India continues to best growth space globally. Higher valuation and some stress on the macro front will mean kind of a range-bound market for couple of months but revival of corporate growth implies a sustainable long-term bull market is here to stay, said Shailendra Kumar, co-founder and chief investment officer at Narnolia Securities, in an interview with Ritwik Mukherjee. Excerpts:
Though there is reconciliation in the US-China tariff war, the period of adjustment will take some time. What would be the likely impact on Indian economy and the capital market?
We are living in a more connected globalised world and issues like the US-China trade war are kind of a correction. Globalisation in the beginning was more about goods, services and ideas moving from developed economy to emerging economy but later half of globalisation had been more about goods and services moving from emerging economies to western developed economies. Imbalances on any side usually follow balancing measures.
China’s multi-billion dollar trade surplus with the US and its policies on technology, industry development and access to state-dominated economy is key concern for the US. After every rhetoric on tariff, we see steps of reconciliation by both sides that amply indicate that there is a very less chance of escalated tariff protection war by larger global economies. Though the period of adjustment will see some fall in global trade and resultant negative impact on global GDP growth, but the period of adjustment will be volatile but not destabilising.
What are your main concerns about the current market?
For long, the world economy had been in a highly accommodative monetary policy and benign interest rate regime. We have entered an economic regime where interest rate is rising globally. It would make asset prices volatile. For last 7-8 years we had kind of linear growth in equity prices particularly in the US. Last year we had sort of a climax. Daily average of the US VIX, volatility indicator had hit all-time low. Lower risk (or volatility) implies lower return and higher risk implies higher return is the standard maxim. But the recent low volatility produced higher return from equities. We believe era is over. Start of 2018 had been all about rising volatility particularly in the underlying asset prices. This regime switch would be followed by lots of shift in the market positioning resulting in higher volatility particularly in emerging economies stocks.
Domestically, rise in crude and other commodity prices implies possibility of revival in inflation trajectory. Though, RBI in its last credit policy hinted of a long pause in rates but pressure on inflation due to rising crude price, low appetite for emerging market bonds among foreign institutional investors, tightening in the US bond market, liquidity swinging from surplus to deficit in money market implies that bond yield may remain elevated in India.
How are institutions/FIIs looking at India?
In last one-year domestic flows has consistently been ahead of foreign institutional inflows. Data for 2018 suggests inflow by domestic mutual funds is outnumbering FPIs by 4:1. A similar trend will continue in the near future. With base of low equity participation in India and rising relative attractiveness of equity investment implies continued strong inflows in equity mutual funds. On the other hand higher valuation, rising bond yield and bit of macro stress in terms of rising fiscal deficit implies foreign flows will remain restricted.
Are there opportunities in the present market?
India continues to best growth space globally. Higher valuation and some stress on macro front will mean kind of a range-bound market for couple of months but revival of corporate growth implies a sustainable long-term bull market is here to stay. One way to understand the bull market is that the valuation multiple swings between its long-term average and its upper bound. If we take the Nifty, it would imply that the Nifty will keep trading between PE multiple of 17 and 22 in forthcoming years. Larger opportunity would be in spaces that are linked to changing lifestyle. The way we consume as well as produce goods and services are undergoing a major reset and this will throw multiple wealth creation opportunity.
Where do you see the Indian market five years down the road?
The Nifty from September 2013 to January 2018 saw a rally from 5,471 to 11,171. This rally of 104 per cent was more due to change in price multiple than earning growth as PE changed from 14 times to 21.5 times. Presently, the Nifty is trading at 19 times its FY19EPS. Anytime market falls to the level of one year forward PE of 18, it offers an excellent opportunity for investment. Along with global issues, there are multiple state elections in India this year. Outcome of these elections would surely influence market, as these will be an indication of all important general elections next year.
But corporate earning over 3-5 years is expected to be strong, so negative surprises if investors to accumulate equities should use any. Although unlike 2014-17 where the rise in the market was mainly due to the valuation multiple re-rating, the rally now will be in line with the earnings growth instead of valuation re-rating. Our base case implies 14 per cent CAGR return for the Nifty over the next 5 years.
Which sectors you would bet on at this point of time?
Digitization in India has changed the way of living. On the other hand GST implementation will have a long lasting impact on the structure of businesses. Seed of shift from unorganised to organised market has been planted. Along with this shift what is playing out in India is what we call – professionalisation of the Indian businesses. Look at it this way, why we categorise paints in a branded space and not a commodity space and assign high multiple? Professionalisation will result in many such categories in India whether in manufacturing or in services. We also continue to like private banking and the entire consumption space. Also one may allocate some investments in metals and PSU banks where we are hopeful of strong cyclical recovery.
How long will the pain persist for PSU banks? Is there value in the private banking space now?
Despite the noise, we believe we are close to the end of this NPA saga. Total advances by PSU banks are Rs 54.69 lakh crore. GNPA is about 15 per cent and NNPA 9 per cent. Of the Rs 5 lakh crore NPAs, Rs 4 lakh crore is from just 40 accounts that are already in various resolution stages in NCLT. Also standard re-structure is another 7-8 per cent and if 70 per cent of it will go to NCLT as per recent RBI directives then 5.5 per cent more will be added to NNPA. So, total NPA will swell to 14.5 per cent.
It would require further provisioning of about Rs 1.80 lakh crore. But the average run rate of provisioning over last 8 quarters had been Rs 50,000 crore. So in FY19, the Indian banking sector, at least in terms of NPAs, will come out in a better shape.