Indian stock markets, which had rallied in January and first half of February after prolonged sluggishness throughout 2012, have again seem to have entered into a bear phase following the recent political uncertainties.
Key benchmark indices on Monday dropped for 7th straight session on political uncertainty surrounding ruling UPA government after the withdrawal of the Dravida Munnetra Kazhagam (DMK) party last week. Adding to the fire, Samajwadi Party (SP) has also threatened to withdraw support to the Congress led UPA government.
"Clearly the momentum of the market is broken with the domestic political environment," Nilesh Shah from Axis Direct told CNBC-TV 18.
"Volatility is definitely unnerving the investors and that is reflected into the domestic investors redemption in the market as well as through mutual fund and insurance companies," Shah added.
He explained that the market is currently polarized, where certain companies in technology, pharma and consumer staple are holding the indices up, small, midcap infrastructure, engineering companies are seeing a good correction. That is also the reason for market being stuck in a range bound trade. Shah remains bullish on defensive sectors like pharmaceutical and information technology in highly volatile environment.
Below is the verbatim transcript of the interview
Q: The political and the global headwinds continue for our market. In your mind which would concern you the most and which would have the potential to drag the market well below the levels we are currently at?
A: Both the forces have similar power. The effect of domestic political environment is going to be heavy on Indian markets, but we cannot afford to ignore what happens in global market. What I read last night Cyprus resolution seems to be nearing to an end. European Union (EU) has extended that USD 10 billion kind of limit and they have taken the cut on the depositors.
Now does this put an end to Cyprus crisis or it boils over to other countries like Greece, Spain, Portugal, Italy? Second is this precedent of taxing depositors, something which will be carried forward into other countries also? Does this result into investors or depositors in weak countries, weak banks trying to move their money into safe banks? All these questions remain unanswered and markets will obviously look forward to that. However as of today from Indian point of view investors will be more focused and bothered about what happens on the domestic political environment. Clearly the momentum of the market is broken with the domestic political environment.
Q: How much more downward pressure do you see for the market because the frustration has been its unwillingness to either fall beyond a point or rise beyond a point? Basically we have been trapped in a range for the last couple of months. Do you foresee some kind of cataclysmic correction to the market or do you think we will be moving around in this exhausting trading range for a longer while?
A: The range itself is optical in nature because there is one part of the market especially in consumer staple, pharma and technology which is holding on quite well. However there is another part of the market especially in small and midcap stocks which have really corrected quite severely.
Today the small cap basket is trading at the same valuation difference over large cap basket which was prevailing in March 2009. And that was probably the bottom of the market. So from a valuation point of view the small cap and midcap portfolio is at a fairly large discount to large cap indices, which current indices are not capturing from an optical point of view. So we are having a polarized market where certain companies in technology, pharma and consumer staple are holding the indices up but small midcap infrastructure, engineering companies are really seeing a good correction, which is why we are seeing index holding back probably in a range bound fashion. However it is covering the huge volatility which is occurring in the market and that volatility is definitely unnerving the investors and that is reflected into the domestic investors redemption in the market as well as through mutual fund and insurance companies.
Q: You won't comment on the company specifically but what have you made of the details that have just come through on the insurance deal and do you think that could be the space to watch in the financial markets, what happens with some of these insurance companies?
A: For the insurance companies the driver will be Foreign Direct Investment (FDI) or Foreign Institutional Investor (FII) limit be increased from the current level and if that happens how the current crop of insurance companies does facilitate investor participation. Clearly last few years have been negative for insurance companies in terms of premium growth. This year to date number has been negative for insurance companies but with the recent announcements in the Budget to encourage physical savings to move to financial savings and liberalization on know your customer (KYC) norms and it is expected that going forward the rate of growth for insurance industry will be positive and that should create investor interest in these companies. This kind of deals which happens they are more from company point of view rather than sector point of view.
Q4: What did you take away from the monetary policy this time and would you say going ahead it is going to be an important driver for the market or do you think that you saw more concern or caution from the Reserve Bank of India (RBI) governor statement and the market shouldn't get too hopeful about large scale rate cuts through the course of this calendar year at least?
A: The monetary policy delivered up to the expectations of market in terms of rate cut. Obviously monetary policy has raised questions about the current account deficit and inflation and indicated there is limited room for rate cuts further down the line. However a lot will depend upon how the growth shapes up and how the inflation gets managed. We are today in a situation where growth certainly is coming under pressure. The Q3 growth number came quite below market expectation and the Q4 numbers are also not expected to be too good. If you see various parameters such as cement, steel, gas production or domestic passenger traffic movement or cargo movement at the ports, they are all either growing negatively or growing at a lower rate than the previous year.
Obviously this doesn’t bode well for the growth going forward and clearly markets will be looking forward for the ways and means in which growth can be revived. Interest rate is just one small catalyst, a lot depends upon faster execution of projects on the ground and the bureaucratic or governance related issues which restricts speedier execution of the projects on the ground. However, certainly market will be looking forward to all steps being taken to revive investment which in turn can guarantee growth and monetary policy albeit small but is an important catalyst for the same.
Q: Do you think the investor pessimism is a little over done at this juncture? Do you think we deserve to trade at much higher valuations compared to where we are trading at currently at about 13-14 times?
A: No I don't think we can be making that kind of statement. If you see our relative premium over other emerging market peers like Brazil, Russia or China, it is still running at the highest level. It is as high as it was anytime in the last five-ten years. So relatively we are still trading at a premium to our emerging market peers in spite of our growth slowing down from 8 percent to 5 percent. So it will be unfair to say that from a relative point of view we are not trading at a premium or we deserve to trade at a higher premium.
From a domestic investor point of view who has been a regular seller in the market for quite some time, Indian markets are today trading at their historical average of 15-16 times one year forward earnings. However that is reflecting the growth slowdown which has occurred. So keeping in mind from domestic perspective, the growth slowdown and from foreign perspective the relative premium India is enjoying among BRIC countries, we cannot make the statement that we are not trading at a premium. We are trading at a fair premium.
Q: What is the expectation with regards to this quarters earning season – how bad could it look in your mind and how do you think the markets will take it?
A: I think the market will have least expectations about the earnings. What we will be looking forward is more of a company specific nature where the expectation is that, the pharma, consumer staple and the technology pack should be able to deliver good earnings growth. Private sector bank and non banking financial services should also be able to deliver good earnings growth and the public sector banks focus will more on non performing assets (NPA) rather than on earnings and on the infrastructure and resources, the focus will be more on project execution, debt reduction and selling of non core businesses rather than earnings. The driver of the market is slowing but steadily shifting from just pure earnings growth to various issues which are bothering these companies.
Q: What kind of investment approach do you take now? Where would you put your money if you have to choose between these asset classes, equities have been suffering for many years. The yields have got to almost 8 percent, gold is not giving the kind of returns it did till last year. If you had to split this up how would you do it?
A: It will be depending upon individual risk profile. But just let us pick up this respective asset classes and where within this respective asset classes one should invest. On the fixed income side, if one is a 30 percent tax payer then some of the tax free bonds which are available in the secondary market are offering pretty good yield. One can lock-in to a longer term maturity over there. As it is expected that interest rates will decline in the primary yield over a period of time, so, for a tax payer tax free bonds in the secondary market provides good opportunity.
If one is not a tax payer then one can look to invest in to longer dated gilt funds. At around 8 percent gilt on a ten year paper it is a pretty good lock-in for yourself and one could expect a return over a period of time as interest rates starts moving forward. Even if one has a short-term horizon typically in the month of March short-term yields are at the highest level and as we roll over to April, short-term yields starts declining. So, short-term funds across March also provide good opportunity even if one has limited time horizon.
On the equity side, one will have to play contra, markets going to be volatile. One can build portfolio towards two things of polarization and currency depreciation. In the polarization theme, one can invest in quality blue chip companies across pharmaceutical, technology and consumer staple sector. The second theme which is worth playing on is the currency depreciation. Clearly we believe rupee has some way to go down and that should be beneficial for exports related sector. The government will also encourage export sector in its commerce policy which is expected to be announced next month. Using these two combinations of support from the government for encouraging export sector and the likely rupee deprecation one can focus investments in companies which will benefit from exports in rupee depreciation. These two combination of polarization and currency depreciation theme along with contra investment in equity markets will do well.
On the gold side, instead of buying physical gold go for gold exchange traded fund (ETF), but do remember that gold should be very small percentage of your portfolio. At least in gold ETF one will not be paying wealth tax and your transaction cost will be fairly small.
Q: You keep an eye on flows as well and that has been the one supporting feature for this market - what is the sense you are getting from there though. Are they beginning to lose out patience because the first couple of months have had far different returns than what one expected going into 2013?
A: Definitely. This is the fifth month running where we are expected to go above US 4 billion in flows. Year to date we have crossed USD 10 billion already and this kind of momentum I have never witnessed in the past in the market. These flows have essentially come from all varieties of funds from global emerging markets funds to sovereign funds to probably some funds which is across the short-term momentum orientation. This kind of momentum of foreign institutional investors (FII) flow is unprecedented and if one continues to see a global scenario where risk off could happen or domestic political environment which could create question mark in the minds of foreign investors, then these flows can slow down and the market which is trending where it is today because of this flow could see a small correction.
Q: At the start of the year all bets were on cyclicals being a big driver in 2013 and that theory has gone completely wrong, how would you approach the cyclicals at this point. Would you continue to avoid it and continue putting your money into defensive names like you pointed out?
A: A larger portion of your portfolio has to be in defensive. In an environment like today where growth is slowing down in the local markets, it is better to with the polarisation of currency depreciation theme rather than playing cyclicals. The time to invest in cyclicals will be probably little further down when they would have corrected another 5 to 10 percent.