The market does offer pockets of opportunity such as infrastructure stocks, where money can still be made. However, investors should not make any sudden shifts in their allocation to equities, cautions Mr Sankaran Naren, CIO- Equity, ICICI Prudential Mutual Fund, when Business Line spoke to him about the Sensex at 20,000.
The Sensex has hit 20,000 again and there is a lot of scepticism about the markets holding up at these levels. Normally markets never correct when everyone expects it to! What are your thoughts on this?
In the Indian markets, there are two types of investors — locals and foreigners. Yes, the locals are very sceptical about the markets and valuations because India is the only market where they invest.
We can afford to be sceptical! The foreign investors don't see growth in their home markets, and thus, find Indian stocks with their strong growth potential, attractive. Local investors have not invested in the markets and local institutions have been consistent sellers in this rally.
You must understand that mutual funds sell only if they have an outflow from their retail investors. We don't operate like hedge funds! In our case, the outflows have been small. However, the industry-wide outflows must be significant, given the consistent domestic institutional selling in stocks that we have seen over the past few months.
One clear theme driving this rally has been domestic consumption. The sectors leading it were consumer durables, to automobiles to FMCGs. What's your take on those stocks now?
I think infrastructure should be the driving theme for India. If you compare China and India, the consumption part of GDP is lower in China and is higher in India. China has a current account surplus while we run a deficit. If you see infrastructure bottlenecks, it is in India that we face them to a large extent. That makes a case for playing the consumer theme in China and the infrastructure theme in India, while the reverse is happening! I think as we approach the retail consumption season with festival sales and so on, this would be cyclically the appropriate time for the consumption theme to peak out.
The ICICI Pru Infrastructure Fund has managed a five-year return of 25 per cent, but has underperformed diversified funds in one year. What's the argument for investing in infrastructure stocks now?
That makes it a good time to invest in the fund. There is a big gap between what has happened on infrastructure and non-infrastructure stocks. Look at the stocks that represent the infrastructure theme; the theme has been a substantial underperformer. Whether you take power utilities, capital goods or even construction stocks they have all underperformed very sharply. If you look at the non-infrastructure space, whether FMCGs, autos, pharma or technology that is where all the outperformers have come from.
Here, consumer stocks have also moved to a premium over the market while infrastructure stocks have seen valuations correct significantly. If you had to invest now, this makes infrastructure a good bet. Valuations in the sector today are much more comfortable than valuations of sectors that have led this rally. I think Indian infrastructure stocks benefit from the fact that demand potential is so high. In the US, for instance, power utilities are dividend yield stocks. In Europe, again, such stocks are not growth plays.
Are infrastructure companies delivering the expected earnings growth?
One factor that is acting against short-term earnings for the sector is the fact that we have had a good monsoon this year. A bad monsoon aids construction activity but a good one leads to a seasonal disruption. This is reflecting in the quarterly numbers. But it does not in any way alter the outlook for the infrastructure sector. We think the period from 2011-2014 will see an infrastructure-oriented cycle.
Another factor is that infrastructure spending is now being driven to a large extent by the private sector and not just by government. If you break it down, power generation capacity is now being driven mainly by the private sector. If you take roads, you have a fair number of projects happening through BOT route. In ports, a number of projects are coming in through the public-private partnership route.
The earnings growth for Indian companies over the past two quarters has not been too high, the earnings for the CNX 500 companies, for instance, has grown only in the single digits. Is that not a risk to the current valuation of 23 times for the market?
The problem is that market valuations have really climbed and stocks have become more expensive. Expectations have risen to a very high level and those expectations are barely being met by earnings.
There is also divergence, where some companies are meeting those expectations while others are not. The problem about valuations is that we cannot today say that Indian markets are cheap. They are expensive relative to rest of the world. For this valuation to sustain, the results have to be good and the GDP outlook has to remain good. If you look at where we were six months ago and where we are now, there is risk. On the positive side, food inflation is not accelerating any more and the monsoons have been good.
What explains the surge in FII inflows in the past month, where over $3 billion of funds has come in within a month? Is it the upward revision in GDP outlook which has made the difference?
In my view, there has been a growth scare in the Western world and a growth scare in China as well. Consequently, all the growth-oriented money has come to India. That has, however, resulted in a situation where the Indian market is no longer cheap. Certain segments such as infrastructure may be cheap, but not the market as a whole.
A lot of the recent inflows into Indian markets are said to originate from passive Exchange Traded Funds who are only chasing the index. Do you thus, see the gap between index stocks and other stocks widening?
I am not sure if that is entirely correct. If a good portion of that money was ETF money then why would we see such a big sectoral deviation in performance? And it is not as if only benchmark stocks have performed. Even smaller stocks within the consumer theme have performed. The advantage with large caps is that they are less dependent on how interest rates pan out. Small and mid-caps are vulnerable to interest rate risks, especially in infrastructure stocks.
We believe interest rates will peak over a six-month period and then one can move from large caps to mid-cap stocks. You are also approaching the busy season in credit, with activity in the short-term money market peaking in March each year.
If retail investors have lost out on this rally, what should they do now?
I would suggest three things. Investors should look out for pockets of opportunity such as infrastructure stocks, which remain attractive. They should invest through systematic investment plans. And they should not make any sudden shift in their asset allocation towards equities.
Source: http://www.thehindubusinessline.com/iw/2010/09/26/stories/2010092651171200.htm
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