Saurabh Mukherjea &Gaurav Mehta
Neither the weak economic data nor the constant GDP downgrades by the consensus deterred markets from powering ahead this year. With over 20% return year to date, India has been one of the best performing markets globally. There is a strong message here. Markets are forward looking and this move up inspite of all the macro negatives is suggestive of expectation of improvement in the broader economy going forward. Eventually this in itself should feed back into stock prices. We believe that the recent spate of reform announcements in addition to our expectation of a relatively smoother winter session which should see more legislative activity than we have seen in the last 18 months, will prove enough to power the Indian economy ahead in the months to come.
The downward trajectory of corporate India?s financial numbers too seems to have found a trough in the latest reporting quarter. We also expect the RBI to move and cut policy rates very soon in addition to the liquidity injection already undertaken by the central bank into the system so far this year. This will aid corporate India?s topline by stimulating demand while also helping bottomline with operating leverage kicking in and with interest burden going down. Corporate financials should thus show improvement at the margin going forward. On a structural basis, however, till we see more reforms aimed towards improving the fiscal situation, it is unlikely that cost of capital will meaningfully come down to trigger a full-blown bull market, nineties style.
The recent opening up of the qualified institutional placement (QIP) market and an uptick in corporate hiring in October point to markets and economy moving in the right direction already. Valuations remain reasonable for most segments of the market even with the multiples being based on trough earnings. In all we find ourselves in a conducive environment for equities to move higher and consequently generate healthy returns for investors.
The portfolio positioning implications of such a recovery will be significant. Clearly the last few quarters have been dominated by FMCG, cement and pharmaceuticals in terms of market performance. Defensive stocks and sectors have outperformed their cyclical peers by a significant margin over the last three years. While the cautious market mood has been a significant contributor to this, these also tended to be the only pockets that were still delivering strong financial performance even as the economy down cycle took a toll on the performance of cyclical sectors. Investors have flocked to these growth stocks even with valuations in some of these names reaching stratospheric levels. Our work shows that for the last three years running, growth stocks have outperformed value stocks in India. However, over the long-term (say, the last ten years) value stocks seem to do much better. Indeed, value stocks have outperformed the broader markets as well as the growth group over the last ten years.
With the economy looking to turn for the better in India we think the more sensible value stocks should look to turn the corner both in terms of financial as well as stock market performance over the next year. On related lines, this also implies that a lot of the cyclical sectors such as automobiles, industrials, construction and real estate will start to do well.
While we expect 15-20% returns at the index level, investors, however, should remain aware of the various risks on the horizon as we enter the new year. These risks range from a macro deterioration globally to the uncertainty arising from a potential early general election in India. Also, the investment cycle is unlikely to go back to levels seen in the middle of last decade and hence market upmoves should be more measured. In this context, investors should stay clear of chasing high beta stocks without due attention to underlying fundamental and promoter quality.
We also think that investors will be best served staying very cautious in the banking space. With deteriorating asset quality and with concerns over the inadequacy of banks? disclosures, finding sensible picks here will be a key challenge. Over the past year, while markets have been wary of public sector banks, private banking stocks have done pretty well. We, however, think that similar challenges exist in the private banking space as well and with the lofty valuations that they enjoy currently both on an absolute basis and relative to their public sector counterparts, the risks are significantly higher in private banking space.
Saurabh Mukherjea and Gaurav Mehta are head and strategist, respectively, of institutional equities, Ambit Capital
