Given the domestic and global economic situation, the markets are likely to trade at discounted valuations, believes Rakesh Arora, managing director and head of research at Macquarie Capital Securities (India) Pvt Ltd. In an interview with Sheetal Agarwal, he says the infrastructure sector will drive the next leg of growth for India and the government needs to increase focus on this sector. Edited excerpts:
When do you expect Indian stock markets to stabilise? What levels do you expect markets to be by March 2012?
The markets have seesawed with global news and some investors seem to be buying on dips and adding beta because defensives look expensive. We think it may be six months too early for this trade. Our estimated 'fair value' for the Sensex, using a two-stage DDM, is 18,500 by March-end 2012, which implies 14 times the one-year forward PE (price to earnings) ratio. However, given high global risk aversion and India's already high premium to the rest of the world, valuations will likely remain around the current range of 13-13.5 times the one-year forward PE ratio, implying an index value of around 17,500 by March-end 2012.
How do you think Indian markets stack up vis-a-vis its peers in the emerging markets?
Though India is less exposed to the developed world (via exports) compared to other emerging peers, the domestic story is currently facing macro headwinds from high inflation, interest rates, stalled investment activity and the political stalemate between the UPA government and the opposition. Given this backdrop, we don't think India will command a very high premium to its emerging market peers like it did after the global financial crisis in 2008. Currently, India is at a 45 per cent premium to emerging markets (versus a 10-year average of 26 per cent) and a 30 per cent premium to Asia, ex-Japan (10-year average of 14 per cent). This seems very high, given the domestic situation.
The outlook on FII (foreign institutional investor) flows?
We think a concrete resolution to the European debt issues would be the main trigger for risk aversion to abate and for FIIs to start deploying their money. It would be supported by the loose monetary policy being pursued by all central banks, who would strive to keep all liquidity channels open. We think it may be another six months before clarity emerges. However, given that other emerging markets are much cheaper compared to India and at valuations below their long-term history, it is likely that FII flows would go to those markets first. FIIs would also be looking at a resolution to India's domestic issues before re-entering the market.
Which are the sectors/themes you like and dislike currently?
We are currently overweight on energy, information technology, healthcare and consumer discretionary, and underweight on consumer staples, financials and industrials (within industrials, we prefer large-cap capital goods over infrastructure)
What could be the next sunrise sector?
Infrastructure will remain the main theme, if India has to remain on a strong growth path. We are looking forward to some stability of political policies before buying here.
Many concerns are expressed around the banking sector on asset quality, as well as on credit growth. How do you view the banking stocks, given this backdrop?
We are bearish on the sector. The 2012-13 earnings for banks are under risk from rising credit costs and operating expenses, which are still not in Street estimates. Public sector banks will be hit by higher pension costs. We believe asset quality is under risk, with stressed assets to rise sharply. Agri, power and SMEs (small and medium enterprises) would be the main sources of non-performing loans. We think public sector banks are deceptively cheap because the book itself is grossly overstated. The discount of PSU banks to private banks is set to rise. We prefer the retail banks, HDFC and Kotak, and also YES Bank.
There are signs of slowdown in the domestic economy. Have you trimmed your estimates for GDP growth?
We had trimmed our estimates for 2011-12 down to 7.4 per cent from the earlier estimates of closer to eight per cent growth.
There is a view that monetary policy measures alone may not be enough to curb inflation. What non-monetary steps do you think are needed?
Indeed, monetary policy can only provide a cure for the symptom but can't cure the disease in itself. The government needs to stop a populist approach and tighten its belt on the fiscal deficit. For the medium term, a focus on infrastructure build is critical.
