Nomura sees monsoon as biggest risk to market rally, but sees 10-11% rally in 2017

Indian market scaled news highs in this week but the rally may not be over yet which investors have already started to talk about. Nomura India which remains constructive on India market thinks that the rally could extend by another 10-11 percent by 2017 end.

“Our view fundamentally for the India market was around 20 percent return but after the rally, it looks like we could do another 10-11 percent return until the end of the year helped by liquidity,” Prabhat Awasthi, Head of Equity & MD, India, Nomura said in an interview with CNBC-TV 18.

“We are constructive on the India story and the country continues to stand out as a market with growth profile among other emerging markets. But, valuations have become pricey; it has not deviated much from long-term averages of the last 5 years,” he said.

The valuations look frothy compared to what they were 3 months ago, but on a macro basis valuations still looks okay, he added. The Indian market is trading at 16.8x compared to 17.1x which is a 5-year average of market multiple on a 12 months forward basis.

Nomura is overweight on the consumption space and the tilt is more towards autos.

Talking about the biggest risks that market faces right now is a monsoon. Most experts are counting on earnings recovery as well as economic recovery and monsoon play a very important role in that.

A bad monsoon could well turn tricky for India Inc. and analyst estimates. Rainfall was normal in the year 2016 after two successive years of the deficit that curbed output of sugar cane, wheat and pulses.

“The risks to Indian story are more global. Talking about local risks, a bad monsoon could well translate into higher inflation and all the good macros we are seeing might get strained a bit,” said Awasthi.

Other risks which India market might have to deal with is a slowdown in China, trade tension ballooning up due to Trumponomics as well as any sharp rally in crude oil prices.

Stock Selection 

The key to stock selection, as the es benefit described by Nomura, is to stick to the macro theme. The global investment bank focusses on those stocks which are expected to benefit from the expansion in the economy.

The top stocks in Nomura’s portfolio such as Maruti Suzuki, HCL Technologies, or even HDFC are trading either close to record highs or near 52-week highs. But, the global investment bank does not plan to rejig the portfolio, yet.

“Thankfully, they are out top picks are trading at all-time highs. Our strategy worked. The key strategy to our stock election is sticking to the macro theme and then we drill down to stocks based on that theme,” said Awasthi.

“We are changing anything. The growth dynamics in the economy is such that some of the names that we have chosen will be the biggest beneficiary of that growth,” he added.

Talking about banking space, Awasthi is the view that consumer-oriented bank are likely to hog the limelight when compared to corporate banks, because the corporate credit will take some time to pick up.

“The corporate credit will take slightly more time to pick up even if the growth in the economy picks up. The first phase in credit pick up will come from consumer’s side because deleveraging in corporate India will continue,” he added.

Below is the verbatim transcript of Prabhat Awasthi’s interview to Anuj Singhal, Latha Venkatesh & Sonia Shenoy on CNBC-TV18.

Anuj: All-time highs for our market do you get a sense that we could move on from here because of the kind of liquidity we have not just domestic liquidity, but even the global liquidity?

A: Our view fundamentally has been for about a 20 percent return from the market that translates to about 10-11 percent return from here till the end of the year. Frankly, obviously, liquidity is helping in terms of market recovery specially after demonetisation. But we continue to be constructive because we expect structurally the growth to continue to improve. India continues to stand out as a market in terms of growth profile amongst all other emerging markets. So, yes, our view continues to remain constructive on the Indian market.

Latha: When you say constructive, we also are at some difficult valuation levels. Would you therefore be extremely stock specific or do you think that given the liquidity or given the political macros even at an Index level we are set higher and how high?

A: I was looking at valuations, valuation obviously have risen quite sharply from where we saw them three months ago or so. But, the three-year average or five-year average of market multiples on a 12 month forward basis has been about 16.8. Right now we are at about 17.1, so some premium to that but not a huge premium to the average valuations we have seen in last five years. If anything the worst case you should be able to get sort of the earnings growth that you are going to experience over next few months. Therefore our view is essentially that while the market has become a bit more pricy it is not very sort of deviated from long-term averages.

Also remember that we have had sort of a softer interest rate regime in India compared to the global sort of markets where globally interest rates have risen, but India because of demonetisation, because of their own inflation, so the numbers that came through post demonetisation our interest rates have actually sort of bugged that trend and alternative investment or rather risk free has essentially come off, so there is some merit in valuations sustaining at these levels. So, I don’t really think that market can be called very frothy at current valuations. They are sort of averaged, slightly more expensive than average, so I think on a macro basis market still looks okay.

Sonia: Everyone is talking about a bounce back that we are seeing in consumption space and within that you have liked discretionary consumption for a while specially sectors like autos. Is it only restricted to autos or would you also broaden that to other companies within the FMCG space?

A: FMCG is not really discretionary consumption. I mean discretionary consumption is essentially there is certain amount of value of good beyond that it becomes a discretionary. FMCG is more non-discretionary. FMCG generally responds to growth, improving growth in economy but the delta in FMCG in terms of higher growth is comparatively less compared to pure discretionary for example autos which obviously respond much more positively to a higher growth trajectory in economy and also lower interest rates and also liquidity environment.

So, purely in terms of growth delta that should come through because of the higher liquidity and lower interest rate should be higher in things like autos. That doesn’t take away the fact that there should be some improvement also in growth rates of FMCG. Also remember that we had a good monsoon that sort of got lost a bit because of the demonetisation, but that growth also should come back. So, we are overweight consumption sort of space, but in terms of our preference if you talk between discretionary like autos and FMCG it will be more towards autos.

Anuj: One thing which has been consistent about Indian market is that the best stocks have been extremely expensive and the cheap stocks keep getting cheaper relatively. If you look at your top five names as well most of these stocks are either at 52 week high or nearly there, stocks like Maruti Suzuki, HCL Tech as well, HDFC Bank. So, how do you approach these stocks which are at life time highs but still the only places which are making you money, at least in the largecaps?

A: First of all the reason that – thankfully there are top picks because if they are at all-time highs obviously they have worked. So, our view essentially is that our stock selection is based more on a macro theme and then we drill down to stocks based on that macro theme. Without commenting on a specific stocks we are not changing anything first of all because we essentially think that the growth dynamics in the economy are such that some of the names we have chosen essentially will be the biggest beneficiaries of that growth.

So, we are essentially playing that growth acceleration theme and our view essentially is that in overall economy it is the consumer related – consumer banks which will benefit at the expense of corporate banks simply because of the fact that we think that the corporate will take slightly more time to pick up even if the growth in the economy picks up the first phase of growth pick in credit will essentially come from consumer side because deleveraging in corporate India will continue. So, even if the growth has picked up in sales it is not necessarily going to translate into a very strong credit growth for corporate India because number of sectors which had basically become very leveraged, will be in a mode to sort of reap. Therefore we are a more towards consumer sort of facing banks than pure corporate banks.

Latha: Is there a BJP theme that you will play because of the massiveness of the Uttar Pradesh (UP) victory say rural stocks, I mean immediate reaction of the market was to push up stocks like Mahindra & Mahindra (M&M) is there a rural theme or a housing theme that you will give added emphasis too?

A: I don’t want to say BJP theme but I think the theme of this government seems to be – I mean what we have seen at least in last two and a half years and we can base our knowledge about what the government is trying to do based on that last two and a half years and that essentially is that government seems to be continue to be very fiscally prudent, continue to emphasise investments over sort of consumption expenditure in terms of how they are spending money seem to be more asset creating expenditure than revenue expenditure. That clearly, this year the emphasis has been added apart from infrastructure which has been a theme for this government they have added affordable housing to that theme.

So, real state actually it is very interesting they have sorted de-emphasised the higher end real estate be it Benami Act or be it the interest rate sort of SOPs or the tax benefits you are getting on high end real estate they have shifted down to interest rate subvention, so interest rate subvention at the lower end housing that has been provided, so clearly there seems to be some emphasis over I would say volume economy over luxury economy.

So, I guess there will be volume economy plays in residential housing, affordable housing that will definitely do well. I would also think that might actually lead to some amount of pick up in semi-urban and rural areas as you go forward. So, I sort of broadly agree with what you were saying that there is some sort of macro sort of direction to the investment cycle that how the government is trying to steer the economy and that could actually play into rural and semi-urban things.

Sonia: What do you think is the big risk for this market upside now?

A: I mean, obviously, the big political event is out of the way. The micro risk per se from the country perspective I think at least we don’t know them yet. Obviously there must be risk but monsoon could be one risk that comes through I mean we will have to see as to how monsoon plays out. We had a good monsoon, but in June obviously we will have to see what kind of forecast are there for monsoons this year. Macro basis I think obviously we are looking at China because China obviously continues to slow down somewhat and we do think that there are some risk because of the fact that structurally there the growth looks a bit wobbly because of the build-up of debt in the economy.

The other macro risk essentially is if the oil prices were to rally and we are not expecting a big rally in oil prices that is one risk which is always present though it has not played out, we don’t expect this in our base case especially, if the US dollar is strong. Third risk is which is again a global risk if the trade tensions were to sort of balloon up because of what Trump administration does again that is not yet sort of materialised. But, if it does become a rhetoric and sort of back and forth issue between China and US then that becomes a global risk to markets. So, risk to Indian story are sort of more global compared to sort of being local.

Local risks as I can see I think is more from the perspective of a monsoon and that sort of translates into higher inflation and all these good macros we are seeing start to get strained a bit at the margin and that could be a risk going forward.

Anuj: You referred to Trump, in fact pharma stocks are surging now, I wanted your thoughts on whether pharma and in fact even telecom two spaces which have destroyed a bit of wealth over the last few months and years if they have made durable bottoms and are good buys right now. Of course stock specifics story in pharma but larger call?

A: We have been under weight both these sectors for a while now and on pharma our view essentially is that the pricing environment is comparably less benign for them as compared to what it was in the last few years. Secondly, obviously the whole generic story is a bit more strained. The kind of opportunity which existed in 2008 to 2013-2014 that kind of patent expiries no longer exists it is far more competitive market. So, on a sectoral basis even those sectors become cheaper we are not very convinced in terms of pharma space, so therefore we continue to remain underweight this year.

On telecom there is obviously, there are two opposing forces. One, there is obviously still a lot of competition in telecom space especially because a new entrant and the kind of aggressive pricing that is going on. On the other hand that has ensured that the sector has fallen dramatically. Our view at this point in time is that the whole competitive action has to play itself out. Only after that we will essentially be able to have a reasonable fundamental view as to what kind of profit will the sector is settling at.

At this point in time we don’t want to stand in the way of this whole price war and also remember the stocks are not very cheap, I mean there could be, you can make a cases that at some point in time the sector will settle down the pricing will start to move up but till the time that happens we prefer to be underweight a sector and this has been again underweight for three-four years for us has played itself quite well. So, at this point in time, we do understand that there is a possibility of price hikes sometime down the line, but we have to live through this pain period I guess and that is why we are underweight.