Indian market valuations have started to look stretched given the run that has taken place in prices and only a moderate bounceback in earnings.But CLSA India Strategist Mahesh Nandurkar says that given the easy liquidity situation, the market screen is likely to stay green in the short run."The global liquidity environment will continue to remain conducive," he told CNBC-TV18. "In a liquidity rally, it is difficult to tell when the market will turn."But over a 12-month period, CLSA expects the market to post flattish returns. "One cannot hope for these unreal valuations to sustain forever."Overall, he expects earnings to grow in single digits this quarter and about 12-13 percent in fiscal year 2017.He also discussed his view on various sectors saying he would prefer IT to pharma. "Results from the cement sector have been encouraging so far."CLSA re-iterates its underweight call on telecom and select overweight on real estate, he said. Below is the verbatim transcript of Mahesh Nandurkar’s interview to Anuj Singhal, Latha Venkatesh & Sonia Shenoy.
Anuj: The question we have been asking for last three or four days is liquidity versus valuations. Liquidity is supporting the market, valuation wise the market is at top 3 or 4 percentile. What wins from here?
A: I completely agree with you. The recent market run that we have seen is largely driven by the liquidity factors and the sentimental factors. However, this is something that has not happened only in India, it is a global phenomenon which has been unfolding in the entire emerging markets world. And a lot of people get surprised when they see that despite the big run that we have seen here in India. Indian markets in US dollar term have actually underperformed the Asia ex-Japan or the Morgan Stanley Capital International (MSCI) emerging markets. So, it is basically liquidity driven. Therefore, to answer your question where from here, one has to look at the same factors in terms of the liquidity events and how it is going to unfold going forward.
My own sense is that the global liquidity environment should continue to remain conducive. In fact there are certain factors within India as well such as the expectations of a dovish Reserve Bank of India (RBI) Governor and therefore more rate cuts in India, a possibility of the fiscal deficit targets also being revised upwards by the government. So, my sense is that the valuations are in a stretched category but it can sustain at that level given all these other factors.
Latha: Sometimes this begins to feel like the 2006-2007 period and while those periods were perhaps supported by growth this period is being supported by almost uncontrollable stimulus. Just heard about 27 trillion Yen or above stimulus from Japan may come later today itself and aside from that Kuroda by Friday may announce an additional 20 trillion Yen in terms of stimulus, the Fed will not hike, everyone is almost confident about that. Is there going to be a disjunct now then that the trader will have to respect the screen and go ahead but inventors could get bitten badly in the medium-term, if they bought now?
A: That is really a possibility. The thing with a liquidity driven rally is that it is difficult to really pin point when things become to turn adverse. As you rightly said now it feels like 2006-2007 and six months ago we were feeling like 2009 when the market was down like 10 percent. So, we are clearly getting into a phase where the market cycle times are very short and these can be the risk going forward.
Therefore, my sense is that a lot of focus is also getting towards the fact that the global fiscal stimulus. So, far over the last nine or ten years or so since 2009 we have been focussing on the global monetary stimulus by the various central bankers and now the market expectations have moved towards fiscal stimulus and with the possibility of a fiscal stimulus coming in from the US after the elections and maybe from UK etc. So, that is next phase.
So, so long as the market has something to look forward to this liquidity environment can sustain, but one has to clearly keep in mind that this can't sustain forever.
Sonia: The fundamental pillars of every bull market is the growth in earnings and in that context there is a lot left to be desired at least in this quarter's earnings so far. How did you read into the events up until now?
A: We haven't really seen that many companies reporting so far as yet, but as a broader trajectory I feel that the earnings growth is under the recovery stage here in India. Last two years were almost zero percent earnings growth. This quarter maybe in low single digits, but possibly as we go into the third quarter and the fourth quarter helped by the base effect the overall earnings growth would get into a healthy double digit and for the full year FY17 we should be at about 12-13 percent kind of an earnings growth. So, it is a steady improvement although still weaker as compared to where the consensus expectations are but on an absolute basis, a positive trend.
Anuj: The stock that we are discussing since morning is Dr Reddy's Laboratories. I wanted your thoughts on the pharmaceutical space. Have the analyst community got it wrong in terms of a couple of stocks here. Dr Reddy's and Biocon, even CLSA for example for the longest has a sell call on Biocon but we have seen such a phenomenal run, Dr Reddy's on the other hand is a favourite for lot of analysts but we have seen such a marked disappointment in that one. Where do you stand on this pharma space as of now?
A: I will not be able to comment on individual stocks, but pharma space has clearly taken a beating in terms of the investor sentiments. The big volatility in earnings has clearly eroded the multiples that it should trade at. My sense is that going forward the investor community will probably have to weigh the pros and cons of pharma versus IT which both are probably export oriented and our house view is that we are more inclined to go with IT than pharma at this point in time.
Latha: Overweight on IT despite the kind of results we got?A: The thing is IT sector is still one space where I see the valuations still in the reasonable zone. Yes, the results have been bad and also there is this headwind about the Brexit fears spreading to the rest of the Europe and possibility of some disruption there as well. But I feel that on an overall basis the value versus growth equation still looks quite reasonable for many IT companies. I don't say for everyone but there are certainly definitely some bottom up ideas where the value seem to be emerging.Sonia: What is the reading of the cement numbers that have come out so far because they look exceptional especially for the likes of Ambuja Cements, UltraTech Cement, HeidelbergCement India do you think this is a multiyear up cycle that we are looking at in cement and how are you guys positioned here?A: On cement some of the result that have come up so far have been encouraging no doubt and we feel that this is one of the sectors that we will clearly see when a long term improvement both in terms of the pricing power, volume growth and the earnings before interest, taxes, depreciation and amortisation (EBITDA) per tonne. One headwind here once again as is the case with the rest of the market is clearly going to be the valuations. But I feel that given the fact that ultimately if you look at from the overall government policy perspective and given the fact that the importance of job creations I feel sooner rather than later the government will have to take up some policy measures that would essentially help the housing sector because that is really the biggest job creator and any place on housing sector including cement we should continue to do well for a long period of time.Anuj: Two calls that have worked for you, one is underweight on telecom and the other is overweight on real estate. Would you carry forward these calls at current levels?A Yes, I would sort of go ahead with these two because I feel that the telecom sector is going to undergo a big disruption with a potential new big entrant and that will keep the investor sentiments at a little bit subdued levels at a little bit subdued level for some time to come and on the real estate side I won't really say that the sector as a whole looks interesting but there are certain bottom up ideas which look interesting which also fit into the theme that I mentioned earlier which is the focus of the government on housing will return at some point in time and also there are some other factors like the expected rate cuts and the expectation of a dovish RBI governor etc.Latha: So, what are you factoring in by way of earnings growth and more importantly multiples for this market. What could be market returns in a 12 month period?A: Multiple is something as I said is a clearly in a difficult to map kind of category and as I said one cannot hope for this unreal valuations to sustain forever. So, if you will ask me for from the point of view of the next 12 months or so there could be periods of better returns but over the next 12 month period we have a very cautious view on the market. I feel that over the next 12 month period the market could just be about flattish.Sonia: As far as the next trigger for the market was concerned a lot of people were hopeful of GST coming through but now there seems to be a lot of issues that still need to get ironed out. If the GST bill does not get passed within this session itself then would that be a big dampener for the market or do you think the market has moved on to other things like earnings?A: No, if that doesn't happen it will clearly a dampener. I don't think that the market has moved on. We still get a lot of questions, lot of queries from a lot of investors. So, there is still a lot of interest in that but yes, apart from that some of the other triggers that the market would be looking forward to would be, let us say, who the next governor is, what his policies would be, what kind of rate cuts could be expected, what would be the type of fiscal roadmap the government adopt. So, there are something else as well. But yes, if GST does not happen I would still believe it would still be a negative.Anuj: In case we see withdrawal of funds in the second half or maybe next year what is the base for this market? The last low of course was 6,800 or near about 7,000 on the index. What is the worst case scenario right now at the index level?A: I would say that Indian story still continues to look pretty attractive in the global context and especially in the emerging market context. So, I feel that there is going to be buyer support that is going to come through if the market were to sell off from the current levels. So, at this point in time I wouldn't envisage a more than let us say 7-10 percent kind of downside.Latha: If it is flattish equity return over a 12 month period should we be putting money in fixed income and actually fixed income has returned very well over the past four-five months?A: Yes, I feel so. I feel that over the next 12 months there is a good probability of getting better returns from the fixed income than from equities. I must sort of add a caveat to that is that a big factor that we are still debating at this point in time is the global liquidity factors and it can sustain for a longer period of time but as I said my base case will not be to play that. Although in the near term it could still very well play out.
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