If you have done your homework, have a reasonable return expectation, and a 2-3 year perspective, the risk-reward ratio at the moment is extremely favorable. Forget about trying to catch the bottom, because markets will always anticipate a recovery in the economy," says Madhusudhan Kela of Reliance Capital
"You will either get good news or you will get good prices," says Madhusudhan Kela, Chief Investment Strategist with Reliance Capital, on why investors should take advantage of the current bearishness in the market to accumulate stocks.
In a free-wheeling chat with moneycontrol.com, Kela advised investors against trying to time the market, and instead focus on companies with good balance sheets to ride the next bull wave.
"I think the market looks good; if the news is so bad, then the prices have to be attractive," says Kela who formerly headed the equity division at Reliance Mutual Fund. But there is a rider: Investors have to take a two-year view at the very least, there is no quick gains to be made in the short run.
The benchmark 30-share Sensex is down 13% over the last year, and is now trading at roughly 13 times one-year forward earning, compared to its historical average of 15-16 times. Yet there have been phases when the forward earning multiple had shrunk to as low as 10 times.
So what makes Kela so bullish when the economy is going through one of its worst crisis in two decades, and companies are grappling with high interest costs and a weak rupee?
"I think most, if not all, companies have learnt their lessons well from the mistakes of 2008 when they let their ambitions get the better of them. Aggression was the buzzword then; now everybody is talking about consolidation," says Kela.
"Companies are getting out of non-core areas, selling assets, cutting costs and focusing on their business models," says Kela referring to stake/asset sales by companies like Pantaloon Retail, Suzlon and many property developers. This, he says, will improve profitability over the next year or two.
Kela is betting on the three events boosting sentiment in the coming months: policy action by the government, falling crude prices and softening interest rates in India.
"History shows that the government responds with strong measures whenever a crisis has reached a point of blow-out. We saw that in 1991, and we could see similar response now," says Kela.
GDP grew at a nine-year low of 5.3% in the March quarter, and economists estimates for FY13 range between 6.0-6.5% even as the government feels the figure could be closer to 7%.
The steep slide in the rupee, high import bill and drying up of capital flows are pressuring the country's dollar reserves and India now has reserves to pay for little over seven months of imports, the lowest level in 12 years.
Kela feels that currency could act as a catalyst for repairing the widening current account deficit, referring to the decline in gold imports. "Had the rupee not depreciated, gold should have been at Rs 24,000 and not at Rs 30000 (per 10 grams). And that is making a difference to demand," says Kela, adding that the weak rupee would also improve the competitiveness of many Indian exporters and attract more dollars into the country.
Kela's optimism on exports is in marked contrast to former Commerce Secretary Rahul Khullar’s grim projection of export growth halving this financial year.
Kela is bullish on financial services as one of his main assumption for a recovery in the economy and the stock market is interest rates falling.
"When interest rates fall, rate sensitive companies will the first one to benefit. I am bullish on financial services followed by capital goods and infrastructure companies," says Kela.
But he does not expect a secular bull run in these sectors like was the case during the boom in 2007-08.
"In 2000, you had over 400 IT companies with nothing much to differentiate one from the other. Today, you can't recall more than 10 companies, and only five of them are the really serious players. Same will be the case in most sectors going forward," says Kela.
The ongoing slowdown has led to a sharp drop in capacity expansion, and when things start looking up, there will not be enough capacity, he says. This combined with balance sheet clean-up and cost cutting, will improve profitability and Return on Equity (RoE) over the next 18-24 months.
"A handful of companies, be it capital goods, infra or any other, will make disproportionate profits compared to the rest, and the winners will be all about strong and clean balance sheets," says Kela.
He is bearish on consumption plays like fast moving consumer goods. "Valuations as high as 40-50 times forward earnings in some cases are unsustainable. Rising inflation will at some point hurt demand, and investors will start questioning valuations. Already, prices of many FMCG stocks have corrected over the last week or 10 days; at least the uptrend appears to have stalled for now.
This is an important technical indicator that money is ready to move out into other sectors promising better returns," says Kela.
This is the money manager's advice to investors who are undecided on whether or not to invest in equities in present market conditions.
"If you have done your homework, have a reasonable return expectation, and a 2-3 year perspective, the risk-reward ratio at the moment is extremely favorable. Forget about trying to catch the bottom, because markets will always anticipate a recovery in the economy."
Kela admits there are downside risks to his assumptions. "There could be a catastrophe in the Eurozone, and/or the government may continue to be indecisive," Kela says.
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