Vetri Subramaniam, chief investment officer of Religare Mutual Fund feels further market upmove is likely to depend on earnings and GDP growth. The BSE Sensex surged over 200 points in early trade on Thursday and moved past its crucial psychological level of 19,000 for the first time since July 2011.
The rupee rose to a five-and-half month high, breaching 52 to the dollar, on the back of gains in riskier assets and as the government is expected to announce further reforms measures. According to Subramaniam, the appreciating currency is likely to dampen export-related sectors' growth. "We need to be company-specific when playing rupee appreciation," he told CNBC-TV18 in an interview.
On the positive side, Subramaniam feels, the liquidity inflow will aid stressed balance sheets raise some capital. However, he does not see any significant earnings upgrades in the near-term. "We have seen some signs of investment cycle revival," he said.
Here is the edited transcript of the interview on CNBC-TV18.
Q: The mood in the markets itself with this string of announcements coming in, how long do you think this rerating story can go, does this look like 6,000 gets taken or do you see too many roadblocks?
A: I think it is good that after a long period where the government was very slow in terms of taking any actions, they seem to have seized the opportunity and started to move the policy momentum along. That certainly is welcome. Given the fact that we have become pretty despondent about this government’s willingness to do anything for the economy, it certainly surprised everybody positively and I think that has given the market a bit of a tailwind. The global liquidity environment has also certainly helped the markets along.
Markets have gone from trading at valuations which were almost about 15-16 percent cheaper than average to almost reaching long-term average valuations. You can put index numbers on it but, I prefer to look at the market in the prism of valuations and in effect what has happened is that a little bit of positive newsflow has helped the market go from trading below average to average.
But, from here onwards, it is more heavy lifting and eventually the markets are slaves of earnings. The market is not a slave of announcements and therefore, we will have to see some traction in terms of GDP growth and earnings growth if the market is to climb much higher from here.
Q: That was what I was coming to, it has been a rerating story as you said, it is not an earning story yet but couple of parameters are changing tangibly and if the rupee average shifts to something like 51-52, on the ground for some companies there could be some advantages and there could be some disadvantages so is there already some kind of an earnings story or earnings revision on the ground, are you seeing some signs of that?
A: That is a little bit trickier to look at because there are a large number of Indian companies who now have a significant overseas operations, a large number of them have significant proportion of their revenues coming from exports. Therefore, I am not very certain that this necessarily has a very positive impact on earnings in the short-term.
If anything, the appreciation in the currency internationally dampens growth in some of the sectors which have otherwise been growing very strongly. On the other hand, what the appreciation on the currency does is that there are a large number of companies which were expecting balance sheet related pain because they had a large component of foreign exchange borrowings sitting on their books and did not have a relevant hedge. To some extent, the sort of solvency or liquidity or debt refinancing related concerns that some of these companies have get lifted but, whether it necessarily improves their earnings trajectory is still a question mark.
I actually think there is a significant component of the market which is the exporters and the overseas businesses of Indian companies which may initially report damp in the earnings because of the appreciation in the rupee. It is not as straight forward or as simple as you make it out and I think you need to be a little more company specific when looking at these issues.
Q: Many of your peers have gone ahead and upped their Sensex targets for the end of the year, given the concerns that you have alluded to, what kind of a trajectory are you hoping to see for the market and where do you think we could close at by the time this year comes to an end?
A: We do not work with the Sensex targets. That is not the way mutual fund operates. We do not have an index target in that sense. I think our operating principle for the better part of this year has been that valuations were at a discount to the average. There were a lot of opportunities for stock picking.
At the same time, we have always been concerned that balance sheet health is not very good for many companies and therefore, while we were willing to take on the risk that earnings maybe muted in the near-term, we were slightly uncomfortable with investing in companies which had balance sheet risks that they were carrying.
All that has happened over the course of this year as we have seen valuations move from below average to average. A little bit of that opportunity has now been taken away from us. There are still opportunities that we see where valuations are reasonable and valuations are still very much within the comfort zone. But some of those cheap opportunities that we were able to identify a few months ago aren’t there.
We are continuing with our approach in terms of stock picking. We remain concerned on the balance sheet issue though the recent currency appreciation and some of these announcements are helping lift equity prices and there is a reflexivity involved here if companies are able to raise money from the market. Some of them will be able to address their troubled balance sheets. That also is a positive for these stock prices going up.
There is some change in the environment, we welcome it. We are enthused by it but, it doesn't change too much in terms of our approach towards stock picking at this point of time.
Q: Where might be the initial earnings upgrades, in which sectors you think?
A: We still cannot see that. I think if you go back to earnings at the end of the day it is going to be driven by growth, it is going to be driven by the two key factors. A revival in the investment cycle and while we have seen several announcements by the government, which are good for corporate sentiment, these are good perhaps in some cases for increased FDI flow, while we can debate over the longer-term high quality FDI inflows along with technology and processes which will certainly help these sectors grow.
I think the key in the short-term for reviving the economy and also in terms of addressing the supply side bottlenecks which cause inflation to spike up every time is reviving the investment cycle. We have seen some signs of this by the government starting to talk about SEB debt recast but I think it is still early days over there and there is a lot more that needs to be done in terms of financing related issues, in terms of land related issues, in terms of the pricing of energy products.
Q: You were talking about the improvement in the investment cycle going ahead or the possibility of that. How enthused are you by the improvement that we have seen in the macro data so far, be it the PMI stabilizing or even the narrowing of the current account deficit? What are you expecting to see from key data points like IIP and inflation going ahead?
A: I think the key really over there is still on the investment cycle. It is still too early to expect and we are not really picking up any signs that companies are starting to ramp up their investment plans. But, to be fair it has just been two weeks since this policy momentum started.
I think you will have to be a bit patient over there. The investment cycle is not something that can be revived with a snap of a finger. That is going to be a long drawn effort and I think we need to see a lot of stuff getting done in terms of the entire pricing approach, whether it is related to fuel or other energy products, whether it is on the issue of land acquisition or environment related issues.
A very welcome step is this stock of a National Investment Board. But, I will take you back about 7 or 8 years ago when we also had the proposal for a National Investment Commission which was headed by Mr. Deepak Parekh and by Mr. Ratan Tata and nothing much came out of that either.
The thing is not just announcement, we need empowered bodies which are in a position to give large infrastructure projects all the clearances that are required by them to be able to hit the ground running and then execute the projects. It is not just about having these announcements, it is about the execution of how you do it. That is what holds the key to getting the investment cycle off the ground.
As far as industrial production numbers are concerned, I think the trend still continues to be a little weak and again even if the government puts in place the right policies, I think you would have to be patient and wait 3-4 months before you see an improvement over there. As far as inflation is concerned, I think it is going to be a bit of a challenge.
The appreciation in the currency will certainly help to some extent, but inflation is still outside the comfort zone of the central bank at this point of time. While we do expect at some point they will have the flexibility to cut, if things continue on the current trajectory, I would not really expect anything very dramatic from them as yet.
Q: Some of the investment problems are truly intractable. It doesn’t look like the fuel supply issue, coal and worst still gas gets resolved anytime soon. Likewise, even on the spectrum issue licenses have been cancelled. It is going to be a little difficult to get people to put in fresh money into investments when previous decisions, which are supposedly legally are being called back and sometimes by agencies outside the government, sometimes by organizations like the Lokayukta or the Supreme Court. Given this atmosphere, does it look like investment can come in quickly? Do you think that the sheer distance between what can be achieved by this government puts a cap on the rally?
A: I don't want to get into what can be capped or what may not be capped. But, I think it is very clear that eventually the decisions that can really get us back onto a sustainable growth momentum is not about announcing reforms that will get you a lot of good media coverage and get the stock market a little bit excited, this is about putting in place the reforms that are actually required.
These are real reforms, not just some of the stuff that we have seen in the recent past which ensures that as an economy we are able to get ourselves up to grow at a sustainable rate of even about 7-8 percent with inflation being contained within expectations of what the central bank has been espousing.
When you look at it from that point of view, some of the things that we have done in recent days is at best supplemental or complimentary to the entire sustainability of growth agenda. But, a lot of the core issues which lie at the core of this sustainable growth have not yet been addressed, which is the entire investment cycle and all the various policies related to that.
We are here for the long-term and we think that this economy is capable of growing at 7-8 percent with the right policies and those are policies that need to get addressed. Along with that the other issue that we need to address is the fact that government spending has been so much out of control over the last 5 or 6 years, government borrowing program is up almost 4.5 times in the last five years, that it needs to get reined in.
That will not happen without some amount of measures to control the fiscal deficit. I think the Kelkar Panel has already presented its views on that in fairly blunt terms. So these are the two issues on which I think eventually the outcome of sustainable growth for India rests. It has not to do with the easy decisions like FDI in retail.
Q: Wanted to get your views on the flows situation. The kind of massive flows that India has seen until now YTD and where do you really see it head from here? Do you see continued contribution from FIIs and that may lead the market ahead?
A: It is always hard to predict the flows, because at the start of this year I don’t think anybody would have expected these kind of inflows coming in and neither did we expect the sad situation that we were in in 2011 in terms of flows. That's always a little bit hard to predict.
At the end of the day, the flows follow the market rather than the other way around. I wouldn't get too much into trying to predict the flows and then trying to predict where the market would go based on those flows. I think what is also true is that you will see a lot more supply come through in the near future as a lot of companies use this window to try and recapitalize their balance sheets.
The government also is looking at this rally as a means to try and raise their proceeds from disinvestment or even more interestingly something that we saw a few days ago talking about trying to raise money by liquidating the SUTI holdings. In terms of what the flows itself might mean for the secondary market I would not draw a linear causality between flows and what happens in the secondary market. There will be a lot more of secondary market placements and IPOs coming through in the days ahead.
Q: What leads can you give a stock picker? The heavy lifting starts from here when you have to look at tangible gains in earnings, but if there are specific features of stocks that you would look at which would they be?
A: I think it just goes back to the basics of stock picking which is not so much about excitement, but more to do with hard work. It is in terms of picking companies which are best placed with strong business fundamentals, healthy return on capital ratios and cash flows and will be in a position to benefit from any cyclical upturn in the economy, whenever that comes. The sooner it comes, the better for them.
That is where we would continue to like to position ourselves for the long-term. In that sense we are still keeping it simple. It is not so much about the themes about defensives, cyclicals and all of that. Certainly, there has been more opportunity in the cyclical segments of the market in the recent past, because that’s where we saw valuations really tread down to a very big discount to their historical averages and in many cases, you were actually buying businesses without any growth option built into them.
The cyclical areas are where we have seen some of the best opportunities and at this point, we would rather focus on the businesses which are eventually more domestically driven than globally driven. As far as the global economy's health is concerned, I think there is still a little bit of a question mark right now.
Q: What about the broader markets? We have seen a huge outperformance from the midcap end of trade. Do you see that continue? Is there a lot of opportunity in the midcap space?
A: It is a question of the timeframe you use. The midcaps have outperformed the large caps a bit, but I think if you look at the data, you will find that the midcaps are just about reclaiming the high that they saw in March this year, whereas the large caps are already ahead of that.
It is really a story of this market. You talked about this market trading at the highest level since May of 2011. The truth is for 3 or 4 calendar years running, every year we have seen the 5780 or whatever level we are at now. It depends on which starting point and ending point you take and I would not get too caught up in those cycles. There have been more opportunities for stock picking in the midcap segment of late, but the valuation discount in midcaps has not been as large as we have sometimes got down to in past times of crisis. There are more opportunities in midcaps, but I would be weary of making those calls on which it is playing catch up with the other.
Q: Given my predilections I tend to worry more about things like inflation and deficit. That area is actually still a vicious cycle, not much headway has been done on the fiscal deficit side. Yes, perhaps on the LPG side it is a seminal change and a change for all time, but even then we are so far away from the target that continues to feed into inflation. Given these two intractable problems would you worry that we cannot make much headway on earnings growth even if we got the investment piece or we are able to clear some logjams for investment?
A: I think eventually it is about making sure that you have a sustainable rate of growth of 7-8 percent which would be a very healthy rate of growth. But, you cannot do it unless you get this fiscal situation and the investment cycle under control. You need that to fall in place to sustain growth.
Other than that you can get a bit of excitement in the market. It is nice to see the market having some upward momentum for a change. We welcome that, but there is a lot more you need to do if you really want to make this sustainable and you are right. I think as far as the fiscal deficit is concerned, we have seen a lot of talk, we have seen a new Kelkar Committee roadmap. But, we really need to see those hard decisions taken. We will just have to be patient and see what the government is able to do on that front.