Focus on asset value now, not earnings growth: HSBC

The current economic situation is testimony of the fact that India is far from coming out of the slump, says Tushar Pradhan, chief investment officer, HSBC. In an interview to CNBC-TV18, he says we will need many confidence instilling measures from the government to rectify the present economic conditions.

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Pradhan adds that an investor should not be focused too much on companies' earnings, but its asset values instead.

"One should focus on asset value because clearly the assets are being beaten down and there is a certain attractiveness to buying something cheap. So, even if you don’t have earnings growth, there is reason to be attractive towards assets which are being trading now for sometime now which are below their marketable values," he explains.

He cautions that equity market is likely to be volatile while the rupee may strengthen in the near-term. Pradhan further adds that export centric sectors like IT and pharma are likely to benefit from the rupee’s recent fall for the next two quarters. Below is the edited transcript of Pradhan’s interview to CNBC-TV18. Q: The market appears to have put a bottom at 5,500 but there doesn’t seem to be yet a bottom put to the economy, we continue to get contracting numbers on industrial growth, do you think that even in the medium-term 5,500 will be respected or chances of getting breached are still there?
A: Predicting where the market will go especially as a level is always fraught with danger. So, I am not going to go there. However, it is safer to talk about economy. It is very easy to assume that the economy very much is not out of the slump that it is in. It is going to take a lot of measures, lot of confidence to bring us out of this situation.
At the moment, demand is slowing down. All of the economic indicators point to the fact that there is slowing industrial growth, there is slowing demand across industrial goods atleast and it appears that even consumption is slowing up. So, it is going to take a while before we kind of come out of this trough and the markets generally lead economic signs anyway. I don’t think the market is going to wait for the economic numbers to change but I think we still are here for a while before it starts to improve. Q: The finance minister has been trying his best to curb the falling rupee, the latest measure being that import curb on gold, how are you positioned on the currency now and whether we have already seen the worst or is there some more to go?
A: There are fairly conflicting views about where the currency is likely to go. There are enough arguments to put a case that it will retrace very quickly back and there is obviously the overhang of the economic situation including the current account deficit (CAD), which points us to the fact that maybe a sharp pullback for the rupee is not something which can happen. So, these are very diametrically opposed views at the moment.
We see a set of people who believe that the rupee will pullback very quickly for a couple of reasons. One is that once the import of gold starts to ease off and then we have a current account situation, which is much well within the target that the government has set itself for. A significant pullback is likely then.
The other thing also to keep in mind is that all the short positions on the rupee start to get covered at any point of time. We also know the effect of the short covering on the currencies. So in that sense, there are enough people on this camp to say that it can happen very quickly without any structural change or any increase in interest rates that need to be run at the point.
On the other hand, there are another set of people who believe that these things are not going to go away in a hurry and the currency is headed much lower from here. So, it is a debate at the moment. We do not know what is going to happen but at this point of time, I tend to believe that while it might be unlikely on the face of this news today that the currency may strengthen, there is enough evidence to believe that it will actually do so because I still do believe that this is oversold territory. The Real Effective Exchange Rate (REER) currently is not in its favour. So, it does appear that it is fundamentally cheaper than what it needs to be. Q: Then how does one position in the markets, is this still a defensive play market or even there is the protection wearing away?
A: One thing is very clear that the currency even if it does not remain where it is, it does move either upwards or downwards. Clearly, there has been a step change in terms of the valuation that one takes the US dollar against the rupee for. For example, most of the analyst models in the last year modeled any earnings growth based on something like Rs 54-55 against the dollar at maximum exchange rate, so that makes all the export oriented companies very susceptible for an earnings upgrade and a margin upgrade.
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However, it is not going to be a very simple one like that but clearly, IT or even pharmaceutical, which is a very large export oriented sector clearly things are going to look very good for the next few quarters for them. So, I don’t think portfolio positioning needs to be changed on a tactical basis but there might be some opportunity there. Q: Many of your peers have gone ahead and scaled down their FY14 earnings growth targets and many believe that even if we get a 5-6 percent earnings growth target we should be satisfied with it, where are you positioned in terms of FY14 earnings growth?
A: There is definitely a lot more uncertainty about what is going to happen in the next couple of quarters. We are also expecting things to be softer than is the expectation. The expectations increase happened in the last calendar quarter where there was suddenly a flurry of reform news and there was a renewed expectation that things were going to improve and there was a lot of upgrades in earnings which came through at that time.
However, prior to that, the earnings picture was pretty dismal and I think if we are turning back to having a little bit of a downgrade on the earnings expectations. It is more or less return to the older positions. So, it is not a new thing. It was just that the whiff of excitement which happened towards the end of the last calendar year that has kind of evaporated and we are now back to normal.
I think one should not focus too much on earnings growth for this time. One should focus on asset value because clearly the assets are being beaten down and there is a certain attractiveness to buying something cheap. So, even if you don’t have earnings growth, there is reason to be attractive towards assets which are being trading now for sometime now which are below their marketable values.
I think one should not focus purely on earnings. Yes, India has been a growth market so it is a little bit of a different lens that we need to look at India from now and it may not necessarily just be for earnings growth.
So I don’t think just because earnings growth is not going to come in this year, the India story is all up. I think there is sense of renewal, there is a sense of an economic upturn whatever time it takes to happen but at that point of time, the growth will come as well. However, it appears that the market is discounting a lot of assets, a lot less than what they have valued for.

Q: We are getting certain categories of debt funds at probably basement bargains but is that the way to go, people who invest in debt are already so terribly risk averse now having burnt their fingers is this going to be a problem area?
A: When we talk about dent markets from a valuation perspective, we are susceptible to changes at interest rate. For example, if someone enters into fixed income, one is not assured of a return X of the volatility that happens in fixed income markets. So, I think volatility is clearly going to remain in the market, that is not going to be wished away.
However, if one takes an absolute look and says how far or how further can rates rise to, I think this ceiling is pretty much visible from here. I don’t think we can sustain a very long period of very high interest rates because that will kill any growth that we are talking or we are expecting to happen in India. So, in that case, going over an 18 months or two years view, going into fixed income markets may not be a very difficult conclusion to come to.
In the interim, I am not saying that it is going to be smooth. However, if one is believeing that there is going to be an economic upturn at some point of time then one also needs to keep a look out for changing back into the equity asset because at some point of time, the discount there also is becoming very alarming. So, in that sense I would let the investors decide for themselves. This is very much of a timing issue.
At the moment, there is a lot of opportunity in fixed income and one has to also be careful about credit quality, because at the down end of an economic cycle, there are some accidents. I don’t think we can avoid all of them. So, in that sense one has to be very circumspect about asset quality and not get carried away by yields in the interim and just wait for the volatility to pass.