BJP’s victory in UP elections removes one political uncertainty from the market, said Arvind Sanger, Managing Partner of Geosphere Capital Management. The improved political backdrop could cause market valuations to go above historic averages.
In an interview to CNBC-TV18, Sanger said he does not believe there is need to rush in to buy today as it is certainly not the only chance to invest in individual stocks. Instead of buying into the index, he advised focussing on individual stocks where earnings would justify valuations.
He noted that non-performing assets problems in the banking sector, and hiccups after implementation of the goods and services tax (GST) could lead to some dislocations in the market but will also provide opportunities to invest.
He pointed out that short term populist measures like farm loan waivers might increase the problems for the banking sector, and make public sector banks much less attractive in terms of value buys.
Below is the verbatim transcript of Arvind Sanger's interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal.
Latha: An all time high now is par for the course, the SGX Nifty is signalling that but what is the significance of this big BJP victory mean to you?
A: I think it removes one of the concerns that the market has: that is if you had unfavourable election result then it could cause the market to selloff. You had enough scares along the way, demonetisation was economically hurtful for the economy in the short-term in terms of creating a lot of uncertainty and some negative outlook for some companies, but that is behind us and the earnings recovery in FY18 looks like it should be happening anyway and now with the political backdrop becoming more favourable, it gives investors the opportunity and fund flows the opportunity to pick this market up to levels which would probably suggest that valuations could go well above historical average and that is where the market is now headed.
Anuj: So that is a big call that investors need to take now. In the near term it is all about momentum and fund flows but is the risk reward still in your favour, if you were to buy now at 9,000?
A: I think the risk reward is in favour depending on time horizon because the reality is that I do not believe that the market is now looking at 2019 election and everything between now and then is hunky-dory. There will be steps along the way. One of the things is that it remains a question to drive the valuations much higher is what is going on in the banking sector, another is - the goods and services tax (GST) is coming, so GST is going to create some short-term turmoil. There will be some short-term probably dislocations in the market. So there will be opportunities along the way as those dislocations happen but if you take two-three year view with GST coming in and the beneficial effects of the flowing through the economy - the economy in a recovery mode and the comparisons are getting much easier as we go through the year compared to what happens with the GST and then the elections looking positive, I think those are all positive steps. One of the concerns that we have is just election result say that populism which may or may not be economically dubious pays off and is that some of the things that the government takes away - and if that were to happen and you got some populist and economically dubious measures then that could be negative for the market but that is not our central case.
Our assumption is that this gives Prime Minister Modi and the government an opportunity to take some of the tough steps that they were been hampered by because of option and this should reduce the willingness of opposition to be opposing just for the sake of opposition. So those are some of the positive catalysts to drive it, earnings would drive it and valuations are clearly going to get stretched because this is going to provide people to able to dream the dream.
Sonia: To take that argument forward, the Uttar Pradesh government before the elections promised that there would be an increase in farm loan waiver in Uttar Pradesh if they won the elections. Now that they have won, if that comes through, what kind of negative impact do you think it could have on sectors like public sector undertaking (PSU) banks etc and how would you approach banking as a whole?
A: Banking remains a problem area particularly the PSU banks and so farm loan waivers would be a negative. The inability of the government and the banks to be able to get a handle on and to be able to put behind them the worst of the non-performing asset (NPA) situation remains one of the biggest disappointments in the economy right now but the NBFCs and the private sector banks have benefited, so as an investor if I step away from the specifics of who wins and who loses, there are enough beneficiaries from overall -- yes, there might be some farm loan waivers and that will be negative for financial discipline and that is negative but unfortunately it seems like governments one after the other have used this as a populist measure that has yielded some short-term results and so that is one of the negatives we will have to live with and that makes PSU banks even less kind of value buy. There will be some chasing of performance but we are not convinced.
Latha: Two questions and unrelated - one, is there not an argument that because the government is so confident of its continuation, it need not dabble in populism and second, how much of multiples will you be comfortable with buying. We are already, as of Friday, closed somewhere at 17 times plus even assuming 15 percent earnings growth for FY18. Now with this 250 point move that the SGX Nifty is indicating, we will probably be closer to 18-19 times. How much comfort will you have buying at 18-19 times?
A: At the end of the day we are not buying the index. I guess that is the answer but the reality is that we are buying individual stocks and we are going to look for companies where we feel comfortable that the earnings growth justifies the multiples we are paying but even in individual stocks that we are look at, we are probably going to have to pay slightly higher multiples than we would have otherwise and the real trade-off is that what kind of multiples are we prepared to pay versus the confidence in the medium to long-term visibility of growth and that is one of the challenges that we as investors will face in this run-up. We would probably be cautious and try to be selective and maybe look for opportunities along the way because earnings are not going to go straight up and so eventually the market will come back after this current euphoria phase we are aware of - where are the companies meeting or beating or disappointing on expectations and there are some possibility that some of the companies that saw surprisingly resilient earnings in the fiscal Q3 could see some of that reverse in Q4 because in some cases you may have had a bit of inventory continue to build and the effects of demonetisation show off with a bit of lag, so we think there will be opportunities and there are companies that could have not that greater quarter in the March quarter earnings and if that happens that will provide opportunities. Therefore, we do not think that we do not buy today, the market is going to leave us behind and we are not going to get opportunities. So we continue to remain disciplined in that.
However, is today a good day to buy. I think it\'s an okay day to buy if you were holding off because you were scared about the election results but I do not think this is going to be the last chance to buy individual stocks that are going to go straight up from here. I do not think so.
Anuj: Last year we saw huge midcap outperformance, about 12 percent outperformance. This year we have already seen that. If not at index level, do you think this market could be creating bubbles at individual stock levels because ultimately too much money is chasing too few stocks? In the midcaps and smallcaps also we have seen a select pocket do better and more and more money is flowing into these outperformers?
A: I think one of the greatest challenges in the market is going to be that this liquidity that is coming in because real estate is there, so real estate is not where money is going and equity is where money is going to come and this election is going to further exacerbate that rush into equities. So one of the things we have to get comfortable with as investors is not to get too caught up in valuations and to look at the growth stories and the momentum stories and even some of the value stories and not try to use too tough parameter of historical valuation because I do believe this is an opportunity for the market given the liquidity that is likely to continue to flow over the next several quarters and years to probably challenge us in terms of valuations getting towards the high end of historical number. So that is going to be one of the things that we have to keep in mind, not to get too cute on valuations.
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