The market is likely to consolidate near term, with events in China likely to have a bigger impact than the Fed rate decision, says R Sukumar, MD and CIO, Asian Equities, Franklin Templeton Investments.In an interview to CNBC-TV18, Sukumar says consumption growth next year is likely to be stronger. However, the recovery in investment cycle could be slower, even as we are at the start of a cyclical upturn in the economy, he says.He does not see the delay in implementation of the Goods and Services Tax (GST) hurting investor sentiment where long term investment decisions are concerned.Sukumar expects the pace of domestic inflows into the stock market to gain momentum over the next couple of years.He sees no threat to private sector banks from the payment banks, as he feels the market share of private banks is still very low even after over two decades since they started operations. Below is the verbatim transcript of R Sukumar’s interview with Sonia Shenoy and Latha Venkatesh.
Sonia: It has been an extremely topsy-turvy ride for the Indian equity markets this year and give and take everything we have lost about 10 percent of our value since the start. What do you expect in 2016?
A: I expect that the market would consolidate and show probably some upside over a period of time. I think the biggest challenge has been the earnings growth for the Indian companies has been below expectations, partly because of global factors and partly because of domestic factors. But, over a period of time, we expect better traction and better earnings growth and should probably improve the optimism and make people invest more in Indian equities.
Latha: More importantly, we have invited also because of the big Fed event that has just gone by – the first hike in a decade. As an Indian investor, how should you look at the Fed and the global events, will they be helpful, will they cast shadows, will they pull out funds? For the next 12 months, what is the reading?
A: The Fed has always been saying that they will be data driven, so they have started an increase because they see that the employment has reached high levels and the inflation should move towards the target of about 2 percent. So, they are quite optimistic about pickup in growth and the employment levels being at high levels. However, if that continues to be the situation, then there should be a gradual increase. I do not think that it should be a major negative or positive for the markets. I think the market is going to be more influenced by a lot of other events other than the Fed increase. What happens in emerging markets like China, are going to have a bigger impact. The extent and quality of growth in emerging markets is something that is not well understood and more clarity coming on that will probably have an influence on the market movements.
Sonia: But what about some of the key positive triggers that was lined up for this year, for example goods and services tax (GST). Now, it seems to be off the table. The Congress has blocked the passage of the GST completely. Would that be a big disappointment for an Indian investor?
A: For long-term investors it should not be because GST is something that will deliver better growth and tax compliance over a period of time, not necessarily on a one year timeframe and so some delay should not have a big impact on the fundamental value of stocks. However, people were more sentiment prone. There could be some sort of a negative reaction and I think that has probably already happened._PAGEBREAK_
Latha: When are you expecting the earnings growth or what are you expecting the earnings growth to be in FY17?
A: Looking at one year earnings growth is not relevant in my view. So, we have to look at what is going to be the sustained in earnings growth over a period of time. So, our model suggests that earnings growth over a cycle is going to be probably 1.2-1.3 times the nominal gross domestic product (GDP) growth. So, if we assume 8 percent real GDP growth and about 4 percent inflation, we are looking at 12 percent nominal GDP growth and about 15 percent earnings growth is real potential. So, at some parts of the cycle, the growth is going to be below the cycle average and at some points, it is going to be above the cycle average. Right now, it is below the cycle average and as the margins expand it will be above the cycle average. So, that is what we are looking forward to over the next five years.
Latha: Then I should have asked the question that I initially had in mind. At what point do you see the cycle turning? As you say, we are now running below average, below 15 percent earnings which an 8 percent real growth suggests. Does it get to that in FY17, FY18, how much longer?
A: In my view we are in the beginning stages of cyclical upturn in the economy. So, basically, in 2016, the consumption growth in my view would be much better than 2015 and the investment growth is also showing signs of pick-up though I do not think in 2016, it is going to be a very high number in absolute terms. I would expect an improvement compared to 2015. So, with both, the investment and a consumption growth accelerating, there is a case for some amount of margin expansion in 2016.
Sonia: In your assessment, has domestic investor sentiment or confidence reduced in any way, because the money that we have gotten this year is largely from the domestic front. Will that continue next year?
A: I would think that over the next few years, there will be more money coming from domestic investors, because still equities continue to be one of the more attractive asset classes to really invest from a long-term point of view and create wealth. So, as people realise, with the improving investor education and better distribution of equity products, I think the equity allocation will continue to increase. In any case, it is at abysmal levels now.
Latha: You are speaking about consumption growth as your choice. How would you play it? Staple stocks are already pretty expensive.
A: As an investor, one has to be bottom-up. One has to really value companies based on the long-term value that they are going to create. So, what I was mentioning is about what are the factors that are going to lead to acceleration in economic growth, whether one has to invest in a particular consumer staple stock is a different issue and bottom-up analysis is what is going to help investors decide on which stocks, they have to invest in.
Latha: Would financials be a substantial part or should financials be a substantial part of a fund manager’s portfolio? Is all the bad news out? Would you worry about the technological disruption from payment banks?
A: We believe that well-run banks are not going to go out of fashion anytime soon. The payment banks might have some play, but in terms of the ability to grow the business for good quality private sector bank, there are still going to be a lot of tailwinds in the next ten years. Even today, after being in the country for about 20 years, the new generation private sector banks still have less than a third of the total market share. There is a potential for that to go might be 60-70 percent over the next 15 years. So, there is going to be a market share gain.
On top of it, we also expect that the banking system itself will be growing at double digits because the banking system grows faster compared to nominal GDP because the financial savings is going to increase as a percentage of total savings. So, I still expect a lot of tailwinds. I think the competition is going to increase. So, to that extent, the banks cannot take things for granted, but the management which builds moats for a period of time, have built a moat for the last 10 years and are building moats in the future as well, should probably see the margins protected and the business grow.
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