Being positive on market for the next one to two years, Prashant Jain executive director and CIO at HDFC Mutual Fund said he expected growth to resume as interest rates begin to soften. "Growth rates in India could moderate slightly, 0.5%-1.5% because of high interest rates. But the impact of this is moderate and limited. So when interest rates come down, growth rate should once again resume," he explained.
Valuations to him look quite reasonable; below the long-term averages. "The downside in my opinion appears to be limited and the risk reward is quite favourable for someone who has a medium to long term view," he told CNBC-TV18 in an interview. However, he was quick to add that it was difficult to forecast equities over a short period.
Though not pessimistic on earnings, Jain said one could see damage to a few companies. "Market price-to-earnings ratio (P/E) is at 13x current year earnings," he added.
Here is the edited transcript of his interview. Also watch the accompanying video.
Q: This week would be very important globally. How have things been shaping up across the world? What kind of damage would the equity markets may still see?
A: Equities over short period are extremely hard to forecast. Short-term calls seldom go right. If we focus on the value, we improve our chances of forecasting or estimating the market over medium to long-term. Today, valuations are quite reasonable. The PEs are significantly below the long-term average PEs. One year down the line, interest rates should be lower from current levels, which will be supportive of higher PE multiples.
Growth rates in India could moderate slightly around 0.5%-1.5% because of high interest rates. But, the impact of this is moderate and limited over a period of time. As and when interest rates come down, growth rate should once again resume. We have a reasonable room for PEs to go up. For over one to two year perspective, I am positive on the market.
Q: The risk to the valuation at this point seems that there is a complete lack of clarity on how good or bad earnings will be. Are you confident about the kind of earnings we may see over the course of the next few quarters because that might be a big problem?
A: I am not so pessimistic on earnings. There could be problems in specific companies or sectors. At the border level, I do not see earnings under any broad based pressure. There could be 3-5% risk to earnings, but it won't become material.
Every month or quarter that the Sensex does not go up, you are discounting 5% earnings growth because India's longer term earnings growth is reasonable at about 15% CAGR.
Q: With respect to the domestic issues, how correlated is our market movement from hereon to what is happening on the macro economic front? Have we priced in most of the domestic issues or is there more pain because of the macro economic issues?
A: The past will again be a reasonable guide for us. In crisis situations like Lehman, when it went bankrupt, there was crisis of confidence in equities globally, the PEs did not hold below 10 times. Currently, PEs are about 13 times one year forward.
One year down the line, PEs should be about near crisis levels. There is no crisis to my mind. There are some pressures, uncertainties and weak sentiments, but I do not see any crisis in the economy. The downside appears to be limited and the risk reward is quite favourable for someone who has a medium to long-term view.
Q: Aside from the downside risk, the fear at this point seems to be that India, amongst the other market, is in some kind of multi cycle bear patch, where perhaps upside is quite capped. For a few quarters from now, what kind of upside potential will this market have?
A: The longer term average PE of Indian markets is about between 15 and 20 times, which is pretty reasonable when we are in a 15% earnings growth environment.
Over a period of time when the global crisis is over and interest rates in India are somewhat lower, the PE multiples, which are currently about 13 times, could move up to 20-30%. The earnings are growing in any case. In one year, they may grow 12%, but the longer term average is about 15%.
Returns should come from not only from the earnings growth, but also from the PE multiples. We do not get good valuations when the news flow is good. It is difficult to invest or be optimistic at times, but with one-two year down the line, this will look like a reasonable or good investment opportunity.
Q: In terms of specific sectors, how would you approach the banking space now? Many of them indicated that credit growth will not be as strong as anticipated at this start of the year. How do you think will the banking stocks move?
A: Banks are quite attractively valued. The real issue for the banking stocks is not credit growth. It will be a little subdued this year, but it will come back over time. The issue is the NPA accretion which has been higher than normal.
If we look at the valuations, banks today are available at 1 times or below 1 times book value. The NPA situation will not be so bad that the book values of banks will stop increasing.
Profits might be subdued for one-three quarters or a year, but ultimately the ROEs of banks are between 15 to 23-24%. We might have slightly higher provisioning for one year or 18 months. In those quarters or years, your ROEs may be slightly lower, but when you are buying these banks around book values, one should do reasonably well overtime.
Q: What would you do with some of the rate sensitive sectors which at this point seem to be the market's least favourite lot?
A: There is intrinsic value in the rate sensitives right now. If we look at the defensives like consumer and pharmaceuticals, the stocks are doing pretty well. There is very little room for PE multiple expansion in these sectors. There is room for PE multiples to go up in the rate sensitive's like banks and cyclicals. In global cyclicals, we do have additional risk of global commodity prices coming off.
Q: Do you see any parallels within the 2008 situation and where the market is right now?
A: In 2008, it was a completely unanticipated situation. This time, the problems faced in Europe were anticipated sometime back. Greece is a relatively small country. In any case, India should be less impacted because we don't have any meaningful exposure in these markets.
The equities are forward looking and they tend to discount anticipated or expected even in advance. The short-term situation in the market is extremely hard to forecast.
The impact of European crisis on India should be very small. Overtime when interest rates move down in India, there might be some room for PE multiples to go up and market should do well.
Q: Is it safe to say that Indian markets may not breach below their yearly lows because of any potential global turmoil or is that still up in the air?
A: There is no correlation between the medium to long-term GDP growth of India and the GDP growth in the world. There is also no correlation between the medium to long-term returns on stock markets of India with those of the world.
However, in the past in times of panic over very short-term periods, there is reasonably high correlation in equity markets across the world. If there is panic across the world, it is possible that the Indian markets may head lower.
Panics don't remain for long. One can phase out one's investment over the next three-four months, which will be a fairly reasonable approach to investments in these markets.
Q: How have you chosen to live out this phase? A lot of your peers from the mutual fund industry have upped cash levels. Have you chosen to do that? Within these defensives versus rate sensitives versus high beta argument, how would you structure portfolio because the valuations of all three are at completely different tangents?
A: We made our portfolios with two-three year view in mind. We have been deploying cash. We are not running high cash positions because we see reasonable and good returns from these markets overtime.
We can only focus long-term. We see value over medium to long-term. The defensives are doing well, but when markets do well, the defensives may not do as well. There is very limited room for PE multiples to whoop in these defensives. We have been shifting some money away from defensives into more rate sensitives.
Q: What do you feel about the currency sensitives? A lot of funds in these sectors have high exposure. Spaces like IT are going through a very rough patch. There was some relief to it because of the depreciation in the currency. Would you look to make those investment calls?
A: By and large, the rupee depreciation is positive for the earnings of the Indian companies. Some sectors are relatively not impacted like consumer. Some sectors like pharmaceuticals and IT are clear beneficiaries of rupee depreciation. Since the global cyclical sell their output at import parity prices, they tend to benefit from rupee depreciation. Rupee can have some negative impact on overall macro economy, but the Sensex earnings tend to go up if rupee depreciates.
Q: Would autos feature on the list of positives as well? There has been a double blow for them, both in terms of higher fuel prices and higher interest rates. Will that crimp growth for the auto sector?
A: In autos, the growth prospects of a two-wheeler company are very different from that of a four-wheeler car company. It is not a homogenous sector. One should focus on individual companies, but they aren't sharply under valued or overvalued at a very broad level.
Q: What is your view on the infrastructure space, which has got beaten down so much? How does the potential look there?
A: We find reasonable values there. Some of the stocks are down 70-80% over last three-four years. Quality is a bit of issue in this sector. One has to be careful in what they buy. One can't take very large positions in individual companies, but there is fairly good value in that space now.
Q: How hopeful are you on the policy? Will something happen for the market? There was some headway with the Land Acquisition Bill, but for specific sectors and in terms of policy on fertilizer, sugar, will there be some forward action by the government?
A: I would not like to comment on that. I don't have any specific views on when and whether these developments will take place.
Q: What is the more likely outcome for the rest of this year? Will there be some kind of QE3 announcement and a big change in tide for equity markets, where India may either lose or gain depending on the tone of QE3? Will we finish off this year in a bit of a range and then take things from thereon?
A: QE3, in any way, will not make any difference to India. It might have a very small impact on the US economy. Given the high fiscal deficits that the government is running, the size of QE3 will be quite small. I am quite optimistic about the markets, but not over the next three months. We do not know how three months will behave. If we take a one-two year view, the market should move up.
--
___________________________________________________________________________________
'I made my money by selling too soon.'
Website: http://indianmutualfund.co.cc/
Blog:http://indianmutualfund.wordpress.com/
___________________________________________________________________________________
