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About a year before, you were not bearish but not too bullish either. Has the rally surprised you?
Our investment thought process was a bit sedate. There is always a pre-election rally but it peters between one and three months. We believed the market would not go up beyond a certain level. The (poll) mandate this time was the strongest in almost 30 years. Also, it was one of the few elections which coincided with an uptick in the economy. So, it turned out to be a black swan event (a term for something unprecedented and unexpected). It was very difficult to predict last year that there will be such a big rally. Most global strategists were saying developed markets will outperform and the emerging market story is over. The Brics (bloc of nations) had become the ‘fragile five’.
Will equity market returns be as robust as in the past year?
We believe investors should relocate their investments to equities. But they shouldn’t have unrealistic expectations. Last year’s returns will not be matched, going forward. So, don’t come hoping for last year’s returns but you will get steady returns for the next two or three years if the economic recovery pans out as we are all hoping. The returns will be in the mid-teens rather than the high double digits that we have seen.
What are valuations looking like?
It has been like a Brazilian carnival for small-cap and mid-cap stocks. A Brazilian carnival, however, lasts only for 40 days; the small-cap and mid-cap rally had been on since January. That has to lose steam at some point. It can’t continue at this level. The valuations don’t offer much upside for another re-rating. Earnings haven’t really come back yet. Small-caps are the most overvalued, followed by mid-caps and then large-caps. All the cyclicals are at valuations that FMCG stocks were in 2010-11. However, no one is shouting from the rooftop as they were in 2010. The hope is that the earnings growth in these sectors will be so sharp that no analysts will be able to project this.
Lately, we have seen a lot of sector rotation.
In the first part of the rally, it was the public sector banks and the so-called cyclical stocks, where valuations were compressed, which did well. In the past three months, the worry that the market has reached fairly robust levels has seen the high-beta stocks take a back seat and better-quality companies have done well. So, sectors like pharmaceuticals and technology services, where the quality quotient is better than cyclical, have done better post-elections.
So, how do you position yourself?
In times like this, you stick to high-quality companies rather than get extra courageous and buy high-beta. Look at companies where there is sufficient room to improve the operating leverage but are not financially stressed. This means you are sacrificing a bit of return but also ensuring that the volatility of returns would be lower.
Are you not in the bullish camp?
We are not in the camp which believes the government will have a lot of ‘big-bang’ reforms. We also don’t believe there will be a sharp economic recovery. Our view is that there will be steady recovery. Those with very high expectations could get disappointed. We think the story is about buying companies rather than buying ownership. It shouldn’t matter if the company is government-owned or private.
Is there more upside in the rally?
Every bull run gives you 100 per cent returns and it lasts for two years. From that point of view, we are just halfway through. Almost 80 per cent of the growth in the bull markets, in the past, has come from earnings expansion and not actual growth. The fourth quarter of this financial year is going to be a very crucial phase of this bull run. You will have the Budget in February, when the government will not have any excuse that they didn’t have time. Investors will also want at least some sign of earnings growth for the March 2015 quarter. If both of these disappoint, then you have to worry that the market will take a period of two or three quarters of adjustment. That’s also the time when the US Fed (their central bank) will increase rates. Till the fourth quarter of this financial year, the market might not correct significantly.
Do you expect a correction if the Budget disappoints?
The macro factors for India will be positive. Our fiscal deficit will keep coming down, there is increase in spending on infrastructure. At some point, the Reserve Bank will start cutting interest rates. So, that gives you hope that even if things don’t work as well as you think or we have a disastrous second budget, the market will not collapse as in the past, since other levers are in place.
Also, we still haven’t reached a stage were earnings expectations are difficult to manage. So, if the Nifty touches 9,000 before March, you should be worried, as at that level you will have to justify those by saying earnings growth will be 25 per cent (annually) for the next two years.
MFs are seeing good investor flows. Has the tide turned?
The numbers are exaggerated. In our view, about 40 per cent of net inflows into equities in recent months are flows into arbitrage funds. If you factor that out, the flows become much more modest. Financial assets, due to inflation, have underperformed physical assets in the past five years. So, gold or real estate have been the preferred routes for investing. Only in the past two years have equity returns outpaced physical assets. As inflation comes down and as financial assets start to perform once again, investors will come back. Equity, as an asset class, is at least a point of discussion for investors. It wasn’t even a point of discussion two years earlier.
Most of our funds are based on being more consistent. We have had steady inflows. We have lost market share but our philosophy remains the same. Most of the funds are based on being more consistent.
