There’s no point correlating stock market show with GDP growth

There’s no point correlating stock market show with GDP growth

Saurabh Mukherjea, head, institutional equities at Ambit Capital, believes that Indian stock markets would not be much affected by slowing economic growth and declining earnings’ estimates. In an interview with Nitin Shrivastava, he says price to earnings multiple in India being too flexible, minor downward revision in earnings’ estimates would not hold markets from moving towards 18500 as abundant liquidity, along with higher global risk appetite, is capable of rerating the PE multiples for India

The markets have not seen any correction despite a logjam on the reforms front. What’s keeping them resilient? There have been three factors that have kept Indian markets buoyant – one, liquidity in global markets has eased considerably over the past 6 months or so, and I have very little doubt that we will see further liquidity injection by central banks on either side of the Atlantic. The European Central Bank has no choice but to buy Spanish bonds although they may make this conditional on Spain behaving itself fiscally. Similarly in the US, even though Fed Chairman Ben Bernanke may couch his words in a diplomatic fashion this weekend, there is very high likelihood that we will see some sort of monetary easing soon. The second factor which has worked in India’s favour is the Chinese economy is not faring well. Most investors expect a slowdown in Chinese growth even though some anticipate a hard landing while others see a soft landing. The slowdown in China means Brazil and Russia too may not do well as they are export-dependent economies with the bulk of their commodity exports being to China. This has led FIIs to go underweight on Brazil, Russia and China while increasing their weight on India as they have a fair degree of confidence that domestic demand in India is relatively robust. The third driver, though a minor one, has been the change of guard in the finance ministry. Mr Chidambaram’s entry is viewed positively by most investors. What has led to change in FII sentiment towards India in recent months? The new FM has brought in a degree of sanity in both words and actions and there seems to be better co-ordination between the PM’s office and finance ministry, which was missing earlier. There is willingness shown by the FM to communicate with markets in a better way and has allayed fears related to GAAR and retrospective taxation. While the final report of the Shome committee will be out by September 30, 2012 and with the draft likely to be published soon, the indications are that GAAR provisions will be diluted quite substantially. This has gone down well with FIIs. Some 3-4 months ago, when I went to the US, nobody seemed to be interested discussing India. There has been a drastic change in FIIs’ stance towards India lately. Two weeks ago, when I met the same US investors, they were palpably more interested in India. What do you make out of domestic and global macros? There are some signs of life coming back into the US economy and you can make out from interactions with the people at the ground level like taxi drivers, retailers etc. who believe that there are more jobs being created. The economic data points, too, suggest some recovery there. On the other hand, the domestic scene in India looks worrying with no economic turnaround seen so far. Our survey of large distributors across the country suggests that big-ticket discretionary spending on items like two wheelers, consumer durables, jewellery, etc. has seen a major crack while consumer staples demand is still there. But there’s no point correlating economic growth with stock market performance as there is no link between economic growth and the stock market. The domestic economy is not doing well and macro conditions remain weak? Do these pose risk to market upside? Whether its in our country or anywhere else in the world, there’s no real correlation between stock markets and economic growth. The economy never leads the market, not here or anywhere else. To give you some sense, take the case of Chinese economy which has grown strongly over the past several years but the Chinese stock markets haven’t gone anywhere. Similarly the case with the US between 1966 to 1982, but the US markets gave you zero returns in spite of the economic growth holding up fairly well at the beginning of this period. In most markets, the ratio of market capitalisation to national income gyrates significantly and there’s no significant correlation between the two. If anything holds true, it’s the fact that stock markets lead the economy and not the other way around. There is normally a lag of around 6 months between markets moving up and the subsequent improvement in economic activity. What do you make out of consistent downward revisions in Sensex earnings’ estimates and its impact on markets? The price to earnings multiples in India in the past have been quite flexible. Hence, a modest 4-5% change in EPS gets easily overshadowed by a P/E rerating if there is a rise in the risk appetite of investors. We have seen P/E in Indian markets going from over 24 times in the late 2007 to as low as 11 times in the months after the Lehman crisis. With so much gyration in P/E multiples, which in turn is dependent on liquidity conditions and global investors’ risk appetite, minor downgrades in EPS of, say 4%, won’t make much of an impact. Although we may see a further 4% points drop in EPS, the same is not likely to influence the markets much. The big story at this point in time is whether the P/E multiple can expand from 15 times to 17 times and if it does so, it will take our markets beyond 19000. Our base case suggests Sensex target of 18500 by Diwali which seems very much on the cards. However, for markets to cross 19000 this year, P/E needs to expand beyond 17 times, which seems unlikely this year. For that to happen, you need an extra notch of investor confidence which may come in by the next year if the US economy shows a more definitive recovery or if we see big-ticket reforms from the government. Which are the sectors you are overweight on currently? We are positive on the consumer durables space that includes companies making pressure cookers, toasters, heaters, etc. There is a whole new generation of consumer that is making their first branded goods purchase and this will likely keep the volumes steady. Also, we like selective light industrial manufacturing companies. Key consumer staples or FMCG companies continue to look good with volume growth remaining robust for them. We also like selective auto and auto ancillary stocks which are export oriented and may benefit from rupee depreciation as they are now price competitive with Chinese exports in African and other emerging markets. What’s your call on the banking sector? We are heavily underweight on banking stocks — both PSU and private banks. While public sector banks struggle with asset quality concerns, private banks are trading at high valuations with markets having already made the differentiation. As a result, I am losing more sleep over the private sector banks than the PSUs. Also, the banking as a sector is dependent on the economic growth of the country and with GDP slowing, the scope for profitable financial intermediation has reduced. Hence, GDP growth has a direct correlation with the weight of banking segment in the overall market index… we expect the weight of BFSI sector in index to come down from 26% currently to a significantly lower figure a year hence. How do you see markets from here on? I expect small-ticket reforms to come through once the monsoon session of Parliament ends as the government doesn’t have too many options if it wants to avoid a potential sovereign downgrade. Though we may not see big-ticket reforms during the term of the current government, crucial measures like diesel price hike or partial deregulation along with reforms on the FDI front are likely to bring cheer to the markets. We should see markets touching 18K and there is always an outside probability that with abundant liquidity around and some positive reforms in India, we may see 5-10% further upside. We have been maintaining that markets may inch up towards 18000 to 19000 and that view remains intact. We remain constructive on Indian markets in the near term.