Lack of earnings recovery is biggest risk to current bull market rally: Prashasta Seth
The earnings are unlikely to improve by next quarter but people are expecting earnings to turn up in the second half of this year. And, that is what market is hoping for.
Earnings expectations continue to be very lofty and my sense that we might be overestimating to some extent, Prashasta Seth, CEO at IIFL Asset Management Ltd, said in an exclusive interview with Kshitij Anand of Moneycontrol.
“If earnings do not come in even by December, then people will obviously become more and more concerned about the valuations because valuations are not cheap any longer,” he said.
Q: There is no stopping to this market or there is no stopping to this bull run which probably started around December 2016 when it hit a low of 7900. Although, the momentum has slowed down a bit, what are your views on the market for this calendar year or maybe beyond that?
A: I kind of look at it more as what is happening globally and we see that markets across the globe are doing well. There is a lot of liquidity which continues to chase markets all across the globe driven by low yields in the fixed income market. That is what is happening in India as well.
What you are seeing now is more liquidity coming into the market, people moving from fixed income to equity and probably still looking to increase their allocation to equities from real estate etc.
There are a lot of flows which are getting routed towards the market and that is what driving the rally. In India, the other positive aspect that is fuelling the rally is the macroeconomic fundamentals which are improving.
I think earnings continue to be the missing link. The earnings are unlikely to improve by next quarter but people are expecting earnings to turn up in the second half of this year. And, that is what market is hoping for.
Improvement in macroeconomic fundamentals should translate into earnings growth. In the shorter run, I think it is the liquidity that is driving the market. In the longer run, it is the hope of an earnings turnaround which is fuelling investment into equity markets for a period of 3-5 years view.
Q: Are there risks which can derail the current bull market?
A: Earnings expectations continue to be very lofty and my sense that we might be overestimating to some extent, the kind of earnings revival that might take place. That is where the risk is.
If earnings do not come in even by December, then people will obviously become more and more concerned about the valuations because valuations are not cheap any longer. They are fairly expensive.
From here on, earnings need to kick up. If that does not happen, even for the next 3-6 months, that is where the big risk will come in terms of returns.
Q: Many investors fear to enter the market at current levels and probably might want to wait out for corrections. What is your advice to investors?
A: My view would be that the numbers that people are talking about are fairly optimistic for FY18 and FY19. I think there is a possibility that some of these numbers might not be achieved. So, that risk obviously remains.
However, what we have seen in the last few years is that markets have not looked at the numbers at all. In the last two years, earnings were not that great but markets have continued to do well.
If people continue to have the visibility that things will improve after GST you see some things improving then I think people will still ignore it.
However even after October or December numbers don’t come in, then I think there could be a bit of a challenge. By December quarter if things don’t move as planned or as anticipated there could be some pullback or there could be some profit booking.
Q: Now that market is at a record high, many investors fear to enter at this point in time. What is your advice to them?
A: Investors should take investment decisions as per their asset allocation. I would not be overly aggressive in terms of going into equities at this point in time and be extremely overweight.
However, an individual investor has to look into his asset allocation before taking a call. The valuations are a bit stretched, but macroeconomic environment is very conducive for equities.
It hasn’t translated into earnings as yet but there is a chance that over the course of the next one or two years this will translate into earnings.
Q) What will define next 5 years? Some experts are already advising that disruptions would be the defining factors in various sectors and some of it has already started happening which have put a model of existing companies in a fix? Ex – Telecom, automation in IT.
A: I am not that clear in terms of what is going to define it, but my sense is that in the next five years I would look at more in terms of how India as a country grows and what kind of improvement you see in the per capita income.
In my mind, it is more of a story on how things play out in India, whether we are able to achieve 3-5 year kind of an economic growth environment in which we grow above 7-8 percent. If that happens that will be good for the country and that would be good for the economy.
Q: What I was trying to get at is you are seeing some reception in telecom and IT. Are there more sectors which you think could be impacted up by the same and companies might have to rethink the model that they are working on?
A: There is another one sector where we are seeing some pain and that is pharmaceuticals. Those are the three sectors where you have already seen a disruption in the business model.
And telecom, I do not know if there is a disruption in the business model or the fact that there is one player who has come in with excess capacity and has taken down the entire sector.
I do not see telecom being at a stage in which there is a change in the business model, but sectors like IT and pharmaceuticals are obviously at a stage in which you are looking for a bit of a change in the business model.
Q: Any top three or five sectors which you think could emerge as a dark horse in the next 2-3 years?
A: I do not know about the dark horse, but my sense is financials will continue to do well. India is still an unleveraged economy and they have put the continued increase in leverage in the economy and if the economy picks up you might see more private sector Capex as well. Other domestic consumption sectors like auto, etc. should also do well.
In terms of a dark horse, IT has been beaten down very aggressively on concerns on the structural chain, but valuations have now become very cheap. I do not see that IT will have a structural issue in which companies will collapse or they will not be able to remodel themselves.
If you ask me from a valuation perspective and where things are trading, IT is looking interesting, but others are still in a phase in which you could see domestic driven sectors doing well.
Q: GST is now closer to reality and do you think it will lead to the disruption in the near-term, but beneficial for larger companies so largecaps now, compared to companies which fall under the mid or the smallcap space? And the way the rally is structured now, GST is focused, is it too early?
A: My sense would be that yes, we do expect GST to cause disruption in this quarter and that is where I think we might not see another great quarter in terms of results for companies because of inventory write-downs and so on and so forth.
But, because of this formalisation of the economy would definitely benefit companies which are listed in some sense. I will not say that it will benefit large-cap companies more than midcap or smallcap companies because in some of the sectors which are informal in nature like plywood, for example, the companies that are the biggest players are still small and midcap in nature.
Market leaders in some of these categories and organised sectors will definitely gain from unorganised sector. It will have a net positive impact on listed space as opposed to the unorganised space.
Q: The next is, what is your call on the mid and smallcap space? The valuations have indeed touched roof and if somebody who wants to invest in the broader market, what would you advise?
A: We are slightly cautious on the midcap and largecap space. This is because as you also mentioned, the valuations there have become really expensive and on a whole also the markets have become fairly expensive.
Till the point earnings start to come back, it is better to be in my mind largecaps than in midcaps or in smallcaps. Midcaps and smallcaps have outperformed largecaps by a big margin in the last 2-3 years. And there are companies trading at 40-50 times earnings in the midcap space.
Now some of these things according to me are fairly unsustainable. So, our humble submission to our investors is that the largecaps where valuations are a bit more reasonable than what it is in the midcap and smallcap and stick to good quality companies.
If let us say for whatever reason earnings does not come in, you still have some cushion on the quality and the fact that some of these companies can grow in a relative tough environment as well.
Q: One hypothetical question. If a client comes to you with let us say, Rs 10 lakh for the purpose of investment to achieve his crorepati dream, what would be your advice? Some analysts are already quoting a print of let us say 1 lakh on the Sensex by 2024.
A: I do not know on some of those things, so what we are actually telling investors, again I will talk about it from an asset allocation perspective. It depends on what the asset allocation is for an individual investor.
And what we are advising investors is to be cognisant of how much they want to be in equity in the longer term. So, if it is an aggressive investor, you might go up to 40-45 percent in equities or maybe even 50 percent in equity. If you are a conservative investor, you would be 10-20 percent in equities.
So, that is a call that what we are telling investors that you decide on what you want to be in equities and depending on your asset allocation, you do that. It could vary between 20 and 60 percent depending on the risk profile of individual investors.
Q: And that is in fixed income or any other asset class?
A: Yes, that would be in fixed income. That is what we are telling. You have a different type of opportunities on the fixed income side. What you are telling investors is to benefit from them.
Q: Tell us more about your IIFL Special Opportunities Fund which I believe has already garnered a commitment of approximately USD 250 million.
A: What we are trying to do is to give investors access to the IPO market through this fund. What has happened in the last few years is that even though the IPO markets have done really well, investors have not been able to benefit from it because of the fact that either IPOs have been very heavily oversubscribed or after the leverage cost, your cost per share comes out to be very high.
So, what we are looking to give investors is a higher allocation and at a price which is lower than IPO price and much lower than the leverage cost would be.The second thing that we are looking to do is to invest at the time of the IPO as well. There, what the value proposition is that if you take a look at the IPO market or the IPOs, 50 percent is allocated to the institutional category, 15 percent goes to the non-retail category which is the high net worth individual (HNI) category and 35 percent go to the retail category.