Jyotivardhan Jaipuria, Head of Research at BofA Merrill Lynch says most of his clients are modestly overweight on India right now.
Jyotivardhan Jaipuria, Head of Research at BofA Merrill Lynch says most of his clients are modestly overweight on India right now. Shareholding of foreign institutional investors (FIIs) in domestic companies has scaled at least a six-year high because there has been a flight of funds to emerging markets such as India. With central banks in Europe and the US keeping interest rates low, overseas funds have flowed to markets such as India, Brazil and China.
Going forward, Jaipuria is expecting a lot of volatility. He is betting on the great rotation, which is the movement of bonds into equities. "Our global strategist says that if we look at a two-three year view, probably the big trade is more money will flow outside bonds and get into equities because equities have been under invested for the last few years," he told CNBC-TV18 in an interview.
For the short-term, he says, there will be a bit of volatility and somewhere in the middle of the year, markets should correct by 8-10 percent before it gets into this greater rotation where money goes back to equities. "We see some movement up in interest rates. We probably may see equities getting hurt," he told the channel.
Below is the edited transcript of his interview to CNBC-TV18
Q: Would you say that from a relatively low ownership position, now India's weightage have got recalibrated and people are more or less overweight?
A: Our analysis shows that most people are slightly overweight, if one takes the aggregate. I have been meeting lot of investors over the last few weeks. Most people now seem to be neutral and slightly overweight. So, that easy trade via India was underweight and under owned by most people, is probably more or less behind us now.
Q: Are you expecting to see any volatility in funds in terms of some outflows now?
A: There will probably be lot of volatility. However, our big trade is the great rotation which is movement of bonds into equities. Our global strategist says that if we look at a two-three year view the big trade is, more money will flow outside bonds and get into equities. Equities have been under invested for the last few years.
Short term probably will be a bit of volatility. As we see some movement up in interest rates, we may see equities getting hurt. So, expectation is somewhere in the middle of the year markets should correct by maybe 8-10 per cent before we get into greater rotation, where money goes back to equities.
Q: In the near term is there a case for a tactical pullback in the market?
A: There probably is. The market had a good run and to that extent we could get technical corrections on and off. However, my view is typically we have the pre-Budget rate play out. So, probably before the presentation of the Budget, we may actually be higher than where we are today. Expectation will be higher in the run up to Budget and that is going to be great project.
Q: Do you see interest rate cuts being a big propellant for the equity markets over the next three-six months?
A: When we started the year, we had three ‘R’s, interest rate cut, reforms and consequent to both of these, recovery in economy and earnings. There is more on interest rate cuts to come. It probably may not come at the same pace at which some optimists in the market were expecting. However, we could see another 50 basis point of interest rate cut over the next six months.
Q: What do you expect to see from the Budget and what do you think the equity market is pricing now from the Union Budget as an event?
A: Most important thing finance minister said there, was that fiscal deficit will be under control. In fact he said for this year, he will achieve a fiscal deficit target of 5.3 per cent of the GDP. That is well below what the consensus, economist view has been. Most people are expecting it to spill over and hit something like 5.7-5.8 per cent.
For next year, he said he would not budget for anything for more than 4.8 per cent. This is one of the biggest things which people are looking forward to. Election year going is on and in that too, if he manages to achieve fiscal consolidation that’s in the longer term is great for the equity market.
Apart from that, everybody wants him to do something to help infrastructure investment. That is the slowdown which we are seeing. There is something which probably will happen outside the Budget like the NIB starting. Hopefully, he will be able to clear some projects much faster. So, I think that’s one of the important things, outside the Budget that one needs to look at.
Q: How do you approach the infrastructure space with special reference to these pockets where news flow is bad, liquidity seems to be an issue and many are having belly up kind of earnings performances?
A: If you take infrastructure as a whole, obviously there is a slowdown. Things are going to be slow there. We like some select companies because probably things will start turning over the next 12-18 months. There we will see interest rates coming down and some projects may go ahead.
Secondly, we will see, the government clearing projects faster. Due to which we could see a bit more activity. Overall, we are neutral on the space. However, we like that there are some companies which are close to completing their projects and over the next 18 months we will see cash flow.
The other thing to remember is that these are very high debt companies. So, to that extent, as interest rates come down will save interest cost. Some of those EPS jumps are quite sharp. In fact, a 100 basis points drop in interest rates could mean 30-35 per cent jump in EPS for lot of these companies. So, that’s the other thing we are building in. We are playing some select companies in that space.
Q: Do you think some of these real estate companies too might have turned the corner?
A: We have been perennially underweight on the sector. For the first time, we are overweight at it, early December which is again linked to two-three things. One is interest rates which would help the end demand at some point. Second is interest rate, again hoping them because these are high debt companies.
The other idea was that probably, after 2.5-3 years period where no real launches were being seen, one will see some more activity on residential launches which would help improve cash flow. Lastly, most of these companies are trying to de-leverage. So, basically it’s de-leveraging by selling of some assets.
We are actually seeing some asset sales happening. So, to that extent we could see balance sheets getting healthier or less worst than what it was a year ago. Nobody owns it, it’s a sector which people have just given up. It just sounded perfect for the market which probably goes up and where we get rate cuts.
Q: The other issue is of supply of paper. Yesterday Axis Bank soaked up quite a bit of the global money, in the next couple of days it could be oil India followed by NTPC. Do you see that becoming an issue for the market robbing it off a lot of the FII impetus that it has received over the last many months?
A: It will be so. If you look at the next six months, at some point the supply will become so large that the secondary markets will struggle to go up. Whatever additional money is coming from the FIIs, hopefully domestics also will start putting in some money. That will probably be soaked out by supply of paper.
So, in some sense, the net flow to the secondary market may become close to zero. That’s the reason market may not clearly go up. In every rally because first we have the secondary market going up in supply of paper, starts to come in and then secondary market starts to slowdown.
Q: What was the sense you got at these road shows in terms of institutional or global interest in paper particularly from the government? Are people excited by Oil India and NTPC kind of issues?
A: In general, most people were interested in India. When we hosted the finance minister in Singapore, it was effectively a full house, all the seats were occupied. There is lot of interest. People generally came back feeling quite pleased that the finance minister knew what has to be done. He was talking in the right language that he will stick to his fiscal deficit, reforms will continue.
So, in some sense, he laid out what he did and what he is planning to do. People feel comfortable that India is probably a place which will do the right things over the next one year. The decision for most people now is India was one of the best performing markets last year.
Though things are improving in India, things are probably improving in lot of other places in the world also. So, whether India continues to have the same sort of attraction it had last year with valuations having gone up a bit and markets having run up is what people will debate. For lot of asset allocates, the debate is, should we start putting some money back into China from India. We have had a great run in India, China has not done well and it’s a much cheaper market.
Once money starts going to China, it is also other country like Brazil and Russia which are more commodity countries which are dependent on China. That’s the debate for people, do we still play the India trade or do we shift at least a bit of money outside Indian. Into some of these other countries which have done much worse as a market.
Q: You have an underperform on Hindustan Lever (HUL). Is it your sense that FMCG now deserves to get a much lower rating over the next couple of quarters?
A: Our view was that it’s a sector well owned. It’s a sector which has done very well and is not cheap. The margin for error was very low in these stocks. Whereas what’s happening to the other side is that things are improving. At least on the margin we are seeing interest rate cuts.
We are seeing some reforms which should help these companies over the next one year. So, that’s the reason we are underweight on this sector. If you look at a PE differential between the rate sensitive and defensives which is probably the consumer type versus some of the others like autos and industrials. It is at a 12 year high. So, to that extent valuations are so high for these defensives that probably it’s a trade worth playing where one reduces weight on these and switch to the other side.
Q: This earning season started with a surprise from Infosys. I don’t see too much IT in your preferred list, Are you still cautious on this sector?
A: We have been neutral on IT going into the result season. It has done better than what we thought. The reason we are neutral and not overweight IT is that the rupee probably in the short term seemed it will do well, though in the later part of the year we could see bit of volatility in rupee.
So, some of that rupee trade is getting over. Secondly, the US is still struggling especially with all the fiscal cliff problems there. We didn’t want to go with a big overweight in IT. The other thing is that rate cuts were going to happen, so we wanted to overweight the rate sensitives. To that extent IT is something which we have kept as a neutral bet.
Q: Are more India kind of products beginning to get some money or it is still the same old vehicles where the money is coming through from?
A: It is has not changed much. Like ETFs have become a global trade. If one sees active money versus ETF money, more money is going into ETFs versus active funds. So, it is true, not just for India, it is true globally. That has not really changed because ETFs continue to get money. In fact last year lot of active managers struggled to really beat the benchmarks.
So, to that extent, it justified money going into ETF funds. We will still see ETFs coming and global funds putting in more and more money. Maybe with a sort of run we have seen in India, we will see a bit more money coming into India. Dedicated funds as people get a bit more bullish on the India story. However, I think the overall picture still will be that we will probably get emerging markets money which comes in and ETFs.
Q: Is there a risk of a threat of a sharp correction for the market, if the market doesn’t deliver as much as promised or as much as market is expecting right now?
A: That’s something which we see practically every year. If we see markets post Budget, even if the Budget is good expectations go so high that at some point people want to take profits. However, bigger risk to market could be not just India specific but global factors.
At some point, the US fiscal cliff has got postponed, debt ceiling negotiations are going on. If things don’t workout to help there then at some point we could see markets globally correcting. India will be very much part of that global correction.
The other bigger risk that everybody is worried about globally is at some point Fed starts to signal that this whole quantitative easing will probably be tightened at some point. So that’s really a risk where interest rates start to move up and we start to get worried that maybe the easy liquidity is getting over.