Valuations fine, momentum will bring back FIIs: Religare MF

Vetri Subramaniam, Chief Investment Officer, Religare Mutual Fund says Indian market is reflecting challenging economic circumstances, and even though the government has done its fair bit, the giant size super tanker is not easy to turn around.

Speaking about fund outflows, Subramaniam told CNBC-TV18 that a lot of portfolio flows are momentum chasers, running away to other markets sensing momentum. He says it the natural tendency of money to move towards momentum. From valuations standpoint, the market is not at risk, he confirmed. He argued that the market remains vulnerable due to dramatic slowdown in corporate growth. Earnings may not see double digit growth even in FY14, but valuations should support market as they are reasonable, he said. Also read: Mkt in for breakdown; bet on ONGC,RIL: Sangeeta Purushottam Below is the verbatim transcript of his interview to CNBC-TV18 Q: Are the signs looking ominous to you the way the prices have been moving in the last few sessions?

A: Not ominous, it just reflects the reality that we are facing fairly challenging economic circumstances at this point of time. The outlook for earnings growth is extremely muted, it is not clear at which point of time the economy will be able to gain some momentum. Things have been happening on the policy front, but it hasn’t yet really translated into action on the ground in terms of an improvement in growth. So, these are the challenges the market faces. Even the one support that one could have looked forward to, which is significant monetary policy support, is going to be a little difficult to come by because even though growth has tapered off, inflation remains fairly resilient. The central bank is therefore likely to cut rates only if the data is supportive in terms of further rate cuts. So, the markets are reflecting a challenging environment and that is about it. Q: The problem for the last few days has been that foreign flows seem to be deserting us. Do you think that is out of disappointment that growth is taking so long to recover or is it just a relative game where other markets are looking more attractive?

A: I suspect it is a combination of everything that you mentioned and also keep in mind that we actually got a fairly large sum of money during the previous 12 months. Infact it is so large that a lot of the regional strategists we have been talking to are still a little bit surprised by the data indicating such robust flows into India. So, trying to predict flows is always very hazardous thing and I am a bit wary of trying to do that. The reasons why the money may have stopped coming in or they are going elsewhere, could be a variety of things. It could be a little bit of disappointment that six months after the new Finance Minister took over and there was optimism that things would start to turn around quite rapidly. There is really no sign.
It is not that the government has not done things to be fair to them. I think they have tried to do a fair bit on the policy front as well as in terms of administrative decision making. However, this is a giant sized super tanker and turning it around is not an easy preposition. So, we are dealing with that battle and industrials are clearing seeing momentum in other markets. Let us not forget that a lot of portfolio flows are always momentum chasing. If one starts to see momentum in some of the markets I am quite sure that it is the natural tendency of money to flow towards those markets. Q: The problem is that that’s the only leg the market has been standing on these last couple of months. So, one wonders what happens if outflows exacerbate and whether the market then becomes more vulnerable on the downside?

A: The market is vulnerable but not for the reason you mention. I think the vulnerability is literally the fact that growth prospects are still very muted. We are likely to have the corporate earning season for the quarter ended March show that Indian companies’ revenues grew at single digit levels of about 6-7 percent. This is a dramatic slowdown that we are seeing. So, the vulnerability is economic, it is not just to do with the flows.
Valuations in that sense are not really a big risk to the market at this point of time. We have been looking only at trailing earnings now for the last two-three years. We have found the forward estimates a little hard to digest. On trailing estimates the market is now about 10-12 percent cheaper than average. So, it is not really a territory where valuations are blinking red. If anything valuations are in a fairly reasonable comfort zone. However, yes it is going to be tricky territory because potentially we could be looking at yet another year, which is FY14 where earnings growth may fail to get beyond double digit growth levels. So, that is certainly a little bit of a risk as far as market valuations are concerned. I would still say that we are not really in expensive territory, we are in reasonable territory and therefore to that extent valuation itself are slightly supportive of this market. Even if I stop looking at averages and look at it from the perspective of individual stocks that we can look at or look to buy in our portfolio then there are several stocks which are now trading significantly cheaper than average. The risk in buying these stocks or these companies is really the fact that we really don't know how close we are to a turnaround. So, we could be six months away from an economic turnaround, we could be one or two years away for all that we know. That really is the risk in buying these companies at this point of time. However as portfolio managers to my mind the biggest risk in markets is not flows, it is not economic data, it is always valuations. Therefore from a valuation standpoint I don't think I can categorize this market at being at risk at this point of time. There are several other risks, but not from a valuation stand point. _PAGEBREAK_ Q: Do valuations really matter though in this kind of an economic and earnings environment as also this much uncertainty? Would it be as easy to construct a scenario where valuations go back to historical lows?

A: It is a probability outcome and therefore what one has to see is what are the kind of odds in terms of the returns one has historically earned in the past at current valuations. If one is having a fairly long term view of three-five years. I think the odds have now turned fairly favourable. We can discuss the data and there is a lot of data available out there, but just to give a nut shell the odds are very favourable, if one has a three-five year outlook. They are not yet favourable if one has a six-twelve months outlook based on past historical trends. So, if one is an investor with a medium term perspective it is not a bad idea to start looking at the market at this point of time. Be clear, the window of opportunity is wide, the window of opportunity may be deeper than what we are currently presuming. However, if one is here for a three-five year outlook there is no reason to argue again starting to make equity allocations at this point of time because the valuations are reasonable.

Q: What is your best case of how long this cycle takes to turnaround? Do you think we are going to get meaningful earnings bounce in the next quarter or two or do you think we are in it for the long haul?

A: I don't think we have ever operated on the basis that we are near a trough because none of the data we have been seeing for a long time now have been telling us that we are anywhere near a trough. So I don't think we have at least been espousing that point of view.
However it is really hard to say as to whether it is six months or 12 months away. I think certainly the government has shown a little bit of momentum in terms of decision making. However, it takes time for these things to translate into action on the ground. So, unfortunately the only answer I can give is that one has to to be patient because we are in this game of predicting whether the turn is three months away or six months away. It is just not clear to us at this point of time.
Unfortunately we have boxed ourselves into a situation, which is a little bit like going into the last over of a T20 match and one suddenly has 24 runs to score in the last over. Can it be done? Yes it can be done, but what is the probability of getting it done, unfortunately not all that good. So one had four years in, which momentum has been continuously decelerating and one is now trying to turn it around very dramatically in the last over, it is not going to be easy.
Bigger point that I would like to make and this is something we have been talking about for the last four five months is that finally what we are starting to see is that the effect of the economy is starting to show up on entrepreneurs. That is in the sense that corporate India is trying to deleverage. We have seen companies sell their so called family jewels to save the business, to save their own personal finances in the last six months. This was completely unthinkable may be two-three years ago that these entrepreneurs would be willing to take such decisions, but it has happened. This is a natural process through which we need to go through in which corporate India will need to deleverage, poor assets will have to get sold, some good assets will have to be sold to somebody else to repair the existing assets. One of the challenges that the investment cycle faces is how many ever good policies government of India comes up with at this point of time, corporate India is not in a position to be an aggressive investor. They have already got projects which are stalled all over the place.
The banks are not in a position to lend aggressively because they are facing the pain for non performing assets and their credit deposit ratios are stuck at 77-78 percent which is like 10 year highs. So, there is a little bit of a natural problem here in terms of trying to turn around this ship. Even if the government were to deliver on policy I don't think corporate India is really in a position to go out and invest aggressively. They are right now in deleveraging mode so we have just got to be patient and wait for this movie to play out. The good news is that because we have entered the deleveraging phase one is closer to the second half of this getting over then you were six months ago. Q: You have a good pulse on the retail mood running a mutual fund. Do you think this kind of disinterest might continue for a long time now where people figure out that equity as an asset class might actually continue to generate sub power returns, risk adjusted for even the next one-two years?

A: If you look at the issue of retail behaviour to be fair to retail I think they have got the last three-four years bang on going into gold and property, as opposed to equity has worked out very well for them. So I don't want to sound like I am beating down on the retail investor, but having said that there is no doubt as will all money allocation flows there is always a degree of momentum, which is required in the underlying asset class for investors to start to increase their allocations to that asset class. Also that has always been the case. In 2003 I recollect going to investors and talking to them about equity markets, which were infact in valuation terms may be about 15-20 percent cheaper than where we are today in valuation terms. At that point of time the answer was that look bond funds have given me 14-15 percent CAGR over the last three years, why should I put my money in equity, which has hardly delivered anything over a three year period.
So, to expect that domestic flows and particularly retail flows will turn around very dramatically in response to valuations is not really the argument that I would make at this point of time. I think there is a case that overtime Indians will have to reallocate some of the money that is gone into property and gold into equities. However, may be not just yet, one will have to see a little bit of underlying momentum come back into the market before that can really start to happen. _PAGEBREAK_ Q: Responses vary on how people choose to define this set up but would you say what you have seen over the last couple of months looks like the market has gotten into a bear patch for itself?

A: Bull or bear we have been in a tough market for the last two three years and we have just been range trading in a 20-30 percent range. I have said this many times in the past a lot of what has happened in the last three-four years reminds me of a very similar environment that we faced way back in about 1994-1998. Then it was punctuated by the whole tech boom. However, those three-four years were very similar as well. We had a range trading market, the ranges were actually much larger than what they are today. The market used to do plus 30-40 percent every six months and loss it promptly all over again.
This time the range is more like plus 15-20 percent. We have gone through various issues, there was the Asian crisis in 1997-98. This time it has been the Eurozone crisis, we had the problem of a weak currency and pressures on the fisc at that point of time. We had companies which were battling to get their balance sheets back into shape again. So, a lot of that is actually similar at this point of time and we just need to be patient and wait for the entire cycle to play out and realize that it is not just about calling global liquidity right, it is not just about government getting its policies right, but everything needs to come together again. One of the challenges that we face in that sense is that we have got some indicators, which are blowing completely cold so when one looks at data like auto mobile sales, two wheeler sales, I have never seen them as bad as I have seen in the last few months in the last 15-20 years of watching data. At the same time we have got some indicators which are blinking red so one look at inflation, the current account deficit, the credit deposit ratio, extremely elevated. So, on average we seem to be okay but half of our indicators are blinking cold and the other half are blinking red hot. I think we just need to give the economy some time to reconcile these, get them back into synch at some level and then we can hope for something more sustainable to build out. So really there is no option but to be patient at this point of time.

Q: You guys run a PSU fund of some kind if I recollect. What have you made of the kind of experience people have had with PSUs, these divestment opportunities and more than that what happens to some of these stocks post that divestment episode taking place?

A: It has been a bit of a disappointment because government policy unfortunately till very recently has actually been perversely hurting PSUs rather than benefitting them. That is not what one would expect a government to do, if it had a lot of stock to sell to investors. So, unfortunately that has not worked out as well. As a basket the PSU companies in terms of valuations are quite reasonable. They tend to be in most cases net cash on their balance sheets. So, potentially they could use a lot of that cash to invest aggressively and grow their business in a tough and challenging environment to their advantage.
However, I think some of that has not played out as well as we would have hoped for or has anticipated. Unfortunately PSU disinvestment has just trended to be a tap in which the government continuously comes out with issues in the same companies with too brief an interval between them trying to raise money. So, it needs perhaps a little bit more thought on how we could go through this whole thing of PSU disinvestments in a more market friendly fashion. Also have policies which are actually supportive of PSUs rather than using them as milk cows to achieve some of your objectives in terms of the fiscal deficit. So, in that sense one of the first good steps that we saw was the attempt to remove the burden of fuel subsidies on these PSUs and transparently take it into the government balance sheet.
For example, if they continue to follow through with that and they have certainly been encouraging to us that they have followed through with it over the last three-four months. Then the case for reevaluation of the prospects of those companies is quite significant. So, they have started to understand the message and do things, but we need to see a little more of that for the PSU disinvestment story to play out.

Q: Do you fear that some of the more expensive pockets of the market which have held the overall average for the Sensex up, they might actually need to adjust on the way down? Prime of them could be the consumer space?

A: Potentially, but the way I look at it I don\\'t want to get caught up in the issue of whether they will necessarily correct at this point of time as part of any market fall if the market falls. Look at it from the perspective of even if these companies were to grow, given where starting valuations are today. Can one realistically expect to make money in some of these companies over a two-three year time frame? If the answer to that is no then in some senses you have to now rebalance your portfolio away from those areas and look for more value in cyclically depressed areas. So, it is a fine balance at this point of time in terms of how one plays out this strategy because you want to keep your performance overall looking good at this point of time. But one has to be sensitive to valuations, look at valuations in the context of if things go right then over two-three years, where am I more likely to make money. Also be willing to absorb a little bit of pain because the market could continue to punish some of those cyclicals areas in the short-term. So, it is a balancing act but we have been taking the call for a while that the defensive and non cyclical areas are trading at very rich valuations. Therefore making money out of these areas over the next two-three years is a challenge. The PE multiples are already so high. So, we need to rebalance away from them. If that causes our portfolios to take on more cyclical areas where valuations are cheap, potentially it could hurt us relative to market in the short term. However, over the medium term that is the right thing to do. Therefore, we are more focused on that medium term approach than what is necessarily the best way in three-six months.