What to expect from equity markets in 2014

Not surprisingly, these issues were enough to fuel a passionate debate among three leading fund managers—Anoop Bhaskar, head of equity, UTI MF; Chandresh Nigam, MD & CEO, Axis MF; and Mrinal Singh, fund manager, ICICI Prudential MF. Moderated by Ramesh Damani, a member of BSE and an individual investor, along with Sanjoy Bhattacharyya, our consulting editor, the hour-and-a-half long discussion was peppered with views on preferred asset classes, sectors and the Dow-versus-Dalal Street debate. Like true equity fund managers, they gave a thumbs down to gold and real estate but were happy to root for long term gilts or fixed income.

Interestingly, this conversation took place on the afternoon of December 18, 2013, where these fund managers were emphatic that tapering would not really matter. On the same night, we learned that it was being made effective but it was going to be a slow moving programme. Just as our experts had predicted, our markets did not even groan.

This, along with many other insights on what will work or not work for 2014, make for invaluable advice on how to build a successful portfolio in the coming months. Some excerpts:

Ramesh Damani: Charles Dickens used to say ‘it was the best of times and the worst of times’. And what a year 2013 was for India. The Sensex was volatile in September and then rose like a phoenix, creating a new lifetime high. Indian retail soared and then international investors kept on buying. Is it going to be QE, GE, NaMo, AAP, NREGA or CPI? Which acronym will move the markets in 2014? Three of India’s best fund managers will tell us how 2014 will shape up for Indian equities. First question to Anoop: What were the lessons from the recent rupee crisis?

Anoop Bhaskar: One, to focus on the inflation of India versus that of the US. If you have inflation of 8-9 percent for three years in India and 2 percent in the US, at some point you will have currency adjustment. Second, when panic sets in, people start looking at the worst things which were always there. It’s not that fiscal deficit was at 2 percent two years ago and suddenly it has gone up, or that CAD was at 5 percent. The government was trying to show some kind of governance, which was not perceived well by investors; it just led to the whole situation going out of hand for a few weeks.

Chandresh Nigam: From an investor’s perspective, it reminds you that what you seek out in an environment is some degree of macroeconomic stability. Sometimes the market lulls you into thinking everything is fine, but the [poor] numbers have always been there. We talked about CAD two years ago. The fact that the economy was at a 6-7 percent GDP growth and the currency was stable was clouding the instability of poor macro numbers.

Mrinal Singh: Beyond a point, you cannot have growth unless you invest. And, for some reason, investment did lag. Fiscal deficit can only be justified as long as you are investing for future growth. If you are not doing that, in some form, it is going to blow up in your face. It did in the form of currency because we were still growing and consuming, and consumption was getting driven by imports; beyond a point, we couldn’t afford it – we hadn’t invested enough for us to be able to supplement the demand from domestic production, which hit us. The currency had to reflect that. In the meantime, QE helped elongate that phase a bit because there was a cheap dollar floating around; we started talking about that getting withdrawn—and we saw what happened.

RD: Have we addressed the underlying problems?

MS: The crisis didn’t happen—people started talking about it. They just mentioned the word taper—they didn’t taper. Interestingly, at that point, we had a G20 meet in St Petersburg where everybody from the emerging world begged them (the US) to be more accommodative about the impact and (Barack) Obama relented because it was coinciding with the Syrian crisis at that point. We had all kinds of currencies under pressure. We are luckily a floating currency. Imagine a situation with a small economy and a fixed currency—we would have seen someone completely blown out.

RD: It’s called Cyprus! Are you still worried? Is the market faking a new high?

MS: It took the inertia of complacency away. People got shaken up. They realised they needed to be better prepared. After that, a new RBI governor has come, [there has been] accumulation of FX (foreign exchange) reserves, he’s talked about a “bullet proof balance sheet” and that the taper is going to happen—it’s only a matter of time. The numbers were there on the face of it—just the market wasn’t responding to it. We are better prepared.

Do I view tapering negatively? The answer is no. The genesis of tapering is that growth is returning to the developed world, which is a very good sign. What has the cheap money benefited? Predominantly physical assets: Commodities, gold, real estate, followed by artificial yields in the global bond markets, and then by equities. In my assessment, the pecking order is the same and this is the same order in which assets will have to readjust now. I am not saying tapering won’t affect equities but the impact on physical assets will be a lot more, followed by a reality [check] in the global bond markets.

RD: Other than tapering, the national election is going to be a huge event. What outcome is the market rooting for?

CN: The market is clearly rooting for stability: Somebody who they think comes with four to five years of rule. The markets have already cheered for the BJP: A strong leader, who can really swing the confidence of the ruling class and bureaucracy. Somebody who will stand up for bureaucrats and say, “OK, I’m there, you can go ahead and take the right decisions.” [But] we will still get a coalition.

RD: Choosing between the parties is like choosing between Tweedledum and Tweedledee. They both support NREGA, they both support food security— where is the difference?

CN: It is in the policy implementation. Nothing is getting done right now is the general business refrain today. Anything and everything is getting pushed to being finalised by the cabinet because nobody wants to take the decision, and that is really prolonging even the small decisions.

RD: Isn’t that true for anyone new coming to the Centre?

CN: Which is why I said nothing will change if that’s the way people are going to govern. It will take at least 12-18 months.

RD: Someone wrote that no politician has ever sold ‘free markets’ in India.

CN: We have seen events and times over the last 20-22 years where the right things do get done —whether that was in 1991-92, 1997 or the BJP government from 1998 onwards. In India, we have never had the luxury of everything going ahead. In 1991-92, we had our backs so far against the wall that we had to do something right—which is what we have done over the last year as well. From an investor’s perspective, when you get some feeling of transparency and fairness, it will do wonders. The demand for products/services is all there; you just need to get the supply side going and you will get the animal spirit back.

RD: What is your view on the election outcome?

MS: Well, I don’t know what the market consensus is because, in 2004, the UPA came into power and the market fell on that day: The FM (finance minister) had to come on television and reassure the market. The same UPA came into power in 2009 and the market hit an upper circuit! People say if they (the UPA) are out of power, it (the market) will hit an upper circuit.

But I don’t think the market as a consensus is a very wise guy. What is important is that if there is stability, if the government restricts itself to acting as a catalyst, I think enough people know what has to be done and can be done. There is some method in the madness that presents itself as India to us. We have grown with all the madness around.

I am indifferent between UPA, NDA or some other coalition. I think the market is indifferent too, as long as they don’t create hindrances and allow the free market to prevail. If we have a strong leader, as the market is expecting, it could do even better.

RD: How do you position your portfolio against all these winds?

AB: The economic cycle in India will turn on its own, whether we have a political cycle that is favourable or not. My only concern is: Are we placing too much hope too early or is it justified? My view is, till you do not see price competition in a sector, you cannot say that it has bottomed out. I don’t see that companies are competing on price the way you do at the bottom of the market.

RD: Telecom, airlines —sector after sector has been decimated by price competition.

AB: But it has all come back! Telecom rates have moved up. Every sector will have its own cycle. Maybe it has happened in telecom; it will happen in FMCG in the next six months; in CVs, it surely happened in the last 12-15 months; and in cars it has started happening.

RD: Would you say we have started a new bull market here?

AB: If it is a repeat of 2003-08? I don’t think we will have that kind of magnitude. If the cycle for the economy turns around, you will see it in the stock market. I think from March 2014 onwards, we should see that bottoming out, but it will be slow. If something happens globally, it will test the lows we hit in September.

CN: The point of a bull market was made when global growth was at 4-4.5 percent. The global scenario now being at 2.5-3 percent, if India can hit 6 percent, it will bring in a lot of investment. We are all expecting the election results to be positive. However, you don’t go and buy all the cheap stocks in the market with high beta in the portfolio. It still remains a 70-30, 75-35, quality, sustainable business—on the margins 25 percent—which will really do well if there’s good economic growth.

MS: Index is an illusion because it is too skewed into three to four sectors, which constitute 50-60 percent and, by their very nature, are consumption-oriented and defensive. Are we going to see returns being made by the funds with respect to the Sensex?

I think the index might remain dormant for some time and the funds can make better returns than the index because it is skewed towards non-investment/growth-related businesses now. It will take time for it to adjust to reality. CY14 would be an interesting time because, at some point, all these events would have passed by and people would have started taking cognisance of that and then things would return to normalcy. Are we on the cusp of a bull cycle? I don’t know. It would be unfair for me to say we are going to see euphoria of the kind we saw between 2004 and 2008.

RD: That’s far away. Are we talking about a 20 percent move up?

MS: We saw that in CY12. Even in lacklustre markets, like in the last five years, we have had years where the index was up more than 20 percent. I think we will see that for sure, if not in CY14 then in CY15.

RD: Typically, a bull market doubles the index. It might happen over three years. Do you see that the bottom is firmly intact?

MS: The first quartile funds in the industry have double digit CAGR, or 12 percent, over the last five years. A well-managed fund, in a bullish market, could return even better. We have given returns to the extent of 1.7 times in five years for our Discovery fund, even in such a dull phase for equities. Can we double in the next 3 years? Maybe yes. The market will give you the illusion that it is going nowhere but funds will deliver very good returns. So it is a stock pickers’ market.

RD: The Sensex/Nifty make up for 50-60 percent of the market anyway. If they don’t double, how are your individual stocks going to double?

AB: I belong to the Rahul Dravid camp, which is to prod, defend, take singles and defend your wicket. The markets are in a T20 mode: 27 percent of the Nifty is banking which has got a beta of 1.3. Your performance as a fund manager depends on the call you take on banking. If you get it wrong for a quarter, you are two quarters behind and vice-versa. I don’t know whether the banks in India reflect anything other than optimism or risk-on or risk-off. Because at 3.5x price to book, a big private sector bank has got no parameters that make you comfortable with that valuation.

You basically say I have got only bad stocks around me to invest in, that I am willing to pay 3.5x for this one. For example, I run an equity fund which, on most negative days, would be in the first quartile and I will beat most of my peers by 5-10 bps (basis points). On most positive days, I’ll be behind by 30 bps because when the market is 1.3, my fund will be 0.9 or 1.

In the last five years, on a daily basis, the funds we have run at UTI have beaten the market on most negative days but have also got beaten on most of the positive days. Do investors appreciate that? My goal is simple: You keep playing Virender Sehwag. From 2014, I will do that. If management supports me, I’ll retain my job. Being a Rahul Dravid has not given us any inflows. None of the distributors has ever pointed to the fact that I have been able to protect [them] during the downtimes. You can only get sold if you are in the first quartile in an up market.

RD: Would you invest differently as a private citizen?

AB: I have done much worse as a personal investor! Most personal investors are too obsessed with the size of market capitalisation. They think alpha is only available in small cap or unknown companies. People forget that from 2003-08, Bharti Airtel gave you a 2,400 percent return, or 26 times your investment. A large cap gave you a 91 percent annual return if you got your economy thought right—in this case it was telecom.

The main food should be large caps and then you have dessert in the form of small caps—don’t make that your main food because then you will have diabetes!

There are large caps with great returns with good ideas, where you won’t lose 95 percent of the market cap—and they are liquid, not manipulated like small caps! Most small caps lose out when markets fall and they show profit when markets go up.

There are a few things we haven’t spoken about. We have a very high level of inflation. You can’t have 10 year G-secs at 9.22 percent and the stock markets at a 52-week high and, say, both are right. One of them has to give. Let’s assume the fixed income side is wrong for once. The 10 year G-sec has to fall by 200-300 bps.

If we stay at 9 percent, then all the talk of a bull market will go out the window. The two problems we face today are that of high interest rates and of high inflation: I think both will be lower by the end of the year.

If that happens, everything will come back: Banks will become more solvent and companies will miraculously find ways of paying off debt. There will be a huge surge in the NPA cycle working for PSU banks because, in India, a lot of these are professional restructuring agents who decided not to pay back. I wish I had the guts to go overweight on banks and sit on it for one year, because that’s the only sector which I think will beat everyone.

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RD: Where is the best risk reward? Is it with the PSU banks?

AB: I wouldn’t buy the mid-sized ones. I would say automobiles—I think domestic demand can come up fast. I think India’s gift to the world is the two-wheeler company. I don’t know why Warren Buffett hasn’t invested in a Bajaj or a Hero. These companies satisfy every criterion that he stands for. They don’t use capital, [they have a] very high RoCE, they keep throwing off free cash each year, they have high dividends. [But] it is still viewed as an auto stock!

Over the last five years, I have been running a campaign that Asian Paints should be treated as an FMCG company. At some point over the next two-three years, analysts will realise that two-wheelers is not an automobile business—it is not cyclical. You can’t beat a business like that: Rs 400 crore for a plant which generates Rs 2,000 crore of sales and generates Rs 200 crore EBIDTA in the first year, all on negative working capital. They spew out cash.

There will always be demand for two-wheelers – people will not shift to a three- or four-wheeler without buying a two-wheeler. Also, the kind of interest rates we have support only two-wheelers. We won’t be a 15-million car market in five years because we don’t have the roads. And two-wheelers are used for business: People need them to earn a living. It is not a luxury or status item like a car. In fact, everyone fears Honda will be 95 percent of India’s market in five years.

I would avoid high PE stocks: I am worried about pharma. It is risky in India because we have low growth in the domestic [market], low profitability over the next two years and high valuations. It’s like the reverse of an option value. You just don’t know what will happen tomorrow.

CN: We are not really focussed on building a portfolio for just one year: The approach has been, build for three-four years and if you can make money in one year, fine. In the last two years, we have made money in autos, cyclicals, select real estate, media and select engineering. The portfolios will stay diversified. When things improve, we will increase the beta of the portfolio. That could mean, with autos, moving more to commercial/HCV side from passenger vehicles, select engineering and capital goods, increasing weightage to financials (change the mix from being more private sector focused to more public sector stocks) and looking at some select NBFCs.

We don’t like to see the word ‘defensive’—they are legitimate businesses growing at a steady rate. Not all parts of the portfolio have to fire at the same time. The last few months were a complete return buying period: If you have done well, your fund gets sold. Nobody has tried it the other way around: Show me your five-year track record and go out and sell. At the margin, you have to make people move from return-buying behaviour to long-term building focus, which is where the entire problem of the MF industry starts and ends.

Ninety percent of the investors in this country don’t even know which the best performing fund is—as long as they are getting their money above the fixed deposit rate, they are pretty happy. The idea is that if you generate 15-17 percent over a three-five year period, that’s where the audience is. Sector-wise, there is significant opportunity in financials. Right now, we are [more focussed on] private sector and looking to move into PSUs.

We are already in tech: I think it will underperform if the entire market does well but that’s fine. We are overweight on IT with a two-three year perspective. We are also overweight on select autos: Cars will continue. CVs look attractive—volumes are at 10-year lows. We are into engineering and construction but only the very top-end names. In pharma, we are moving from Indian to MNC. Our top three sectors: Financials, IT and autos. Right now, the part of autos we are in is consumption-led.

[In media], we are in the electronic media, but we also have some position in print. We are in the content side—we haven’t yet understood the distribution side as such. What excites us about media is you get reasonable growth in top line and disproportional growth in bottom line. This is a business which is more secular—not as much as FMCG but still quite secular. People will try to make brands; foreigners will keep coming in because we are a 1.2 billion population. The TV industry should quadruple its content revenues over seven years. I would avoid global commodities.

If the election result is positive, one area we will look at is PSU banks, because the risk-reward will be disproportionate.

MS: I cannot deny PSU valuations are at some very interesting levels. I would like to take my chance with a few select stocks: I would have a couple of PSU banks with a higher concentration rather than a basket. I might blend a small mid-cap PSU bank with a large cap, because with lesser weight in a mid-cap PSU bank, I can have superior impact on the alpha generation.

In terms of sectors, I like auto ancillaries. The entire game for them has completely changed. There are so many global majors who are willing to make losses and sell cars in India, and they all have robust systems about vendor evaluation. It takes two to three years for a vendor to get approval but once you get into a global auto major’s scheme of things, you are no longer a geography specific supplier —you are a global supplier. India has cost advantage on the ancillary side. We are going to see disconnect between the local auto cycle for the ancillary guys. China is growing, and the US is always big. Forging companies did that successfully. CVs are bleeding from a top-down perspective because everyone is crying. If they revive in the medium term there is good money to be made—the question is which companies can capture the demand. But the auto ancillary is better placed than CV, auto and two-wheeler.

I keep evaluating infra companies and I have narrowed down on power as an interesting space. I am not a believer that the power deficit has been breached. We are having the demand-supply closing in on each other because we have had no demand. As power reforms kick in and manufacturing picks up, the demand for power would definitely go up. In Asia, there is only India which in the last 20 years has not increased its power capacity five times. We are at only three times. Consumers are too expensive. Large cap pharma doesn’t appeal to me. Technology would merit investment as the demand outlook is still good.

AB: We’ve not made any money on cement for the last three years, so that’s the last sector I’d look at.

MS: For some reason, the large cap cement stocks didn’t display any cyclical downtrend. They were so resilient because their balance sheets were so strong. The mid caps did display the down-cycle.

CN: We sold out some cement because we realised the overcapacity was just too much. We made money but it is a 100 million tonnes of excess capacity—at GDP growth of 5 percent, it doesn’t make sense. If 5 percent goes to 6, and the multiplier on cement comes back, then yes [to investment].

RD: If you could invest in the Dow as a proxy for developed markets or Dalal Street as a proxy for emerging markets, where would you put your money? Dollar denominated?

CN: Certainly India. One year is too difficult to call. Three years, yes.

MS: I’ll pick Dalal Street. Three years certainly; one year, I’ll take my chances.

AB: I don’t know the currency part because we get whipped by currency. I think we will have a correction. If you were to look at local currency returns, they will beat the US returns. If the rupee goes down to 60 because of optimism, it can go up to 70 and kill all your returns.

Sanjoy Bhattacharya: Let’s say we have good outcomes on politics, improving macro balance, what would that do for industries which are export driven, capital light? Other than pharma and IT, are there other industries you would be interested in?

MS: Textiles is one of them.

AB: What is the largest exporting industry by market cap? Forget the IT companies. If there’s an improvement in India, industrialists won’t focus on exports because the margins are lower and there’s much more hard work. The only large cap Indian company that has done work on exports in the last five years is Bajaj. Whatever you say about Rajiv Bajaj, he is the only one who has created a $1.5 billion exports business. In terms of global major auto companies, they are so entrenched in China that it is difficult for them to take out capacity and put it in India.Why is it that after a 45 percent differential with the yuan, no foreign major has made it a point to expand more in India than in China? There has to be something wrong at the ground level: It is the political process, which doesn’t allow them to set up a plant.

SB: That’s not entirely true. One of the largest companies in the world has done exactly what you’ve said: GE.

AB: If you look at Cummins, they have not announced they will expand operations – with the rupee at 60, they can make more money out of Cummins India. The volatility of our currency is so sharp, if you’re a CFO sitting in New York you can’t make out what’s happening. You can’t plan: You can’t take a long term call on India. Exports require more hard work which Indian businesses don’t want to do.

CN: You want to be with a business with some degree of pricing power. In exports, you have some pricing power and you have a little bit of depreciation. What we have seen is, the guys who don’t have pricing power have gotten massacred. We saw that between 2006 and 2008, where people wanted to take their business model abroad: You have to be in the front end and buy some brand. We’re not seeing that now.

MS: Just as we love a B2C company because brands are more resilient and you are able to pass on the cost, the entire Chinese economy has grown without a brand.

SB: If I create: Mega/Large Caps, Mid Caps and Small Caps – and you were greedy/aggressive investors, how would you allocate money in 2014?CN: I am mentally trying to put into place a relative risk number. Large and mega are the same. I would go 40 percent large, 40 percent mid and 20 percent small. Balancing out the risk, selecting small should give you the best place to be. The risk is in large; mid is where you get enough opportunities.

MS: Sixty percent mid caps for liquidity consideration. Large caps would be 25-30 percent. Small cap, one would be very selective, to 10-15 percent. Large cap is good enough protection. Mid caps won’t be resilient in bad times but as an individual investor I have a risk appetite.

AB: I follow Chandresh. 40-40-20 is good. It balances out risk with return.

SB: If not in equities, is there any one other asset class where you would put money for the next 12 months?

AB: Just buy a tax free bond of NTPC – a highly quality tax free bond. You will get 200-300 bps on it.

MS: Long term gilt.

CN: I’ll take long term debt. It depends on tax considerations. If you want to hold on to the investment then tax-free is good, otherwise look at more liquid long term income funds/long bonds.

I think India’s gift to the world is the two-wheeler company. I don’t know why Warren Buffett hasn’t invested in a Bajaj or a Hero. These companies satisfy every criterion that he stands for. - Anoop Bhaskar

Make people move from return-buying behaviour to long-term building focus: This is where the problem of the MF industry lies. Ninety percent of the investors in India don’t even know the best performing fund. – Chandresh Nigam

The main food should be large caps, have dessert in the form of small caps—don’t make that your main food, you’ll have diabetes.  - Anoop Bhaskar

I am indifferent between UPA, NDA or some other coalition. I think the market is indifferent too, as long as they don’t create hindrances and allow the free market to prevail. If we have a strong leader, as the market is expecting, it could do even better. - Mrinal Singh

If the poll result is positive, one area we’ll look at is PSU banks; the risk-reward will be disproportionate. - Chandresh Nigam 

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