Speaking on valuation issues, Tushar Pradhan highlighted that they did move higher last year and PE expansion also contributed to returns from the market.
With earnings and Union Budget announcements being the next set of triggers for the market, investors are in some kind of a wait and watch mode now.
But HSBC Global AMC-India believes in the long term, market will be working only on the basis of earnings.
“What happens to the fiscal situation is a concern for the market and it does react in the short term though. But we have had record high fiscal deficits, high interest rates and inflation earlier, but the compounded return of equity during that period was very good,” Tushar Pradhan, CIO, HSBC Global AMC-India told CNBC-TV18 in an interview. So, from a long-term perspective, the equity market may not be impacted by fiscal slippage.
Speaking on valuation issues, Pradhan highlighted they did move higher last year and PE expansion also contributed to returns from the market. But, with earnings expected to rebound going forward, PE multiples are set to normalize. This rebound and PE normalization will be watched by the market, he told the channel.
In terms of a big picture, Pradhan expects more volatility for the market in this year as there is a caution among investors, but does not see crude at current levels as being a big worry.
Below is the verbatim transcript of the interview.
Sonia: The one thing on everyone's mind is the possibility of a big fiscal slippage this time around because of a whole host of issues including the way crude is surging. Do you think this would be a big deterrent for the market if it comes through?
A: I think in the past history just tells us that the stock markets actually does work on earnings and earnings alone. While all of the macro events and what happens to the fiscal situation is something of a concern, and the market does react in the short term, I am not saying no, but if you see that we have had very record fiscal deficits, we have had near collapse situations from a government finances point of view, we have had very high interest rates, we have had very high inflation, and if you look at the compounded return of the equity markets through all of this period, it has been excellent in terms of the mid-teen kind of average return that we have got through them.
So I think from a longer term perspective, fiscal slippage and we are talking about a very marginal slippage, if any, and that is an estimate, one does not really know whether that is actually going to come, I don’t think the equity markets in the long run are going to be anyway affected by this.
Latha: But we are seeing this repeated resistance to 10,500. Will 2018 or at least the first half be a period of consolidation at all or do you think there will be enough fuel in the earnings to take it past?
A: It is an interesting question because it is about which aspect do you focus on. So there is in any market valuation and there is something supporting the valuation which is the earnings. Now, last year we saw valuations actually take re-rating upwards which means given the fact that there was no earnings growth, you saw valuations continue to go up which means the multiple is what actually has given you the return. So if you were to say what return did I get and if you decompose the return of the market, most of the returns have come from the re-rating.
Going forward, the expectation is that the earnings are going to come back. Now there is going to be a mid-point between where the elevated earnings P/E ratio and the earnings growth actually do match and come together. If I were to be a theoretician and to say that market always will trade at a fair value, that is somewhere where it is right now which means that once the earnings actually catches up, you will find a normalisation of the P/E ratio over the last 15 years average. Now, having said that, normally if you were to take that as theory, then you would think that the market will consolidate here, but the market is never driven by theory.
I think what will happen of course is that there is going to be some volatility; I believe that is because of all the news flow which is so now I would think jammed up in the first half of the year. So you have got a Budget coming up, everything to be curious about what the slippage is all about, you have got a lot of elections coming through the entire year as such that will always lend some volatility. There is external geo-politics all across the world which also makes this a very interesting time to be. This does not really seem very benign as oppose to when we look at the last year where we called it a goldilocks situation where you had low interest rates, low inflation, high growth across all markets, and fairly benign external.
I think this year is clearly going to be a lot different than that. So, that would tend to point to the fact that maybe we will see a bout of volatility before it starts to balance out again.
Sonia: I know we are talking about a lot of caution in the system but the one positive data point that we got over the last couple of days is the way the manufacturing sector is picking up. The PMI data was strong, the commercial vehicle sector data was extremely robust. Do you think this is something that is just a one-off or is this something that could turn into a positive trend?
A: Again a very interesting question because if you look at what happened last year, the level of benign market atmosphere was not very visible at the start of the year or throughout the year. If you see the news flow continued to bother people. So it was not as if there was euphoria, there was a lot of caution, and I think the caution persists into the New Year. So this is again a very good sign from my point of view where the hard data, like you mentioned the PMI, the auto sales numbers, the hard data continues to be very supportive.
However the market sentiment does not seem to be euphoric which I think from a longer term perspective, having been in the market long enough, is actually a positive. I would really be worried if everybody is excited, if everybody is euphoric and they think that it is just going to keep going up from here, that would make me worried. However, I think currently the sentiment seems to be pretty cautious in the face of pretty strong hard data. So that is a good thing.
Latha: There could be genuine reasons for caution - crude for one and of course rising interest rates because that also pulls up inflation, actually the Indian exports have not taken advantage of the global uptrend either, so you could pick holes in the Indian macro story, is that a bother?
A: There is always something to worry about, but I think your specific point about having to look at what is happening to crude, I would still think that is not really a very large worry simply because of the fact that when we talk about global growths what are we talking about. These rates are between 2.5-3.5 percent, right? So it is not as if the demand for crude is going to shoot through the roof. We still don’t see private capex at a level which we have seen in 2007 for example where crude prices short off beyond USD 100 a barrel and stuff like that.
In a sense, even if it does harden a little bit, I think we get worried about the percentages because the low that the crude prices gone to was somewhere in the 30’s. So, when we talk about USD 65-66 we are talking about a doubling. So, 100 percent rise, but I think in perspective if you look at the average take the inflation into account then it is not really a very large rise in cost per se for most people. And on top of it there is a huge amount of supplying. If you look at the newer producing countries and the people who are really producing crude at this point of time are very desperate to sell it.
So, the supply is pretty strong and it all really depends marginally about how much more demand you get and my argument is that the demand that we are talking about is not really very significant. It might be sustained, it might be between 2.5-3 percent but I don’t think that is going to drive oil prices all that much as we saw in the commodities boom 10 years ago.
Latha: Finally, what would your positioning or relative weight be? Will it now shift in any fashion, if yes to what?
A: In the past with a lower interest rates and expectations of lower inflation throughout the last year there was a preference for holding financials and rate sensitives. I think there would be a little bit of kind of readjustment in that view because of interest rates which have hardened for a little bit, remain here or inch up then that is a worry in that sector. However, with the new 10-Year coming around and the possibility that the issuance will start to ease off once the fiscal picture becomes a lot clearer I think India could see a possible levelling of these rates. So which means again it is not really in a sense doom’s day.I think there is a reason to get interested in the private capex story. I mean we are talking about it for two years now I think that this might just be the time to kind of focus on the orders which most of these companies have got. The kind of execution that we are seeing, the margins increase in the construction companies for example. I think these are very early signs of a cyclical upturn which eventually lead to private capex. So, I think these are the kind of areas that one should start focusing on from what we were looking at, for the last two or three years.