'India has the most robust success story across emerging markets'

HSBC Mutual Fund feels the market may move in a narrow range for a while and the next move will come when there are earnings upgrades for the next financial year. The fund is upbeat on infrastructure and construction equipment sectors, but a bit wary on materials. Tushar Pradhan, its Chief Investment Officer, who manages over Rs 6,500 crore, shares his views in a conversation with Vandana. Edited excerpts:

Markets have been moving in a very tight range. How do you see them panning out from here?
Indian markets take cues from international flows. We have not seen either dramatic outflows or huge inflows since the beginning of this year. As a result, we saw markets drifting off. My sense is that foreign institutional investors (FIIs) were waiting for some sort of a signal in the Budget. The fact that there was no negative in it was a great relief. Hence, we saw significant inflows post Budget, which led to the rally. That was money waiting in the wings.

Going forward, two things may happen. One is that the y-o-y (year on year) numbers for the fourth quarter, compared to the fourth quarter of last year, could see a significant increase in earnings for Indian companies. The fourth quarter of last year was when maximum forex charges were taken by companies. The Q4 y-o-y numbers could be significantly higher as compared to last year, as the base effect will play out.

Second, after the Budget, a number of companies in infrastructure and construction have become confident that the order flow will continue. So, the momentum that builds up after earnings are announced may sustain for the next two quarters. Then, we will move to the next cycle, of whether there is a normal monsoon. At least for the interim, there is a string of fundamentally sound news coming out. Mid-May 2010, you may see a lot of analysts changing their 2010-11 financial year numbers. When the upgrade cycle starts, some of them may be aggressive and take the market to the next level.

When do you see markets breaking out of this range and is there a case for India to get re-rated?
The range may change only if two things happen. One, the earnings growth trajectory suddenly becomes non-linear or exponential. This is not going to happen anytime soon. Second, if there is structural re-rating for emerging markets as a whole or if investors start saying that since India has long-term growth prospects, it needs to trade at a higher multiple.

Traditionally, developed markets used to get a premium even if earnings growth was not there and even if earnings growth was there in emerging markets, they used to get a discount. We are currently at the same multiples now. So, if India is at 16 times, the S&P 500 in the US trades around 16 times. Now, investors will question that if growth is going to remain challenged, why are we paying the premium for developed markets? And, if emerging markets have a long-term growth story, there may be a chance of re-rating of the valuation of emerging markets. That is when India could be a part of the whole re-rating process, because India has the most robust story across emerging markets, based on domestic growth and demographic dividend.

How is the global picture?
The global economy has shown incipient signs of a weak recovery. However, I don’t think we can call it normal for a long time. Eurozone as well as the US are under severe stress, in their banking industry as well as economies. The fallback option in these economies is not there, with financial services getting impacted badly. The problem is more structural, much more long-term. I think a number of countries will re-examine their growth models. With a lot of regulation, the attractiveness of these markets may have reduced.

Further, banks funded by taxpayers’ money will need to be more risk-averse. The government, on the other hand, has not been able to push anything. There is no confidence that things will turn back very quickly. With weakness in their domestic currencies, they will find purchasing power becoming more challenging. The world seems to be in for some more rebalancing. Global impact on Indian markets is likely to be only a blip, and the intrinsic value of the domestic consumption story may drive growth in India.

Commodity prices have been going up globally. Inflation, being one of its offsprings, continues to haunt the growth story. How do you see it?
Inflation is a big worry and in a country like ours, it is a bigger problem. Frankly, I do not understand why commodity prices have been going up, because the demand scenario hasn’t improved much. The US, a $13-trillion economy, is not growing. So, if consumption is not happening in the US and the Eurozone is going through similar problems, what kind of demand are we talking about?

The concerted demand we saw in 2007 for any and every commodity is unlikely to come. I don’t think commodities can keep going up, mainly because I do not see demand hitting the roof in the near future. Inflation is transient. It is also on account of the base effect but my feeling is that it may start receding by the middle of the year. We also hope the next monsoon to be normal. We could hit double-digit WPI (wholesale price inflation) for March 2010. Beyond that, it may not continue to gallop, because there are countervailing forces which will bring it down. On an average, we think WPI may settle at 6-6.5 per cent for the whole year.

What is your sector outlook?
We are quite agnostic to sectors but if I look at portfolio positioning, we are spread across sectors in a diversified sense. Some of our portfolios are underweight on materials, for the reason that commodity prices cannot be sustained for too long and we could be growing a slower pace than we have been in the last few years. We think construction equipment and infrastructure in general could do well. Public sector banks look attractive in terms of valuations. We were bullish on the consumer sector sometime back, but valuations have reached a point where we are not very comfortable anymore. Telecom has pretty significant headwinds in the short term. Return on capital is not seen in the near term, so that does not make it a very attractive asset.

There is a huge line-up of primary market issuances. Is bunching a worry for markets?
We have been conservative on IPOs (initial public offers). So, much supply of paper is not healthy for the market. I believe this could have an impact and one of the reasons why we are seeing subdued sentiment. Considering the divestment target of Rs 40,000 crore, it may weigh heavily on the secondary market. The money is coming in but it is not going into the secondary market.

Source: http://www.business-standard.com/india/news/%5Cindia-hasmost-robust-success-story-across-emerging-markets%5C/388706/