India may have been the biggest growth story in the beginning of last decade after foreign institutional investors flocked Indian markets. However high current account deficit, sharp decline in Indian rupee, contraction of GDP from 9 percent to 5 percent, policy paralysis and many such factors have taken tall on India’s shining image.
"India story is not as compelling as was the case probably a few years ago. The risk of stance that is currently on in the developed markets has led to that dramatic outperformance of the developed markets versus emerging markets," observed UR Bhat of Dalton Capital Advisors.
Ben Bernanke's recent comments that US may taper off the quantitative easing by year end would also restrict this easy money from flowing to emerging market.
He expects FII inflows to taper going forward as developed markets like US and Europe are likely to bounce back. Given the unprecedented fall in rupee, now Reserve Bank of India is also unlikely to extend any further rate cuts.
"It does not look like as if they (RBI) is in a great mood to cut interest rates anymore and since the last statement the rupee has collapsed. Therefore, there is absolutely no case for forfeiting interest rates anymore," Bhat stressed.
Below is the verbatim transcript of his outlook on the markets:
All of us expected in the early 90s foreign institutional investors (FIIs) have come to dominate the market. They are the ones who give direction to the market and therefore in a manner of speaking we have become as a nation hostage to those inflows, the market has become hostage to those inflows. As you all know, high trade in current account imbalances have been one of the causes of the foreign institutional investors taking a slightly dim view about how things are panning out here. Of course the precipitous decline in the rupee is something that will make everybody nervous including foreign investors because if you see year-to-date (YTD), foreign investors even after this billion dollar that has gone out over the last couple of weeks have brought in about USD 14 billion in this country and this USD 14 billion has produced a dollar return of something like minus 12-13 percent, which means that we increasingly require more and more foreign institutional investors money for the market to even stay where it is.
So I think declining rupee is one thing that can shake the confidence of big investors and that is probably taking a toll today. The cause of the plunging rupee – we have come to a situation where all of us were expecting – in fact at least the government was expecting that Reserve Bank of India (RBI) will keep cutting interest rates. With the state of the rupee today, I do not think that looks like a distinct possibility. Therefore there might be further danger for foreign debt investments in India to leave the shores even further because as I said, only just about under 10 percent of money has gone out and these are the consequences.
Therefore, if there is no prospect of further softening of interest rates in India. So we should brace ourselves for that. Everyone knows what is the reason for foreign investors or in fact any investor to take a rather dim view of Indian equities. On the macro side, it is tepid economic growth. As you know, we have come to about 5 percent from the 9 percent that we were having just a few years ago and an array of stalled projects, halting reforms, dysfunctional politics as everyone knows (the parliament is hardly functional) and waning consumer confidence. All these factors are affecting sentiment quite dramatically. While investment was halting for quite some time in this country, but now even consumer confidence is faltering.
As you see, even two-wheeler numbers or auto numbers or in fact white goods numbers are falling. Against the background of all this finally earnings growth of corporate India is also sort of moderating. Therefore, the outlook for market is juxtaposed on all these considerations.
Therefore given the fact that capital inflows from outside the country have been giving direction to the market for quite some time. Let us see what is the outlook there. One is the US economy appears to be on a mend. If you see the data coming out of the US whether it is housing stocks, whether it is unemployment figures, things have started looking up and that is what has given Ben Bernanke the confidence of saying that maybe we will taper off the quantitative easing 1,2 and 3.
Therefore, there is a chance that the people may start thinking in terms of pulling out money. Quite a lot of that money has leaked into emerging markets including India. So all this money that we have got, almost about USD 14 billion from January 2012, a significant amount of that has been on account of QE and this could reverse. Even Ben Bernanke has put lots of caveats on that saying that if everything goes according to plan then maybe he will start tapering at the end of this year and probably withdraw all QE and come back to normalcy sometime in the middle of 2014. That is juxtaposing quite a lot of developments which should be true to the liking of the economists in the US.
Europe continues to fester as we are discussing now - hardly any bond sells are happening, most sovereign bonds are not getting subscribed. Therefore things are pretty bad. We were talking about just six months ago like for example a bank blow-up, sovereign bankruptcy, breakdown of the European union, I think these things are not being talked about anymore. Therefore, while Europe seems to be still festering, it is not as if something dramatic could come out of Europe. As a matter of fact therefore what we are seeing is that things look a bit better in international markets. If you see the US Dow probably is up about 15-16 percent YTD and we are down by about 12-13 percent today, therefore someone who has invested in India – a foreign investor invested in India in January 2013 has had an opportunity loss of almost 13 percent that is continuing in India, it lost about 12-13 percent but if he had gone to the US, he would have probably made another 15 percent. Therefore, the opportunity loss is as high as 28-30 percent.
In Japan, there is a huge amount of quantitative easing happening. Therefore even though there might be some tapering off in the US, in Japan things should continue to be sort of soft as far as the monetary easing is concerned. We have also seen that China itself, which was of course the big bull as far as the global economy is concerned that also, has seen signs of slowdown.
As I said, a possible end to the rate softening cycle of India, which is possible because if you see the Reserve Bank of India (RBI) sort of policy statements, it does not look like as if they are in a great mood to cut interest rates anymore and since the last statement the rupee has collapsed. Therefore, there is absolutely no case for forfeiting interest rates anymore. If there is no softening of interest rates, there are no great capital gains that can be made in the fixed income market. So there is a case for foreign investors to probably further take back money from the fixed income market, which could have even further effect on the rupee and also on equity markets by implication because this contagion could spread. If rupee cracks further then it is just a matter of time before corporates also starts bleeding and therefore this contagion could spread even to the equities market. Of course, the absence of hard decisions that all of us want the government to take remains a possibility.
So as sum and substance is that India story is not as compelling as was the case probably a few years ago. The risk of stance that is currently on in the developed markets has led to that dramatic outperformance of the developed markets versus emerging markets, which India being a part of that. There could be more pain on account of that. I am sure, all of you are tired of listening to further pain, we already had huge bout of pain as it is. Therefore, I think we should look at something better than having further pain.
I think one thing that we need to accept is that capital flows on the back of monetary easing will not be switched off dramatically in one day. It will probably take time, it will probably get done over the next one year or two years in US and it will probably continue further in Europe and Japan for quite some time. So it is not as if all money that was finding its way to India is going to dry up dramatically immediately. But, I think we should certainly be bracing ourselves for the fact that FII inflows will be much less robust than what it used to be for the last couple of years.
As I said, increasingly higher fire power is required by FIIs in order to even keep the markets here because domestic investors whether institutions or retail like all of us have been very pessimistic with the market for quite some time. Because if you see, I think in recorded memory, domestic investors have been net sellers for ages now. It is only the FIIs who have been positive about India; but the domestic investors have been net sellers. That could change because domestic investors if you all listen to Udayan Mukherjee’s words, I think we may start nibbling into the market and so therefore things might change. I think there are few things that the government can do, increase government spending which is likely in the run up to the elections. That can change the consumer sentiment a bit. A good monsoon, in fact we have had much better than a good monsoon as of now if the floods are any indication. A push towards much needed reforms because we have seen some baby steps, some movement towards reforms over the last few days. At some stage, rupee should find a bottom and it should remain stable and improving current account balance. The finance minister has been saying that you should not buy gold, there might be further measures that he might bring about and so therefore there might be some stability on the current account deficit. So, all these can actually change fragile sentiment. It is very dark as of now outside but I think things can change quite dramatically over some time.
Equity valuations are not exactly very expensive at about 13 times current year earnings which is not very expensive based on historical sort of averages. But if earnings growth expectations are sub 5 percent then it is extremely expensive so that’s where we stand. Therefore, earnings growth expectations have to change. If they change then equity may look less expensive.
Even going beyond the Federal elections, the first year of a new government is always the best year for taking tough decisions. We hope by early 2014 or mid 2014 when we will have a new government, whoever it is, can reignite reforms and address all these decelerators of growth and can lead to market optimism. Therefore, what I am saying is that while it may look very dark today but it is probably a matter of few months or probably a year or so when things can change quite dramatically.
Therefore, what is the investment strategy that we should follow? I think that is very simple. I think it has been very well articulated by Udayan Mukherjee. We don’t necessarily have to be in equities. It is not as if we are compelled to be in equities. For someone like me who runs an equity fund, I have no other goal, we have to be in equities. But for you, as investors, you don’t necessarily have to be in equities. If all of us think that there is further pain to be experienced over the next few months, you can get out of equities and sit in fixed deposits, and then come back. But at the same time, it is very difficult and almost impossible for any of us to even call the bottom of the market. Therefore, it is always better to be invested a bit in a market and probably whenever things get worse, you could probably increase exposure.
So what we need to do therefore is, as discussed earlier, fairly valued largecap stocks in defensives, this is one sort of sector, one segment we should be invested in. If you have Rs 100 to invest in equities, probably you should invest about Rs 20-25 now when the market has corrected. Probably if it corrects a bit further, probably another 5 percent, maybe another 20 percent and that is a way to build a portfolio which can really give you very good returns over the long run. If you had invested in 2008 January, there was a hell of a lot of money that would have made even though we are very bearish today but still we would have made lot of money if we had the guts to invest in 2008 January. So I think we are probably heading towards something like that in the near future so therefore we should actually nibble away at the market. As I said, to fairly valued largecap, quality, defensives, I think that is one area where you should be invested. Of course the private sector banking and NBFCs have done a very good job of negotiating with the slowdown and that is one area where whenever there is a correction I think you should start nibbling it in. That is another sort of sub segment which we should be invested in.
This is sort of hoping against hope that the government may not be able to win an election without doing something about roads, something about electricity, something about mining. These are the three sectors which really have brought down the growth in this country over the last few years. So I think slowly they are doing something about coal allocation, something about making available coal, reforming electricity boards, seeing that they pay the electricity producers. So I think these things take time but I think it is worth taking a bet on these also. As I said, a small allocation, sprinkling of conservatively funded infra and power stocks. I think that is some small amount of maybe 10 percent of the portfolio is worth keeping there because they could give huge sort of deltas if things turn out to well. That’s why I said, conservatively funding is very important, not those who have 5:1, 6:1 debt equity ratios but those who are very conservatively funded.
Oil and gas sector is taking a turn for the better with a gradual increase in diesel, oil prices and possibly some more movement on the gas pricing front. I think that is one sector where one should be invested in. Of course beneficiaries of weak rupee, typically the exporters, the IT companies, I think a sprinkling if that also is very important. But I think most important than anything else, you should constantly review the portfolio based on emerging developments because we cannot anticipate everything. Things might change dramatically. Government maybe really doing something dramatic to that, the outlook changes, consumer confidence improves, the demand situation improves. As I said, as of today, as a retail investor I think one should probably invest 20 percent of what you actually want to allocate to equities today. But overtime, whenever markets correct more, I think we should increase that allocation and quite largely, as Udayan Mukherjee said, the best companies, if they are available at half the valuations than they were at peak. I think these are the sort of companies we should be really buying into and hopefully probably one year from now, we will be much more cheerful lot.