Union Budget 2013 has largely met its key objective of fiscal consolidation, but it was an over hyped event so it punctured some expectations of foreign investors, says Gautam Chhaochharia, head of mid-cap research, UBS India.
The Union Budget 2013 largely met its key objective of fiscal consolidation, but it was an over hyped event so it punctured some expectations of foreign investors, says Gautam Chhaochharia, head of mid-cap research, UBS India.
India's widening fiscal account deficit has been a worry for FIIs and now the current account deficit issue has come to the forefront. However, foreigners continue to remain optimistic on growth opportunity in India and are ready to bet their chips subject to reform measures.
India's growth slowed to a 15-quarter low of 4.5 percent in the October-December quarter lower than the 5.3 percent a quarter ago, and the 6 percent growth seen a year-ago.Finance Minister P Chidambaram expects the economy to grow at 6.5 percent in the next financial year.
Chhaochharia feels 6% GDP growth would be good enough to revive corporate sentiment, but given the twin deficits the recovery of Indian economy is expected to be fragile going ahead.
Meanwhile, the key driver for Indian markets will be first quarter earnings and one can expect Indian markets to post double-digit returns this year, he adds. UBS India is bullish on Bajaj Electrical, Redington and Exide from the midcap space.
Below is the edited transcript of Gautam Chhaochharia's interview with CNBC-TV18.
Q: What are you hearing from your institutional clientele and whether the mood has soured significantly on India? Or do you think the worst in terms of selling pressure is behind us and people are willing to look at India in a more constructive light after this correction?
A: The mood is now again getting back to normal so to say. The expectations and the hype around the Budget were built up too much. In our view, the key objective of the Budget was the fiscal consolidation and that was largely met. But the hype around that was so much that it punctured some expectations for foreign investors.
It is coming back specifically after the Budget, the interactions by the finance ministry officials including the finance minister has gone a long way in terms of assuaging investor sentiment both on the tax issue and in terms of the entire Budget issue.
The mood is gradually coming back. Over last month the current account deficit has become the mean issue on the forefront for even institutional investors into India beyond just a fiscal deficit issue. So that issues has come to the limelight.
Beyond that, investors remain bullish on the growth opportunity in India and are still willing to invest in India subject to government keeping to its stance of continuing on the reform part ahead.
Q: How are you approaching trade now and what’s your sense of what we will have in the near to medium term? More downside risk or you think now the market can regain some ground, we have got the potential to make a 5-7 percent move in the upside?
A: I would say the later. The market definitely has the scope to move up from here both - through the next few months as well as over the medium term. The key driver for markets would be earnings and for that the key driver would be the delta in economic growth trajectory. It is not just the absolute number per se, but the delta would be important.
If we see the delta turning positive which is what I hope this year then that would drive up earnings as well as market so I would say so for the markets. Having said that, one should remember that unlike previous cycles of economic cyclical recovery this cycle is different.
The recovery is more fragile primarily because of twin deficit and more so because of the current account deficit. We have been telling investors that to be constructive and bullish on Indian equities, don’t expect a rerun of 2005 to 2008, but a double digit kind of returns in Indian equities is definitely reasonable to expect.
On the other hand, one should also be careful about the currency because of the current account deficit which doesn’t seem to be going away in a hurry. One should be looking to hedge INR at every appreciation level.
Q: How did you react to the big midcap carnage that we saw last week? Are there any interesting buy ideas from the midcap space after the sell off that we saw?
A: The midcap carnage is a reflection of two things. One is the local liquidity environment for retail public still remains tight and the interest levels remain low. Secondly, the bigger holder of midcaps is beyond retail investors, domestic mutual funds and domestic insurance companies.
They continue to see outflows. That has led to this squeeze finally happening. Thankfully, the stocks we cover, bulk of those didn’t fall or get impacted by this carnage in any significant way. From our coverage universe, we like Bajaj Electrical, Redington and Exide.
Q: Do you think that despite a further deterioration of local macros - any improvement in the global growth situation could compensate for that and take our markets higher in the first half of the year?
A: Our house view also is that the global growth seems to have bottomed out. The trajectory of growth recovery which we see in this year or next year will depend on multiple factors including US fiscal cliff and European political issues. Even in China, we are seeing some sort of a cyclical rebound happening.
The extent of that is still unclear for us, but it has definitely bottomed out with again, just like in India’s case, when we say recovery, we do not expect a recovery to be similar to what we have seen in the last decade. It will still be a muted environment. But even stability and the tail risk being out of the window - that should be supportive of inflows into Indian equity markets.
Q: You raised an important point about growth. While many people are at pains to point out that there is a recovery coming, at this point, it all looks quite poor. What’s happened at the GDP level and the earnings season? Is it your sense that earnings are probably going to limp along for much longer than people expected? In that context, will India still be as much of a preferred market as we were last year?
A: Clearly, investors in India are primarily coming in or attracted by the growth story. So that will remain the key. Therefore, earnings growth will be the key. Talking about GDP, we cannot have the cake and eat it too. The market has been demanding fiscal consolidation. When you have fiscal consolidation, the very immediate short-term impact is weaker economic activity. That’s what we saw in the December quarter, and what we will possibly see in the March quarter.
That’s what creates space for the private sector to come in, and for corporate sentiment to turn around. So this is the basic first ingredient for economic cyclical recovery. So, what is a big hope is that the government is finally doing what we all have been hoping for it to do for a while. The near-term or short-term impact will obviously be negative and that’s what the market I think ignored initially, and it was too optimistic.
After digesting the short-term impact, it will look for signals whether this is creating the right impact on corporate sentiment. Then it clears a good base for cyclical recovery to happen. Even a small delta positive momentum in economic trajectory, like for example, if we end FY13 at 5 percent GDP growth rate, whether we achieve 6.5 percent GDP growth rate in FY14 - that’s not really the critical thing.
Even a 6 percent GDP growth will be good enough for corporate sentiment to revive the investment cycle to see some kind of bottoming out and therefore for earnings trajectory to come back. So the delta in economic trajectory has to be a positive. That has not been the case for the last couple of years. So, that is a bigger driver for earnings as well as markets in my view.
Q: I see from your India note though, that you guys are overweight on spaces like banks, infrastructure, capital goods, many of which are going through a bit of an identity crisis now. What’s the call that you are taking over there. Is it linked with what you expected to see on interest rate relief or do you think that these stocks have come to very low valuation potential?
A: There are three things. One is obviously the biggest macro top-down call is that we are expecting cyclical economic recovery. It might be a mild one but we do expect a cyclical recovery. Secondly, for that to happen, the RBI monetary circle will have to be supportive. We do expect a mild monetary easing cycle this year, not a very strong one. Thirdly, in terms of expectations on earnings, in terms of valuations, I don’t think the stocks at these levels are building in that recovery.
The earnings estimates by the street are also very muted. They are not really building in any economic recovery so to say. This is unlike the sectors where we are underweight, the defensives, which is consumer staples, discretionary or even pharma sector where the expectations are at all-time high in terms of analyst estimates are extrapolating the high growth rate we have seen over the last two-three years.
So, the estimates imply continued high growth, continued peak level margins and the stocks are trading at all time high PE multiples. So, we see a clear disconnect between these two spaces. If you see an economic cycle recovery, then clearly the cyclical, the banks, infra, etc will be big beneficiaries. If you don’t see a recovery, then even the earnings estimates for the defensives might be at risk. Therefore, susceptible de-rating is there.
Q: On the subject of defensives itself, the IT space has been so resilient despite the down take that we have seen in the market. How would you approach that sector now? Many of the stocks like HCL Tech are sitting at 52-week highs. Is there still more potential to pump in money into this sector?
A: Selectively yes, we are neutral in sort of strategy positioning but as per our analysts, we are expecting a cyclical rebound this year in terms of revenue visibility, guidance, etc. So I think stocks will get support in terms of both quarterly earnings as well as the macro data points in US and Europe compared to what you have seen over the last two years.
When we say selectively, for us the big bet is clearly Infosys. The stock has been beaten down for a while because of both top-down as well as company-specific issue. I think both seem to be bottoming out and that stock should do well from here.