Although rupee has been weak for almost 18 months, it should stabilise once the economy recovers, says Prashant Khemka, Co-CEO, CIO- Active Equity, Goldman Sachs in an interview to CNBC-TV18. Khemka says the rupee has not been as big a concern for foreign institutional investors (FIIs) as it was 12 months back because the risk appetite of the investors has improved significantly over last year.
Below is the edited transcript of the interview on CNBC-TV18
Q: Let me start by asking you about the rupee because stock markets have done well but the rupee is at nearly 55.5. Are you a bit worried about that?
A: Certainly rupee has been weak for more than 18 months now. We don't have very strong view on currency markets but to the extent how we think about rupee is it is a reflection of global markets view about Indian economy's competitiveness. Over the last two years the competitiveness of Indian economy has deteriorated in global markets. They have to bring it back into equilibrium with other trading partners they have to depreciate the rupee and that are what causes the depreciation of the rupee.
As the economy gradually recovers and the investment cycle turns positive with some lag, the competitiveness of the Indian economy should improve compared to the trend that it has been over the last couple of years. Then from a longer term perspective, the rupee should stabilize back again and depending on how the economy does, might start appreciating as well. While at this time it seems like rupee is on a path of continuous depreciation forever, if you recollect five years back most of us believed that rupee is going to appreciate forever. However, that was a function of how the economy was doing there, what was the view of global investors on competitiveness of Indian economy. Now that is 180 degrees on the other side. So I would just caution against extrapolating it forever. As the economy recovers, the rupee should stabilize as well. So our view on currency is quite closely tied to what happens to the economy.
Q: How do you read this for the market because there is one side of the argument that this kind of rupee depreciation is actually earnings accretive for us whereas the other one is that this kind of headline depreciation is not great for people who want to invest in the market? Which way do you think this will lead, would you rather some kind of earnings improvement courtesy the rupee falling or do you think it is bad news in any way for the rupee to fall this much?
A: Overall, it is always a bad news. In my mind that is a very low quality earnings. Just as in case of companies you can have earnings rising but due to sources which are not the right kind of quality sources. Similarly for an economy or for a corporate sector overall, to gain in terms of growth or earnings potential on the back of a weakening rupee, I consider it as a low quality easily gotten source of earnings growth.
Foreign investors concern has certainly been one of the key concerns. It was more till 12 months ago when rupee was on a continuous slide more or less but that factor has somewhat taken a backseat now given that rupee has been some what stable around Rs 54-55 now. However, if you were to start seeing that deteriorate rapidly, that would come to the forefront again because when equity market falls, stocks fall, people have a long trusted matrix in terms of P/E multiples. So P/E multiples go down when equity markets go down and then one may be able to make the case that markets have started looking attractive.
However for rupee there is no such standard way of looking at what is the fair value and how much from the fair value rupee might be. There are some estimates but they are far from - not that P/E multiples are accurate, far from accurate but in terms of rupee there is no such matrix either that one can take shelter from.
Q: You keep speaking to a lot of global investors. What is your sense of where risk appetite stands at this point because liquidity is what we watch every morning and that is what is driving sentiment and stock prices? Any possibility of the tap getting turned off in the near term or do you think this is here to stay for now?
A: Difficult again to say what is going to happen in a few weeks or month’s time based on so many macro factors that may evolve. However, having met many investors over the last couple of months particularly in Europe and US, I would agree with you that the risk appetite has far improved from where it was 12-18 months ago.
It is not as much to do with that is happening in India but what is happening in their neighborhoods. So European clients are far more secure about themselves today, about the firms that they work for, about just things in general in the economy. They are in a much more comfortable place today than they were 18-24 months ago like in late 2011 where the risk of Greece falling apart or euro region breaking up was the risk in your face. Every morning and every night you would go to bed watching CNBC whether Greece has fallen apart. Now that risk is behind us. People are focusing on normal risks to the economy rather than worry for a cataclysmic event to happen like the one in late 2008. So risk appetite being much improved, they are far more open to investing in equities in general and emerging markets in India as well.
Q: How do you position your portfolio right now? Is it the time to go haul hog on cyclicals and slightly higher beta profile stocks, infrastructure, real estate, autos or you want to be selective there and not just jump the defensive bandwagon completely?
A: Generally speaking, we have a very bottom-up investment approach and we maintain a balanced portfolio of stocks which we believe would outperform through this cycle also during its different legs. So we don't need to reposition the portfolio tactically at every move in the macro and that is true now as well.
We generally tend to find historically great stock specific opportunities in domestically oriented sectors. Now those sectors may be from top-down perspective, may be at any given point in time good or bad but even sectors like real estate for example, which over the last many years has done very poorly and generally the consensus has been that of avoiding that sector. We have tended to find some extremely good investment opportunities throughout the last five years even in real estate sector because often times when a sector is hated across board and is painted with the same brush, some of the very good companies in there also might get beaten up unnecessarily and may provide opportunity for extraordinary returns.
So at this point in time, more or less in line with what has been the case over the last many years, we have tended to be more overweight in domestic oriented sectors like financials and consumer discretionary. Industries like automobiles, retail and so on whereas we struggle to find good investment opportunities in sectors like energy as well as in telecom services. It just so happens that a declining interest rate or an improving macro economic backdrop would also be beneficial to the domestic oriented sectors that I talked about.
Q: A lot of the spaces that you mentioned that you like are also the ones that currently have offers for sale open. Have you guys been participating in some of them? Is that a good way of getting into or taking exposure in some of these sectors?
A: Certainly selectively. I think it is a good time. From time to time, Indian markets are relatively inefficient and based on non fundamental reasons you may get good opportunities for investment. So there is a certain deadline that many of these companies have to comply with; they have known that they have to comply with for a long time but many have, for variety of reasons, chosen to or ended up just waiting till the very last week or month. In the process, we may get opportunities to invest in some of them at fairly attractive valuations. So we look at case by case basis just as we would look with any of the stocks listed on the market. Or we would be taking advantage and invest in some of these names which we were anyways looking for an opportunity to invest in.
Q: The obvious outperformer at this point because of the run in the rupee should have been IT but that sector is dealing with problems of its own. There is that immigration bill overhang as well. How are you approaching IT?
A: In IT services we don't have a big difference in terms of where we are positioned right now compared to where the market is. There are individual stock specific opportunities that we like and we have substantial exposure to them. These are the same companies where we have had substantial exposure for considerable period of time well before the concerns around the immigration bill have built up. So these concerns, while not dismissing them, are very real. There are lots of things that need to take place, lot of decisions that need to be made before those things become a reality.
So I would not want to be dismissive of those but one has to appropriately factor in the probabilities and not consider them as a given. So all things balanced even with that risk, even with that immigration bill risk, it is a sector which presents some very good opportunities.
Q: How closely are you eyeing politics now as we get closer to the end of the year and those critical assembly elections? Would that have a bearing on your investment view or do you think the markets may ride it out without too much volatility?
A: Certainly I always eye politics very closely whether it is from professional perspective. Usually politics is one of the hobbies for most people in India along with cricket and bollywood and it is no different in my case either. At this juncture it is also very critical from where the equity markets are. It is one of the key risks or opportunities as you may want to see it over the next 12 months.
I think the markets would continuously, as we move everything forward, formulate an opinion about what might be the outcome of the central elections. If the market formulates a view that it is going to be a stable government that can last its full term then generally market would firm up further. If the market gets worried about the outcome of the next elections, it could throw up a formation that may not be as stable to last five years and might tend to weaken and obviously the day post the elections as we have seen the last couple of times the market would readjust its view to reality. So that is a very critical event.
Unfortunately as everyone knows any degree at least last couple of times; all the crystal balls were completely wrong. The reality turned out to be the opposite of what was expected last two times. So it is just an event that you have to wait out and let it take place and then decide how to go forward but until that time it remains a risk.
Q: We have had a fairly powerful rally in a short span of time given the current global and local context? What would you say is still the downside risk that you see for the market?
A: First of all the rally is about 3-4 percent since the beginning of the year. Also from the low points, a single digit percentage point rally. So on 5-10 percent, I would not put a lot of emphasis personally on that. From where we are right now, our base line expectation for returns is in line with trend line earnings growth which is about 15 percent as I have mentioned several times before. You can add or detract from that, any reasonable expectation that you may have for multiple expansion or contraction.
Given the risks that we talked about the central election in front of us, it is difficult to see a significant multiple expansion from where we are right now which is about 15 times forward; in line with historical leverages. So that should cap on the higher side any sort of runaway rally till such time that the elections are behind us.
On the lower end again you have the recovery in the economy which gradually but certainly is steadily taking hold or at least we have bottomed out on that front. So that should also keep a floor on the lower side because there is a lot of resiliency in earnings. We have almost bottomed out in case of earnings growth. So I don't see any reason to reasonably believe that the multiple can expand substantially or contract substantially at least till such time that the elections are behind us.
For a minute, I am ignoring all the external factors to India assuming they would be more or less status quo in terms of commodity prices; where the global bond markets are. So under those assumptions, it is reasonable to expect about in line with trend line earnings growth about 10 percent base line return assumption for the rest of the year.