If the market continues to go up in the very near future, then some more outflows can be expected from mutual funds. Steep valuations and the disconnect between the economy and markets is making investors cautious, Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities, tells Moneycontrol's Sunil Shankar Matkar in an interview. Edited excerpts:
Q: Given the 51 percent rally in the benchmark indices, should one still buy stocks or wait for a correction? Is it really a buy-on-rumour and sell-the- news market?
The Nifty50 has gone back to its February 2020 levels but in the absence of earnings and aggressive retail participation (ie on the back of left out feeling), valuations have gone through the roof. Between February 2020 and now, we have seen a swing in GDP forecast for FY21 from +5.5 percent to -5.8 percent. In February, we were projecting FY21 Nifty50 EPS to be around Rs 670 which now stands at around Rs 457 (a downgrade of 32 percent within six months).
In India, the Nifty50 has historically peaked at around 19x on forward PE basis. The Nifty50 trades at 24x FY21 estimates and 18x FY22 estimates. One year forward PE still looks very expensive at 22x, considering lower forward RoEs of around 13-14 percent. Globally, too, most developed markets are trading at new peak valuations. Hence, the risk-reward ratio is not favourable for either global markets or Indian markets. The upside could be in mid-single digit, whereas the downside could be in higher double digits. Be conservative, hold some cash and look to enter in corrections.
Q: What is your reading of the June quarter earnings and what are your expectations for the September quarter? Have you changed earnings estimates for FY21 and FY22?
The June quarterly results have been above expectations, mainly due to very low estimates. The surprise has come on two counts: revenue estimates were very low on which there has been a slight beat and expenses have been way below estimates, mainly due to drastic cost-cutting measures taken by companies. We have seen around 5-6 percent improvement in FY21 Nifty50 estimates between pre and post-result season.
As compared to earlier single-digit earnings de-growth, we are now building in around 1 percent earnings growth for Nifty50 companies in FY21. After the spread of COVID-19, the indicators that we monitor have seen a smart recovery in June (over May) but activity has been sideways in July and August.
Intermittent lockdowns in various cities and the rise of COVID in rural areas could impact demand, which, in turn, could lead to sub-optimum revenue growth for companies. On the other hand, since the lockdown has been lifted, corporate expenses will shoot up. Hence, September could also see aggregate earnings de-growth on a YoY basis.
Q: Equity mutual funds saw their first outflow in July in 52 months. Do you expect the trend to continue and why?
The non-SIP investors, mainly HNIs and advisory kind of clients who are well versed with the markets, are pulling out money. Some investors are also booking profits as all indices have seen a pullback of around 50 percent from the lows and have gone back to their February 2020 levels. However, we have seen only a minor drop in monthly SIP figures at around Rs 7,900 crore. If the market continues to go up in the very near future, then we can expect some more outflows from mutual funds. Steep valuations and the disconnect between the economy and markets is making investors cautious and leading to outflows.
Q: What is the biggest risk — US-China tensions, the US presidential election or something else—that equity markets face globally?
The forthcoming US elections could be one major risk for US markets, which, in turn, can impact global markets. The other major risks could come from bond yields and the dollar index. Any sharp rise in bond yields and fear of them going up further could lead to a fall in equity markets. The dollar index has fallen by 10 percent from its peak, which has helped flows into the emerging markets and also fuelled a rally in other asset classes. As and when the US economy recovers from the pandemic and heads towards normalcy, the dollar index could rise. If the dollar index goes back to or above the 100-mark from the current levels of around 93, then it could lead to outflows from equities (especially emerging markets).
Q: More than 50 percent of the rally, so far, has been led by five stocks — RIL, Infosys, TCS, HDFC Bank and HDFC? Will they continue to be in the drivers' seat and what should investors do with them?
Of the five mentioned names, it is Reliance Industries that has contributed the most. From the lows of March 23, the Nifty has pulled back 49 percent, whereas Reliance has gone up 142 percent. The weight of Reliance has moved up from 8 percent to 14 percent and could have contributed around 1,000 points out of the 3,800-point rally seen in Nifty50.
The outlook for all the top five companies is quite promising. The concern is less on the business but more on valuations. Investors should continue to hold these top five blue-chip companies for the long term. In this entire pullback, banks have grossly underperformed due to the threat of rising NPLs (non-performing loans). Given this, BFSI stocks have room to outperform in the next one year.
Q: Experts feel two fundamental ratios—BEER (bond equity earning yield ratio) and India's total market cap to GDP—are fairly valued. What does it generally indicate and what is your advice to investors?
Today the earnings yield (ie 100 divided by forward PE of 22x) works to 4.5 percent, which is far lower than the 10-year G-Sec yield of 5.9 percent. Equities, being far riskier, need to have earnings yield way above the 10-year G-Sec yield. From a peak of more than 8 percent, the 10-year G-Sec yield has fallen consistently to less than 6 percent.
The inverse of bond yield is the bond PE, which works to around 17x (100 divided by 5.9 percent). In the last 15 years, the average premium of forward PE over bond PE has been around 300 bps. Hence, till the time bond PE remains on the higher side, equity PE will also remain at elevated levels. The real threat to equities comes from the bond market. If global bond yields rise and inflation in India goes up sharply, then bond PE will fall leading to lower valuations for equities also.
Disclosure: Reliance Industries Ltd. is the sole beneficiary of Independent Media Trust which controls Network18 Media & Investments Ltd which publishes Moneycontrol.Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.