See 12-15% earnings growth ahead; like Tata Motors: Alchemy

Below is the verbatim transcript of Hiren Ved’s interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Latha: These are all crucial days. The market is actually looking for direction. Until now, one would have looked for, ‘how high can it get?’ but now we are actually asking, “How low can it get?” What is your sense? Does it get to 7200? Are things looking at bleak? 22000 was a possible negative scenario that Ambit Capital put out. How bleak can things go for us?

A: The near-term is obviously challenging at this point in time. But, we need to realise that a lot of what has happened in the markets or the trigger for what happened in markets in the last week or two weeks has been really what is happening outside of India than more to do with what is happening within India. I think the challenge that most investors are grappling is that while our macro is getting better, it is not translating into a good micro. So, in the absence of earnings growth support, the markets are likely to be vulnerable to shocks like the ones that we have seen.

So, at this point in time, instead of the macro aiding the micro, it is more like an insurance policy which means that you cannot avoid a downside, but probably you will outperform on the downside, or probably you will bounce back faster when the market stabilises. So, right now it is more like an insurance policy than a guarantee for better returns in the near-term.

Sonia: We were speaking with someone just a while back and they indicated that the downside for this market could be 10-20 percent, but in the longer term, 3-5 years, the upside is much higher. So, if you take that into consideration and you decide to invest into say, increase your allocation to mutual funds, what kind of returns do you think one can expect in the next one year? Because, I know you personally manage this Alchemy high-growth fund. Say, someone was to put money in it, what kind of average returns can we expect?

A: If you look at the fair way to guide people on returns is to say that, can you deliver a couple of 100 basis points above nominal gross domestic product (GDP) growth, because that is what earnings growth has been over the last several years. So, there was a time when we used to grow at eight percent and then you had inflation of another 7-8 percent, so your nominal GDP growth used to be 17-18 percent. Now, the problem is that your real GDP growth is down to probably 6.5-7 percent and your inflation is also trending down. So, you will probably get a nominal GDP growth of 12 percent.

So, I think it would be fair to say that long-term earnings can probably grow at 12-15 percent. And if you have an active manager who is probably doing a good job, he could probably add a little more alpha over and above the nominal earnings growth. But, as we all know, earnings growth are not linear, you do not get that 15-18 percent every year. So, last year we got a very strong returns, this year could be flat.

And also, investors know that if you go back and at least look at historical trends, we get so nervous about the fact that the markets corrected about 8-10 percent from the top. But, if you look at every correction, even in a bull-market, like when you saw 2004, 2006, we had a correction, even in those years, the average correction was 20 percent from the top. So, people have to keep that in perspective that you could have a correction which could be deeper than what you have seen. I am not saying that it will or it will not happen, I am saying that in the past, a 20 percent correction has been par for the course.

Having said that, I think that as I mentioned, I think we have to take heart from the fact that our macros are improving. I think what Governor Raghuram Rajan is trying to do is to reduce the volatility of the policy rate. And which means that you do not have these asset markets that react very violently if you have interest rates in an economy moving up and down very frequently. Rather he is trying to have a more sustained rate of inflation and policy rate, so that your overall macro variables do not become very more volatile and as markets appreciate that over time, those will start to reflect in our valuations going forward.

Sonia: So, you are saying that this is a good time, as good a time as any to increase your allocation to equities?

A: Absolutely. And it has been such a great welcome experience. I mean we have been managing money for 14 years now and this time when the markets fell, people did not panic. In fact we had more calls saying that we would want to increase our allocations to equities rather than panic. So, that is a pretty welcome trend that we are seeing from the domestic investors, hopefully all the learnings of the previous corrections and bull and bear markets has made them a little more wiser that you have got to be a little more strategic and long-term about your asset allocation. You cannot be fretting over every correction in the market.

Latha: Would you say that therefore this market has not bottomed because people have not panicked?

A: One way to look, it is like half glass empty, half glass full. You could say that because people have not panicked, so will there be a panic in the future? I think that till we get earnings support, we are going to be vulnerable to corrections. Having said that, I think that the fact that we have seen a mild rupee depreciation should help earnings going forward. Also, we should understand that so far the sectors which were leading to an earnings downgrade which is the more commodity oriented sectors, they will also get some protection because there has been some custom duty hikes. You have had the rupee depreciate, so I think that the off-sets of a rupee depreciation would be actually better for earnings than worse for earnings going forward from here. So, on the whole, we are okay.

Latha: Now to come to how you play this market. Precisely because you are confident that the macros are evolving well and they have to tell on the micros. Would you be focused on the economy oriented stocks?

A: Yes, I mean that is where the value is right now. I mean in the sense that if people are focused on near-term earnings, then probably the traditional sectors that have done well will continue to do well, like IT and pharmaceuticals, because they get a little bit of lift-off from the currency depreciation. But the economy is slowly turning and I think the interest rates sensitive sector is where I see the strongest possibilities of an earnings growth..

Latha: Private or public?

A: I think in public also, if you look at the stance of the government, they are very clear that they want to support the larger public sector banks. So, in terms of whether it is capital infusion, and they are far more better off handling this situation coming out of a recovery than the tail of the public sector banks. And also, amongst the private, the wholesale borrowers will have a better time, because I think rates will fall faster for them. And they will be able to transmit the lower rates faster than probably what banks will be able to do.

Sonia: But, what about some of these names that have seen significant derating this year, but are still great businesses. So, say something like a Tech Mahindra, Tata Motors, these stocks have corrected 20-30 percent this year. Is there something fundamentally wrong with names like these or is it just market correction that has hit them?

A: I think it is not fundamentally wrong but I think that they had a couple of rough quarters. Tata Motors had a challenging time in terms of what is happening in China. But, I guess that those are now fairly well reflected in the valuations. So, the long-term competitive strengths of these companies has not gone anywhere. So, these do represent reasonable valuations for entry for long-term investors to come back into, these are all good quality franchises, high quality companies where I think the near-term risks seem to have got priced in already into the stock prices.

Latha: How much weight would you give, since we are speaking about domestically focused companies, how much weight would you give consumer companies, how much weight would you give capital companies? I mean we saw some good numbers from Cummins, we saw good order books from Larsen and Toubro (L&T). At the same time I think car sales, commercial vehicle (CV) sales are picking up. So, where is your weight?

A: Consumer discretionary is where it makes sense to look at because we ye have to see improvement in demand but they also benefit from the macro in terms of lower commodity prices, potentially lower interest rates going forward from here. So, they are not trading at their peak earnings capacity if one were to use that word. I mean some of that obviously the market has implied in their valuations but if you take a slightly longer-term view, there is much more to go for these domestic oriented sectors than what we have seen in the past. And especially the consumer discretionary is a very interesting area.

Sonia: What is the next big positive trigger for the markets that could take the markets back to the all-time highs?

A: I think the near-term, from a global perspective, people are looking at what the Fed is going to do. We have seen some different voices come through there. So, that is a big factor globally. My sense is that what happened with China, we have to be careful about, but whenever, if you jog back your memory and say that whenever the whole world is looking at one variable like the Chinese stock market and reacting to it, experience has shown that these very heighted short-term correlations do not last for too long. There was a time when we used to wake up in 2011 and look at Greece or what happened to the Dubai exchange because the whole world’s focus was on that one particular variable. And it never lasts. So, this too shall pass. I think we have this heightened worry about everybody gets up in the morning wanting to see what has happened to the Shanghai index, and this does not last too long.

Sonia: But, those issues were a bit different because they were much smaller, Greece and Dubai. I mean this is the second largest economy, so you would worry about that a little more.

A: I am saying that I am not belittling the fact that there is a re-pricing around the world in terms of what the Chinese growth. I think people are finally realising that there is a real challenge that they have on their hands. What I am saying is that this heightened correlation, no matter how big or small anything could be does not last for too long. So, hopefully this shall also pass.