The linkage between elections and inflation has been tenuous. No government likes to enter an election phase with high levels of inflation. Though inflation is broadly under control and within RBI’s comfort zone, inflationary expectations have started inching up due to rise in fuel prices and recent rupee depreciation, said Mihir Vora, director and chief investment officer, Max Life Insurance, in an interview with Falaknaaz Syed. Excerpts:
What kind of Q2 earnings you expect?
The first quarter ended on a strong note with 13 per cent YoY earnings growth for the Nifty. If we remove the impact of some extraordinary items, the growth was even better at 24 per cent YoY. Despite increases in input costs, companies have maintained margins, which show that pricing power was returning. The earnings momentum may continue for Q2 due to continuing lower base advantage of last year when we saw the impact of GST disruptions. For Q3FY18, it remains to be seen whether earnings growth will sustain, given the sharp rupee depreciation and tightening liquidity, which can impact sales growth as well as margins due to continuing rise in input costs.
What would be the impact of depreciating rupee and rising crude on the market?
A depreciating rupee and higher crude prices have multi-fold impact on macro parameters like inflation and interest rates, current account deficit, fiscal deficit and currency. They will ultimately impact consumption growth, corporate margins and borrowing costs.
Is the market getting into a correction mode? How much downside do you expect for the Sensex and the Nifty?
Our view has been that the market is expensive and was so far being supported by strong flows in mutual funds. Recent numbers on mutual fund flows suggest some pull-back by investors. Thus, the current correction does not look abnormal. But if the macro situation continues to deteriorate with high oil prices and weak currency, there could be more downside.
2019 is an election year. Such years usually increase the pressure on the fisc and spur inflation. What’s your take?
The linkage between elections and inflation has been tenuous. Incumbent governments would not like to have high levels of inflation going into an election. Where we stand today, inflation is broadly under control and within RBI’s comfort zone. However, one could argue that inflationary expectations have started inching up due to rise in fuel prices and recent rupee depreciation. RBI has been proactive in rate hikes and we do expect another 50bps of hikes by end of FY19. This should keep inflation expectations within the target band of 2-6 per cent. On the fiscal link to elections, we saw deterioration in FY09 on the twin impacts of wage commission awards and the stimulus by the government to tide over the global financial crisis. FY14 did not show any real increase in fiscal slippage. This year, we are in a complex environment. The oil price shock and shortfall in GST collections have upset the fiscal calculations. While we expect some overshoot of the deficit target, this is likely on account of these factors and not increased government spending. We may see a slowdown in government spending in the second half.
What’s your outlook on foreign fund inflows?
In the scenario of near-zero US interest rates through FY10-15, emerging markets (EMs) witnessed average annual flows of nearly $100 billion per annum. As rates normalise upwards in developed markets and concerns relating to oil prices are increasing in energy-hungry EMs, we see a reduction in flows to them. Within EM flows, India has received disproportionate share in the benign crude era of 2015-17. As oil strengthens, India looks vulnerable, since it impacts the currency, inflation, interest rates and fiscal deficit. Due to this, we have seen FPI outflows from equities as well as fixed income. On the positive side, India’s low reliance on exports makes it less vulnerable to any major issues on global trade.
What are the major global and local negatives that can weigh on the market?
At a global level, crude oil remains the biggest worry for investors. Strong crude could undo fiscal gains and worsen our CAD and thereby place pressure on the currency as well. The Fed interest rate policy and trade wars would be other factors to watch. China’s resolve in combating pollution would be the other monitorable especially on commodity sectors. In the local market, the continuing asset quality issues on banking now seem to have spilt over to the NBFC sectors as concerns relating to real estate backed lending. The tighter monetary environment has exacerbated temporary liquidity issues on ALM mismatches. These could potentially dampen consumption. Earnings estimates are elevated and valuations are higher than mean levels. A tighter monetary environment could lead to some pullback on ratings. Poll calendar gets busy post-November and it would inject more volatility into the market.
How should investors approach the mid- and small-cap space? Are the valuations reasonable after the recent correction?
The mid-cap index is trading at 18.0x forward earnings compared to the broader Nifty index that is trading at 17.7x one-year forward earnings, which is a premium versus the average discount of 5 per cent. Therefore, we do not think that valuations of mid and small-caps are favourable even after the 22 per cent correction since February. But the mid and small-cap universe is large and offers many opportunities for stock picking on specific companies with good fundamentals and investors can take a contrarian view.
What sectors are you bullish on?
The big themes will be in sectors that are favourably inclined to depreciating currency. We are bullish on exporters like IT, pharma and refiners. Within financials, we like private sector banks – both retail-oriented as well as corporate banks. Though we are positive on metals, the near-term news flow around the trade-wars especially China and its response could keep prices volatile here. We will look to buy stocks in these sectors whenever market corrects.
Bond yields have surged quite a bit. To what extent can this impact the market?
The market has witnessed sharp rise in yield over the past few months due to higher crude, rupee depreciation and RBI rate hikes. In addition, recent credit events have led to risk aversion. Insurance firms have a long-term liability profile and higher interest rates prevailing currently help them in their asset liability management. We expect the 10-year G-sec to trade in a range of 8-8.25 per cent over the next few months and more clarity on fiscal deficit, outlook on crude and currency will drive rates going forward.