reported in the Nikkei) where China granted an allocation of $38 billion of stocks and bonds to the US, and in return got a concession from the Treasury Secretary that the US will fully consider how normalizing its monetary policy will affect global financial markets.
This is a remarkable change. As the RBI Governor had mentioned in a speech recently, central banks the world over only have a mandate to think about their own economies, and never about spillover effects. They have at times talked about spillback effects, but never spill-over. Changing their mandate therefore is important, particularly in a deeply interconnected world.
The volatility in global financial markets we saw earlier this year was partly caused by concern around the renminbi (RMB) and that concern was triggered by the sharp appreciation of the trade-weighted dollar. That in turn was caused by the US Fed's rate hike in December last year. So if the US Fed is made to take into account the impact on the RMB, among other things, strong and frequent rate hikes from here seem unlikely.
Are the current market valuations in India sustainable?
The current 12-month forward P/E (price to earnings ratio) for popular indices are higher than past averages. MSCI India is at 17.5 and the Nifty 50 at 16.5 on consensus numbers. Both are meaningfully above 10-year averages. The market has only seen higher multiples in all-out bull markets. So, one can say the markets are not cheap.
However, two further considerations point to the market also not being very expensive. The first is relative market P/E. The MSCI India P/E premium to MSCI World is only about 15 per cent. At the 2008 peak, it was 80 per cent, and in the 2010 peak, 40 per cent. So, in a way, the high absolute multiples we are seeing are a reflection of the high valuations seen across asset classes globally. The second is the change in index EPS (earnings per share).
We have to stay watchful of global events, particularly as the popular indices like Sensex, Nifty and even the BSE100 have strong global linkages. They cannot do well if the global markets and economies are in turmoil. But, if there is no new crisis globally, we think the Indian markets should do well from here.
What are your key takeaways from the March quarter results?
They were encouraging. Aggregate BSE100 sales grew five per cent year-on-year (y-o-y), after four quarters of decline. More important, perhaps, nearly half the Nifty companies beat estimates, the highest proportion in three years; so, the earnings revival was better than expected. As a result, the pace of earnings cuts slowed sharply. That supports the headline indices.
Which sectors and stocks are you overweight and underweight on in your India portfolio?
We recommend an overweight on non-banking finance companies (NBFCs), several private banks, some utilities, consumption stocks (both staples and discretionary) and oil marketing companies (OMCs). Our advice is to underweight public sector banks (PSBs), capital goods and industrials (we like a few stocks but not the sector), and telecom.
Given the delay in cutting rates, do you think a recovery in India Inc's fortunes, given the high debt levels in some corporates, could get pushed back?
I don't think the rate cuts are delayed, and what's more of concern is the delay in transmission of lower rates by banks. Despite the improvement in the liquidity situation, rates are still not falling.
At a much deeper level, with 90-plus per cent of India's workforce in the informal sector, I would question the rate sensitivity of growth in the economy. Of the remaining 10 per cent, a large number of employees are in the public sector. Rates, in our view, have more of a signalling impact, and that's important for inflation.
Further, as we are seeing in the developed world, only cutting rates doesn't drive growth - at the margin, it brings forward future growth. Even in a high-interest cost system, if there is deficient supply in a sector, investment does happen and capacity does get added. Investments are still happening - the record high FDI (foreign direct investment) last year wasn't all into the advertising and discounting spends of internet companies.
By when do you see a revival in private sector capital expenditure?
Investment revival or, to be more accurate, private sector capex revival, could be 18-24 months away. Till two months earlier, so sure were we that this was unlikely anytime soon that we weren't even trying to estimate when it would restart. However, recently, our analysis of state budgets and the work on UDAY (the government's scheme to address power distribution companies' finances) has pointed to some interesting changes on the ground. We have turned the radars on and started tracking these changes.
Is the worst over for the banking sector?
We don't think the worst is over for the PSU Banks. Their problems are much deeper than just the non-performing asset (NPA) issues or a lack of capital. Even if they had great asset quality they would still struggle to earn their cost of capital. Some relief on improving prospects of metals, and from the recent RBI policy has moved up these stocks, but we remain cautious on them. On the other hand, the private sector corporate lenders have less of these structural concerns, and while NPA resolution is still going to be a challenge, we believe the problems are now well defined, and that should suggest the stocks have bottomed.
Should one stay away from pharma, FMCG, information technology (IT) sectors as an investment theme?
We have an Underweight recommendation for IT, as improving domestic growth means this high-quality but low growth sector becomes less attractive for investors. We went neutral-weight on pharmaceuticals about a year back, as valuations were starting to get extreme.
As regards FMCG, we remain buyers. The stocks are expensive, but the visibility of earnings growth is still good, and some of the more bottom-up changes in the economy, in the form of state government action, and improvement in basic infrastructure and therefore ground-level productivity, is hard to play through any other sector. Company specific issues, including management quality, strategy and valuations are important to keep track of.
How much headroom do you see in monsoon and consumption related plays from here on given the run-up we have seen over the past few months?
Analysis of the impact of a good monsoon after two consecutive failures needs to be somewhat more detailed. It's important for example to understand why prices did not go up despite two years of very weak volume growth. People simplistically attribute it to low increase in Minimum Support Prices or a suppression of black-marketing activity. The reality is very different, as we explained in a recent report after a deep-dive on Indian agriculture.
Per capita calorie consumption in India has been falling – it's been falling for more than thirty years. The most likely reasons for this are a reduction in manual work (walking vs. bicycles, motor-cycles vs. bicycles, tractors vs. manual ploughing, fewer people needing to travel long distances carrying water, etc.), falling frequency of calorie-depleting acute illness like dysentery/diarrhea, better immunization, etc. With population growth slowing as well, this puts a cap of sorts on how much total food we need.
In parallel, the nature of calories consumed has also been changing – this is something most people agree with – less cereal consumption, and more fat, milk, eggs, chicken meat, etc. This has meant that cereal demand per capita has been falling at more than 1 percent a year for nearly 30 years. As population growth has slowed to about that level now, the total demand for cereals in India has flattened out. This is at a time when yields continue to increase, and more than half our acreage is still employed in producing cereals. We have therefore been generating significant surpluses in cereals. In the absence of a lucrative export market (global prices have been weak in the last two years), the 10-12% jump in output that would result from good rains this year may actually cause prices to weaken, particularly as Food Corporation of India is also shedding excess inventory.
The items where India has shortages, i.e. pulses and oilseeds, have been very badly affected by weak rains in the past two years, as only 16% of pulses area and 28% of oilseeds area is irrigated. So, output fell, and our imports of pulses and oilseeds shot up to US$12bn last year. While in oilseeds there is a global market, in pulses there is none (as only Indians eat pulses, pretty much). So, oil prices did not rise, but pulses prices have continued to. This year with good rainfall both these should see 25-30% rise in output, which should bring down imports. But that should also see pulses prices fall, and fall quite sharply.
For perishables like milk, fruits and vegetables, the substantial improvement in rural infrastructure, in the form of better access to electricity, roads and phones, and the sustained high inflation for nearly six years, has finally driven a supply response. Technology adoption has also been much better than in the past. These are still immature markets, so there is likely to be continued volatility, but the average price increases should come down.
So, as output from the good monsoons start hitting the market, towards the end of this calendar year, price increases should slow. Agricultural income growth should improve from last year, but would still be in high single digits, vs. the mid-teens growth seen in the prior decade. On the positive side, as visibility on low food inflation improves, we could start to see reasons for more rate cuts: there could be a "goldilocks" phase where growth picks up while inflation falls. Low food prices should also help discretionary incomes at the low end of the pyramid, particularly in rural areas. One must remember that while all agriculture is rural by definition, only 30% of rural GDP comes from agriculture. So there is a large non-agricultural rural economy, which should benefit from higher output and lower prices. We recommend low-interest rate plays, road-freight plays (best through NBFCs) as agriculture is 20% of road freight, and discretionary consumption (electrical appliances, etc).
