Earnings to perk up once private capex cycle kicks in: S Naren

Corporate earnings may not turn around this year, says S Naren, Chief Investment Officer of ICICI Prudential AMC. He believes earnings will pick up gradually over the next two years. Earnings will accelerate once we have a private capex cycle, he says. He expects a private capex cycle by 2018. His oulook for the market is positive for the next two years. The market will be led by financial, capital goods and the utilities sector for the next few years. He does not see the IT sector turning around anytime soon.Although non-banking financial companies are going through a boom, Naren says he is cautious on the NBFCs for the next few years.Below is the verbatim transcript of S Naren’s interview to Latha Venkatesh on CNBC-TV18. Q: How do you think the earnings season has turned out so far? A: I don't think the earnings turning quarter can be this particular quarter. Clearly if you look at the quality of earnings it will improve in metals and many of the other areas but there are industry related earnings in banking and capital goods which all have to improve over the next few quarters and without that happening I won\\'t call it turning quarter. Having said that we are a believer that earnings would pick up gradually over the next two years. The economy will pick up continuously over the next two years and earnings will accelerate once we have a private capital expenditure (capex) cycle which we expect now only in 2018 which is why we believe that the outlook for the next two years is pretty positive. Q: But capex is not turning, what will you rely on as the leaders of say the next 12 months, will it be consumption? A: Clearly it has to be over a period of time it has to be cyclical sectors. Today, it can't be the consumer sectors or the very defensive sectors like IT, it doesn\\'t look like IT is turning around immediately. So, clearly it has to be financials over the next few years. It has to be capital goods over the next few years. It has to be areas like utilities and maybe sectors connected to the economy like construction which all have to improve over the next two years. That is where the battle is. When we look at valuations we can clearly see that the market is not cheap although we think that the underlying economic cycle is improving we don\\'t think the market is cheap and that is clearly a bottleneck in expecting big returns. Q: Let us start with financials then. What in financials, for the longest time we have heard this private sector being better than public sector but would you say that tide is turning and likewise would you say the Non-Banking Financial Company (NBFC) sector is still worth buying? A: Actually if you look at the NBFC sector while it is not part of the large cap indices any sector where you have so many new entrants coming and so much of money being raised it is normally a sector which is in a boom. So, I would say that NBFC sectors going through a boom and over the next year or so we will have to be cautious investing in equities of NBFC stocks because they have all actually gone up substantially. On the other hand banks on the non-performing loans (NPL) cycle will possibly peak out this year and over the next two years you are going to see an improvement in the NPL cycle and that improvement in the NPL cycle is likely to result in earnings improvement which will happen over the next few years rather than one or two quarters. Q: We have been a function of global flows. Would you worry that there can be something like an apocalyptic situation either because of European banks or the Fed's moves? A: If you wouldn\\'t have an apocalyptic situation you are not going to see any returns in equity markets and what we do believe is that the global central banks have spent the last five years trying to prevent apocalyptic situation. Consequently we do believe that when we look at the next few years the optimism is based on the local factors and global factors we believe only can be marginally negative over the next few years because none of the issues that are there in most of the world except US have got resolved. Growth doesn\\'t seem to be coming back and we are not able to see that problems are getting solved in many of the countries. So, clearly the global backdrop is nothing great. They have used the interest rate route significantly and today post the US election if the government in US decides to use the fiscal route to revival and you have a big move in yields that would turn out to be negative for Indian equities. So, clearly the biggest risk as you correctly pointed out is global and we should not see a big spike in interest rates. Any big spike in interest rates can lead to Indian markets going down. Q: The favourite question these days is how much are we dependent on the US elections. Will that be just a lot of drama and it will pass or should we be prepared for something nasty on November 9? A: We are not able to guess Indian elections and then do you think we have any capability to guess US elections. So, what we do is we look at what is happening to the Mexican Peso and we are seeing what is happening to the betting markets and making a judgement clearly if the US election result turns out to be someone who is interested in increasing interest rate significantly in US that would have a massive negative impact not just on Indian equities but on global emerging market equities. We hope that any increase in interest rates in US is orderly because a disorderly increase in interest rates would lead to Indian equity markets coming down. I would say if I had to look at the risk in Indian equity markets coming down. I would say if I had to look at the risks to Indian equity markets it doesn\\'t come out of local reasons. It comes out of big spike in the interest rates in the western world. I am not a believer in it but if it were to happen it can cause a correction in the market. Q: Crude, we have seen it go to USD 57 per barrel, should we worry that this may be the last of the year when we have this low crude advantage in some of the current account, fiscal deficit and other advantages that have accrued to us may fray away in 2017? A: Clearly we are hoping that at USD 60 per barrel crude, shale comes back into production and acts as a cap on global crude oil prices. So, if that were to happen that would be bad if oil prices were to shoot up I don\\'t think it will be good for Indian economy. But one thing we should remember is that as oil crash from USD 50 per barrel actually a lot of petro money invested in India went out. So, if oil were to go up there is a chance of petro money coming back to India. So, the more immediate impact on Indian markets would be on fixed income and not equity. Equity can benefit out of sovereign wealth flows if the oil prices go up.