Morningstar spoke with Bhupinder Sethi, Head of Equities, Tata Asset Management Company, to get his view on issues plaguing markets: the Eurozone crisis and the fall in the rupee, and sectors he is bullish on.
Just when it seemed that optimism was coming back into equities, markets have started declining again. Do you see things stabilizing? Where do you see the markets headed in the coming months? Could you also provide us the possible range in which the market is likely to trade in the near future?
The recent sell-off is principally because of concerns on the breakup of the euro as a single currency and EM currencies and equities coming under renewed pressure. Branching out of any Euro-zone country from the common currency would mean continued high volatility and period of uncertainty in the market.
Steps taken towards survival of Eurozone and tactical steps by the Indian government to stem the fall in Indian rupee should bring stability in the equity markets in the near term.
In the coming months, the Indian equity market would be driven by the decisions the European leaders take on the future of Eurozone and also would be a function of Indian government's policy actions with regard to fiscal consolidation and on the ground execution.
Through such uncertain times, on the overall basis Indian equity market would continue to be volatile, though on a stock-specific basis, the consumer-facing and export-oriented sectors should continue to be on a stronger wicket.
Is there anything to your mind which is pointing towards a strong buy signal for equities at this juncture?
Right now, long-term growth prospects in India and valuations seem to be the principal investment arguments. Valuations are below long-term average and are reasonable at the current juncture.
A strong sell-off in crude oil price and any policy action by the government either on the lines of fiscal consolidation, or speeding up execution on ground, would be the key triggers for a structural rally in the Indian equity market.
How is the global scenario shaping up according to you and what factors according to you could impact Indian equities?
The Eurozone crisis has again come to the fore, because of hostility towards austerity measures amongst people in the troubled Eurozone countries. In any case, austerity alone is not the solution, as what is required is the right mix of austerity and growth.
The recent events in Europe are forcing the European leaders to decide on either of a complete fiscal union or exit of certain countries from the common currency. A complete fiscal union may mean long period of slow growth in the Eurozone but such a move should not have any immediate disruptive impact on the rest of the world.
On the other hand, if some countries exit the Euro, then there can be an immediate disruptive impact on the global financial markets, which could range from a wave of risk-off trade to a sharp contraction in the global economic activity. One needs to see how ECB/EU governments can tackle this possible disruption.
Over a period of time, things should again stabilize, but like everyone in the world, India too would have to brace itself for that initial period of volatility. A sharp dip in the market arising in the scenario of a breakup of the common currency Euro, can be used to buy aggressively in the Indian equity market as the valuations are already below long-term averages.
The rupee has seen a significant depreciation versus the dollar. Do you expect the slide to continue? To your mind what are the key factors that are putting downward pressure on the rupee?
In terms of global factors, there is a flight to safety globally in light of the resurfacing of the Eurozone crisis, and hence the demand for US dollars. India-specific factors causing rupee to depreciate are a high current account deficit, a high fiscal deficit and a policy paralysis which means sub-optimal capital inflows in the country.
The Indian rupee at around 54 to a US dollar has already depreciated by a very significant 20% from its highest level over the last one year. There is a natural self-adjusting mechanism which should kick in, in terms of making our exports more competitive and imports more expensive. We are already seeing signs of gold imports slowing down.
Given the extent of depreciation in the rupee already, Indian government and RBI can be expected to take some tactical steps which should lend support in the short term viz. dollar denominated-bond issuances to NRIs, raising the limit for FIIs to hold government and corporate debt, relaxing the norms for raising ECBs etc.
However, given the extent of our current account deficit, for the rupee to strengthen in the medium to long term, structural solutions are required viz. controlling fiscal deficit, passing on the fuel price hike to consumers as it would force them to economize, more proactive, investment friendly and consistent policy stance which boosts FDI, investments and infrastructure roll out, which should help make our exports more competitive.
The government should also consider issuing inflation-linked bonds and ask SEBI to re-consider its stance on distribution commission in selling of mutual funds, since these would provide investors avenues to invest to ward off inflation and veer them away from gold.
Almost all the funds managed by you seem to have a bias towards software sector. What is your view on this sector going forward? How do valuations look within this space now?
Companies in the software sector have high capital efficiency ratios and good cash generation. Near-term demand seems to be softening as evidenced from the lower guidance by NASSCOM for FY13.
However, the quality of the companies in the software sector is high, and medium to long-term prospects for the companies are still good, especially as a lot of companies are striving to increase share of the non-linear business in their overall revenue.
In an environment of Indian currency being weak, the sector has an added attractiveness. In terms of valuations, the larger-sized companies are reasonably valued, while we believe that in particular the Tier-2 companies are very attractively valued.
Apart from software, which other sectors seem appealing to you presently and which sectors would you stay away from?
Consumer-facing sectors have very visible near-term growth and long-term structural growth drivers. We continue to be positive on this part of the market. We also are positive on pharmaceuticals and private-sector banks.
Apart from that, on a stock-specific basis, given where the valuations are, there are attractive opportunities across the board in the market.
We have been underweight on public sector banks and global cyclicals like oil refining, petrochemicals and metal companies.
However, given the recent sharp fall in some of these sectors, we are having a re-look at some of these companies again from a valuation perspective.
What is your assessment of the corporate earnings? How do you expect the earnings to be in FY12-13? Please elaborate on how you see earnings shaping up for India Inc, and the key risks involved.
The sales growth in fourth quarter of FY12 has come down to high teens from 20%+ that was being recorded earlier, and this seems to be the harbinger of things to come, given the slowing growth in the economy.
In FY13, therefore, we expect the sales growth to be lower than the sales growth witnessed in FY12, though it should still be in mid to high teens. In terms of operating margins, incrementally we see a bottoming of margin pressure, however, higher interest costs would continue to hurt the bottom-line growth.
So, less leveraged companies should be able to grow their bottom-line in line with the sales growth. However, highly leveraged companies would see profit growth lagging sales growth. The key risk to earnings would be the interplay of rupee and the oil price, as it would have a bearing on the cost pressure that the companies would face.
For an investor looking to diversify away from equities, what asset-allocation strategy would you suggest to give the portfolio a little more tempered look?
Given the current high interest rate environment, locking in part of the overall assets in high-yielding long-term debt, as also making use of the flat yield curve by buying some income funds, should hold the investors in good stead.