A panel of top market experts like Navneet Munot of SBI Mutual Fund, Manish Gunwani, CIO of Reliance Mutual Fund, Vishal Mahadevia, MD & Co-Head-India of Warburg Pincus, Sam Polyak, Senior Portfolio Manager at Fidelity Management & Research and Vikas Khemani, President & CEO of Edelweiss Securities discussed market trends and outlook for 2018 with CNBC-TV18’s Latha Venkatesh.
Indian investors have been having not a tryst but a very deep romance with equity markets for the last 24 months.
We thought the systematic investment plan (SIP) culture is ingrained, month after month we saw higher and higher flows into equities. So this sudden jolt to this relationship that has come over the last one week has left everyone a little stunned.
A panel of top market experts like Navneet Munot of SBI Mutual Fund, Manish Gunwani, CIO of Reliance Mutual Fund, Vishal Mahadevia, MD & Co-Head-India of Warburg Pincus, Sam Polyak, Senior Portfolio Manager at Fidelity Management & Research and Vikas Khemani, President & CEO of Edelweiss Securities discussed market trends and outlook for 2018 with CNBC-TV18's Latha Venkatesh at Edelweiss India Conference 2018.
Below is the verbatim transcript of the interview.
Q: How would you describe the 4.5 percent correction in a single day or the 8 percent correction from recent highs? Is this just a letting off of air or is this the start of a deeper correction?
Polyak: It is a great question. I strongly believe that markets cannot go straight up without any volatility forever and so what we have had over last week or so is just kind of getting back to normalised levels. Stocks are still up a lot over the past year, I still see the prospects for equity markets, and emerging markets in particular, as being quite good for fair amount of time. This correction is healthy, there is nothing that I see globally or in the US, that would make me think that fundamentals have changed that much in one week. So I would not really worry about it and if the correction continues, I would see it as pretty good buying opportunity.
Q: I just want to persist a little more. The questions about a little bit of correction is countered by people who say that valuations have never been so rich, that to get to even normal valuations even a 25 percent fall will be par for the course and only then we will come anywhere close to historical valuations, is that right?
Polyak: Depends on how you look at valuations. I believe the margins are higher and higher structurally and so because of that you have to look at multiples data in the high teens which are expensive, but at the same time they are going to be getting a nice benefit, one because of the multinationals in the US have a global book of business and that book of business is much improved because of a recovery in places like India, places like Brazil, and places like Europe.
So, that is improving. You are getting extra benefit from taxes that are coming down, so, you are actually going to have earnings growth, accelerating earnings growth this year which I think is part of the reason why the equity markets have done so well going into this correction. I do not believe those are going away, and so as part of that I think overall the US markets are very healthy, global markets are healthy.
Q: Are you saying that historical valuation, 12 month trailing valuation may be unrealistic, but forward valuations in the US are normal?
Polyak: Correct, because earnings growth, in my opinion it is going to surprise to the upside.
Q: You would be willy-nilly tracking global markets as well. Is that the received wisdom for you from your sources and your own analysis that 8 percent, maybe 10 percent, but the growth story is intact and therefore the financial markets will be able to weather the storm?
Munot: Of course the global economy is seeing a synchronised growth momentum. Profit cycle has been pretty good, in fact MSCI World if I remember the number correctly, is likely to -- the expected earnings growth this year is 14 percent on a high base and my view is that corporate profits as a percentage of GDP are already at an all-time high. If the global economy, let us say even the real GDP, even if you had the inflation and the corporates profit again are likely to grow at 14 percent, almost double the nominal GDP growth of the world, at some point in time that is likely to create some political trouble somewhere.
Of course Trump's tax reforms, the regulatory reforms which I believe will be followed by several other countries, will also make the picture look quite interesting and quite good for the year or two. However, at some point in time I think there should be some pressure on that simply because you cannot have an economy where the corporates are grabbing a larger and larger share of the pie. At some point in time it is going to create a problem, and I think whether the fiscal policies or the political agenda, may start shifting a little bit. So that is one of the concern I have.
Also interesting thing that we have been in a world which has been quite growth starved, which has been quite yield hungry. Now if the yields go up, which are likely to, simply because we are seeing this inflation trade, inflation is going up, so far it has been a great story, you had the growth coming back, but inflation not roaring its ugly head so far, but the initial signs are there, the hourly wages, etc. have started rising and at that point in time if yields also start rising, then the relative attractiveness of most of the other asset classes also get impacted.
Q: What are the chances that inflation rises very quickly; at the moment the markets are not even entirely factoring, I mean the Fed fund futures, or such other derivatives or not even entirely factoring in three rate hikes. There are people who are freely talking of four rate hikes. So, will that be a source of instability?
Polyak: It depends why rates are going up. I think the rates are going up because we have good prospects for growth. One of the biggest positives that I believe we have seen over the last 6-12 months is for the first time since the global financial crisis, we genuinely see the output gap closing globally, not just in the US, but globally. The fact that you have wage hikes in the US at the lower end of the income spectrum is actually quite good. It is good in terms of political stability, it is good in terms of consumption which we have not really had, a broad based consumption for quite a while.
Q: So you do not agree with the inequality thesis so much, you think this is in fact a bottom of the pyramid growth?
Polyak: I think right now it is. Whether it will sustain is another question because you do have the structural issue of automation which is impacting the bottom of the pyramid, but automation takes a while to play out and so in the mean time you really have the higher wages – Walmart's announced a USD 10 minimum wage, you have had other companies go to USD 15 and states are looking to mandate that. So that should really help.
Q: The Ruchir Sharma thesis has been that the 4 percent growth is not possible because the labour force itself is shrunk, if you are going to compare it to the post war baby boom generation. You had people then. Now you do not have that many people so generating 4 percent is not going to be possible. You have any view on that?
Polyak: I think it is a great point. I mean that is one of the biggest positives for India that is because India has demographic benefit that is coming through. The US had that benefit because of emigration and because of that we are not in the same position as countries like Italy or Germany or Japan which have a shrinking population. Our population is not shrinking. We do have some structural headwinds but I think they are being addressed and we are adjusting to it.
Q: Sam Polyak’s thesis is very clear, I asked him repeatedly only to check out whether he sees headwinds to the US growth but no. Navneet is not that sure that global instability will not come our away?
Munot: I think this is one of the best period you are living in last couple of years, the global growth momentum is pretty strong. I am quite positive on capex cycle returning globally, I mean capacities are reaching everywhere. I think shareholders are going to put a lot pressure on corporate to stay away from the buybacks and dividends that they have done over the last few years but to actually invest more in the new capacities and improving the productivity.
So from that perspective it is going to be good, but I keep thinking from a very macro perspective, more from a political perspective that if increasingly, which has been the case for last several years even when the growth has been quite muted, a larger and larger pie has gone to the corporate sector - will it create some political challenge and how it will ultimately unfold in what manner.
This is not a view on like next few quarters going to slowdown, in fact the corporate profits as a percentage of GDP based on this quarter and the quarters expected will hit an all-time high; it is almost reaching 11 percent GDP in the US, substantially higher than long-term average and it is quite in contrast with India where we are hitting the all-time low as a percentage of GDP. So something is different about India.
Q: Coming to the Indian context, the US pullback coincided with the aftermath of the Indian Budget. So what is your sense about the Indian market? You can make a strong case that even the Indian markets were overvalued. So is this a start therefore of a slightly deeper correction here?
Gunwani: Valuation is one part but from a business cycle perspective I am more comfortable with Indian economy rather than the US economy because US has more signs of late cycle than the Indian economy because Indian economy along with most emerging markets bottomed out in February 2016 and if we did not have GST, demonetisation, RERA we probably would have had a much better growth year in 2017, but along with all emerging markets we are going through a revival in growth which is only two years old.
US been in a growth cycle for almost nine years, it is one of the longest expansionary period they have had. So from a business cycle perspective which to my personal experience in more important than valuations and more comfortable investing in Indian stock market than -- I do not invest in US stock market but if allowed I would pick India over US at this point of time.
Q: What about the near term problems for India in the sense, do you expect this Rs 16000 crore, Rs 20000 crore of retail money to continue now? There is one, long term capital gains and two, yields hitting 7.8 percent on the 10-year, making debt attractive. So, will the markets grow but not with the ferocity and the linearity that we saw in 2017?
Gunwani: One is that when you look at yields going up, growth going up, I think you have to also look at the mirror image that all this is happening because the growth is coming back. So, if your EPS growth picks up then these are manageable hindrances to the - we will obviously climb a wall of worry in a bull market. However having said that I think even in a long bull market it is not that every six months is good. If sometimes the markets do run ahead, we have just seen that some froth comes out.
Q: Are yields going up only because of growth, would they not be going up because the government is borrowing more than it should borrow? Would it not be going up because there is a cost push inflation we expect in food and crops?
Gunwani: The point is that if crude were at USD 40 per barrel, you wouldn't have these yields, right? Crude is at USD 65 because of global growth to a large extent.
Q: You don't see yields as disturbing the picture at all because the Indian inflation if it doesn't behave, if even the delta is not lower but higher which I think it is, the RBIs forecast at least for calendar 2018 is 5.0-5.5 percent, so the delta is already higher as far as inflation is concerned.
Gunwani: Every bull market has rising bond yields, it is a characteristic of a bull market.
Q: So, you wouldn't worry that the retail flows or the valuation could get challenged in 2018 more than in 2017?
Gunawani: As I said sometimes the market runs ahead but let us say in a three year block we get a Nifty earnings of 50-60 percent, I think we will have a decent market because even if PE drops 10-15 percent, it is still probably the best major asset class for lot of people.
Q: So, you have not seen already any investor shift in preferences?
Gunwani: Not, right now.
Q: Since you are not in the business of having to daily convince investors about one asset class or the other, do you think the Indian story will look from now to the next 15 months as smooth as it looked in the last three years? My main problem being we have a Budget that was populist, that had some seeds of a cost push inflation which we don't know, we don't know the details of the MSP, which clearly had a fiscal deficit number which can be challenged as an overestimation of revenues and under provision of expenditure. Also we will have a election in 15 months. Given this combination, have we already seen the highs or do you think the growth story is enough to pull us along?
Mahadevia: The last three years have been terrific, so to claim that the next 15 months would be as smooth as the last three years - it is possible but not something that I would bet on. We are obviously big believers in India at Warburg Pincus, we have invested a ton of money last year, over a billion dollars of invested and committed capital into the country and I think it is early innings.
So, if you actually look around the globe which we do being a global fund, I wouldn't trade our set of cards in India for anyone else's. You are still early in the growth process, you have got sectors, you have got technology, you have got a stable government, I know elections are coming up but really when you compare it to some of the other places around the world, we in India always complain about government, regulation and my friends in other countries tell me, you should be lucky, you should be happy.
Q: Our best macro in the last three years or four years has been political stability. In the next 15 months we will all be wondering, will this continue, will that put a floor or put a ceiling to valuations, not so much earnings?
Mahadevia: I think it is possible. Markets don't like uncertainty and they don't like risk. Could there be a pause? Potentially. But I don't think it has anything to do with any fundamental factors because when we look across our portfolio and we look at our companies, growth is good, I won't say it is great but it is good. I don't see any big worrying signs, all the factors that you pointed out, there are small issues that will continue to crop up but there is no big sign that I can point to that says I am really worried, there is a crash coming.
Having said that, it could always come, we have been around many cycles before but we remain pretty optimistic if you take 15 months or 5 years, timing is always difficult but the growth potential remains fantastic.
Q: What kind of a downside is possible in this market, it just soothes nerves and that's why this question?
Gunwani: I really can't take a shot at short term downside.
Mahadevia: I don't think there is much downside because I actually come from the view that people and investors like Sam pointed out, one of the reasons flows haven't come in is because people are worried about where valuations are. So, unless you have some Blackswan event which no one can predict but in a normal world if there is some crack in the market, there are buyers waiting because the story is good, fundamentals are good.
Q: What would your guest be, do you think we can get away with a minor fall only this year?
Khemani: Difficult to predict unless there is a major macro which is Blackswan event as Vishal Mahadevia was saying, we will be happy around 580-600 kind of Nifty EPS and I would assume that at Rs 16-18 kind of P/E range, which is 10,000 of Nifty, there will be enough and more buyer given the kind of growth ahead of us. So probably somewhere there will be a lot of money in case market falls. I doubt, that market would fall below that but markets are always difficult to predict.
Q: I am only asking for what can be a reasonable fall. We have to exclude Blackswan event, max of another 5 and you would think four figure Nifty is unlikely - four figure Nifty is not something that would be your base case?
Khemani: Possible, it can happen but I would assume that that is where lots of money will come and start getting invested and on a given day, on a particular week, market can go to any level. It is difficult to predict.
Munot: I think investors have forgotten volatility and this is a beast that we have to live with this year. This is my strong view.
I think markets have been extraordinarily calm globally and any kind of risk at any point in time on the horizon whether it is the missile firing in North Korea or early morning daily tweets by Trump or whatever that did not make any difference, any time in terms of the stability in the market. We are going to see higher volatility. That is the strong view I have.
But from the investors perspective if this is soothing the nerves, I think for the next couple of years, the micro looks interesting. I think India had an extraordinarily macro, that at the margin probably you may not see incremental improvement there, probably you will see little bit of deterioration but for my micro story, I think purely bottom up looks very interesting next couple of years but those returns are not going to be like coming in that linear fashion where every year you will have what we saw in midcap and smallcap last year. There are several pockets where there is bit of froth and that needs to get corrected. We have seen lot of that correction happening in last couple of weeks and I think that trend will see for some more time be it for volatility and then but remain prepared to put money on dips.
Q: 8 percent is a pullback, 10 percent is a correction, and 20 percent is a bear market, what is the most likely scenario if you want to put it that way? What is in store for India in 2018?
Khemani: For any unforeseen circumstances, I think India will do well.Munot: You put money in my funds and don't worry for five years.