Speaking to CNBC-TV18 Madhu Kela, Chief Investment Strategist, Reliance Capital said that pain from demonetisation is coming down. Queues are coming down in banks, he said, adding that he sees the situation getting stabilised by January end.
Valuations have corrected a bit, he said, in largecap companies owing to a lot of selling by FIIs. Domestic institutions are buying, he said.
Real estate has taken a beating, he said. The term deposit rates in some banks are lower than savings rates. He stressed that domestic money coming in will only accelerate.
Below is the transcript of Madhu Kela’s interview to Udayan Mukherjee on CNBC-TV18.
Q: We speak in very difficult circumstances, but do you think things will beginning to improve in 2017 or we will be need to be very patient for the next many months?
A: After this demonetisation, what I am hearing and what we have collected that the next one –two quarters could still be little tough from an economy perspective. However, things must start to improve in the second half of this year fundamentally for sure. Whatever the impact of this is, maybe the worst is behind us, as far as the impact of the demonetisation is also concerned. We must start to see some kind of things coming back to resemblance in the second half of January once the notes in currency improve over the next 20-30 days. It is already coming down. You can see the queues are coming down in the banks, etc. But the hope is that this situation will get normalised by January end.
Q: Have valuations corrected enough because in many high quality businesses they seem to have corrected. At the aggregate level of the Sensex on Nifty, it may not have corrected that much optically. But do you see valuations having adjusted to this problem or is there absolute downside in prices you think?
A: I think valuations have corrected quite a big, specifically in largecap companies I would say because there has been a relentless foreign selling. In the last three months, they have sold Rs 25,000 crore. Most of the foreign selling comes in the largecap names; while domestic institutions have participated and bought the equal amount but there has been a lot of selling through the year and specifically more importantly in the last three months. So, I see there is a lot of valuation comfort, which has come in select names, definitely in the largecap arena.
I would not make that same comment with that kind of conviction about the midcap segment specifically the companies which are just getting listed. I do not understand market seems to have completely divided. A lot of these companies which are getting listed are trading at such rich valuation versus very large companies in the same sector being available at much cheaper levels. So, there is definitely a disconnect in the market, but in the largecap side, you are right, things have corrected quite a bit. And they are looking attractive from an investment perspective.
Q: What is the sense you get when you talk to large domestic investors, high networth individuals (HNI), professional investors, even participants in Reliance Mutual Fund if you happen to interact with them because the reason the market has not crashed completely is because of this domestic money that you spoke about. Do you see that as a comfort, the fact that they are wading through these periods of pain without panicking or do you see it as a risk that if this foreign selling continues and results are bad in January, it is possible that even from the domestic side, we might see some selling?
A: That does not look the case to be honest with you because of two-three reasons. One is that, still you have a USD 2 trillion economy with 10-11 percent financial saving. So, you are still talking of USD 200 billion of financials, leave alone the physical savings we are not talking about it. So, when you have that kind of resource to be deployed every year and that is going to rise, where is the alternate opportunity? Specifically after the demonetisation, clearly real estate has become challenging. Interest rates, today, the term deposit rate in SBI is lower than a lot of saving bank account rates with a couple of banks, which are offering and debt funds have done quite a bit in last two years. People have made a lot of money. Gold, you know what the situation is. So, where do you put the money?
The domestic money what we are seeing, in my view, it can only accelerate that if at all there is a decline, there are a lot of seasoned investors and people who have missed the bus and who have not participated in equity, I would say more money will come. So, I am not worried about domestic redemption. Unless you know things don’t recover at all and there is some international big event which basically starts to play out a large impact in our market that kind of situation we are not discussing. However, in a dual course I think things are set that more and more money will come in equities especially from the domestic investors.
Q: What about foreigners because as you said 2016 has been very poor from an FII flow point of view do you see more of the same in 2017 given the backdrop that we have strong dollar, US markets doing very well, India going through this demonetisation phase where returns become challenging do you think the relative case for FII flows is weak as we walk in to 2017?
A: It has been weak for the whole of last year it has not been strong. If you see there has been patches of few months where foreign money has come. So, even when I look at things internationally your bond yields is already at 2.5 to 2.6 percent 10-year bond which is roughly doubled from where it was at the bottom. There has been tremendous losses on the bond side. Having said all of it which we are discussing Donald Trump impact this that the reality is that there is only 0.25 basis more interest rate hike prediction over the next 2017. We were expecting two hikes to happen in 2017, now we are talking of three hikes. So, I think maybe even out there in the short-term I don’t think too much pain coming in the US bond yield and subsequently I don’t see a lot of foreigners actually starting to sell now.
Maybe out there also there might be a bit of comfort because one thing is to say and second thing is when you are in the chair I am sure Donald Trump being a business man whatever may have happened at the time of election I think he will be more sensible and more proactive growth than what the market by and large may have factored before actually he won. So, I am not very nervous on the FII flows. However, let me add one point that 2017 in my view is going to be an extremely eventful and may be volatile year. There are so many events which are lined up through the year, so you have first Trump coming in then you have France election, you have German elections, you have obviously how Fed is going to be hiking rates plus you have large stimulus which was being provided by printing money that will also come to an end in 2017. So, I would say that this will be a year wherein people who are well prepared, market is going to be volatile, so as long as you will be able to basically bifurcate between risk and the volatility. So, the volatility actually can be your friend in this kind of market and if you are prepared everyone wants to act at one go. So, stocks have fallen like 20-30 percent in matter of one week or two weeks or three weeks and that is where I would say opportunities will lie in 2017; you have to be prepared it is going to be a stock specific market. I don’t think it is going to be top down as we saw for many years. So, when you are prepared in this kind of volatile environment you will get opportunities.
Q: Let me ask you about a sector which I think is top of mind for a lot of investors which is NBFCs. We spoke about it last time too. Valuations where very different than and post demonetisation they have got crunched down many stocks are down 40 percent. Has value emerged in that space or you would still wait it out because the picture is unclear?
A: When I talk to you, something from my heart came so last time we spoke we remember that Index could come to 8,000 not that I expect that it will come to 8,000, but it actually came to 8,000. We spoke about the NBFCs sector and I was clearly worried at that time. I think value is starting to emerge over the next quarter or so in this uncertainty. I think there are solid franchises which are being built over many years. On one hand because of the interest rate declined more than 200 basis point over the last two years they are getting cheaper funding. Let us not forget that lot of this unorganised funding which was happening to specifically to small and medium-sized enterprises (SME) sector and loan against property (LAP) that sector is going to open up. I am sure lot of these NBFCs which are prepared will capture that opportunity.
So, I know that there is the general fear in the market regarding LAP funding, but I don’t think people should fear that much because lot of these NBFCs companies I know they are lending against real businesses and they are keeping property as a collateral. So, it is not just you are lending only against property. I would watch this sector very carefully. I would be very excited, I am sure lot of opportunities will throw its way given the correction. However, you have to have a at least two-three year view to make money in these kind of companies because in the short-term as I said because of this so many events it could be volatile. However, I think I would be brave to buy this sector selectively.
Q: You spoke about LAP, you would include housing finance companies as well which have corrected significantly in many cases even companies which have a reasonable 15-20 percent LAP book?
A: Yes, absolutely, I would say that when I talk to people in the semi-urban and village areas lot of the funding was definitely happening to these people in cash. I would say LAP as a product if you have a genuine business and you have a property as a collateral in my view post this uncertainty of the next few months that product actually should do well. So, I would definitely include housing finance companies as an investment through these volatile times.
Q: What about the other theme which became such a hot theme for the last year or couple of years, which is anything to do with domestic housing demand- whether it was paints, electrical, ceramics or sanitary ware? All these themes blossomed over the last couple of years. Now they have been hit very hard by demonetisation. Should one use this as an opportunity to accumulate those businesses or do you think the disruption has still not been fully priced in?
A: The valuation out there are distressed too far. All of us spoke about making money in lot of these so called consumption theme, it had become so easy that it had gone to other way. So, as housing sector stabilises and then subsequently that sector will stabilise. However if the companies which are making 18-22 percent return on equity (RoE), if they themselves are available at 1.5 times book value then my preference would be to go and buy such companies because I have a relatively better handle than the companies which will benefit out of housing demand.
So, you will have to be very selective. Market is throwing up lot of opportunities across sectors. So, you will have to chose your stocks and sectors very carefully. I would say that there should not be any hurry to buy something which is unobvious because there are lot of obvious names which are becoming attractive.
Q: You keep an eye on policy as well. What is the next move according to you - the government has stung the economy with this demonetisation thing. I am sure it is planning many things which will alleviate the pain, maybe improve the general mood in the economy, what is a reasonable expectation to have as the next move from this government to counter some of the negative effects of demonetisation?
A: I think after December 31 2016 we might see a slew of measures from the government to stabilise confidence in business and people because even the common man is being hit and the sentiments are being hit.
Firstly the government has enough elbow room in their fiscal math to that stimulation. If they do not stick to 3 percent target which is being setup for fiscal deficit this year and given the circumstances if they have to postpone it by year or two, I don't think heavens will fall. I am quite confident that the government might choose that.
If the government decides to stimulate the economy they have many levers, like housing is one big lever that they could announce.
We are hearing and it has been in the air for some time that you scrap vehicles beyond 15 years, that could stimulate a lot of things specifically for the steel industry. Automobile has a very big cascading effect for the financing businesses.
So, I am sure there will be slew of measures which should come between January and February to calm the situation and to make this whole thing more smoother and I am optimistic and confident that it will happen.
That is the reason why one is not overly concerned about the markets in that sense because we have seen the worst. Worst seems to be getting into prices in lot of cases. If these policy measures come in and the governments intend becomes clear that they will defend it then these positives should stabilise the market rather than taking it down.
Q: Worst case scenario- do you think it is possible that we revisit the February lows even in the case of serious disruption or serious ugly numbers in the January quarter? Do you see the market going back to those 7000 kind of levels or do you think it is unlikely that will happen in this year?
A: I don't think we will go there. Markets as they say, anything is possible but I don't think we will go there. There is so much domestic liquidity which is there. I have seen over the last 25 years whatever is talked about - today demonetisation, if there are 120 crore Indians there are 121 crore opinions on this. There is not one single soul in this country who is left out not discussing demonetisation and its impact on himself and the economy.
So, when this subject is so much discussed, I don't know whether it is being fully factored by the markets or not but I would say it is. I don't think that 6800 levels are possible only because of these events. If something internationally goes wrong like there is some big geopolitical tension between US and China and those are again things which are possible then I would not rule that out. However given whatever we can see, I don't think we are going to those levels.
Q: When is growth going to come back, that is my biggest question always to an observer like you? We spoke about it last time, this year too we are hoping that we will get 15-16 percent earnings growth, now we will surely not get it because of demonetisation. Next year again we will hope for 15-16 percent growth, will we get it or because it has been 2-3 years longer that we have been waiting for this growth recovery and for one reason or another every year we are not getting it. Again we have GST in 2018, do you think we will get it next year or we will have to wait one more year and again speak in December saying one more year past but we did not get the growth recover that we were looking for?
A: For next year there are couple of things which are positive, one, your base will be much lower because of this quarter and next quarter- hopefully things are bad and base will become much lower. So, from here also if we don't get 15 percent growth in 2018 then I think there is a serious challenge because then even holding these valuations will become tough.
I think we should start to see growth recovery in second half of this year which is from July-September quarter we should definitely start to see growth happening.
One thing which I hear, which I also worry is that if the GST is being introduced, as I understand in the beginning there will be a lot of hiccups and there will be challenges, so owing to that it could shift by another quarter or so. However I would say that things should start to look up from second half of this year.
Q: What about capex, when does that recover in your book now?
A: There only the government is the hope. I don't think that private capex is coming back in a hurry at all because people are completing whatever they have in hand. However whatever analysis which we do at least private capex is not looking up.
Every time we have seen it starts with the government and gradually hopefully if we have a 50-75 basis points interest rate reduction in this year then hopefully some private capex will start to happen but that is not visible as yet.
So, again we are hoping on the government capex, we are hoping on the 7th pay commission coming up and people having money in their hands for the overall recovery to happen. However private capex is not looking good even now.