Over the last few months, foreign inflows to India have been quite healthy but, Nemkumar believes it will moderate from hereon. He also added that India is a disproportionate beneficiary of international liquidity. As far as the rupee in concerned, he thinks it will weaken unless crude prices decline.
Besides, Nemkumar feels that market is driven more by hope than actual economic improvement. He is of the opinion that the market is heavily dependent on FII flows to sustain valuations. He maintains a downward bias for the Indian equity markets but, expects quality to outperform across the market cap spectrum.
So far as the upcoming Budget is concerned, he is hopeful of seeing an optically austere Budget on February 28. He also feels that the Reserve Bank of India will opt for back-ended easing in FY14.
Here is the edited transcript of the interview on CNBC-TV18.
Q: Last few days have not been great for the market, how do you expect the next few months to pan out with this kind of volatile, tepid kind of trend and the given fundamentals?
A: Yes, I think the macro cycle is proving to be much more hostile than all of us thought. More than the economic cycle if you look at the profit cycle, it has been very weak.
We did one analysis of BSE-500 companies. If you look at the past history between 2004 and 2008, profits grew twice as fast as the nominal gross domestic product (GDP). In the last five years, it has been the other way around. So, it is definitely not a good environment for equity investors.
Generally when people look at valuations and say, India is cheap relative to its history, we forget about the changes that are underway in return on equity (RoE) and earnings momentum. There have been a number of sectors where the aggregate profits today are lower than what it was in 2008 and 2009. In some sectors, like telecom for example, absolute profits are down about 85 percent from the levels we had.
Effectively what has happened is that the only part of the market we are seeing e earnings delivery coming in. In fact, there are only four sectors, consumer staples, consumer discretionary, IT and financials which have seen earnings growth and in all other sectors, earnings have significantly lagged normal GDP growth or they are in the negative territory.
Overall, I think the problem is that the investment climate has gone from bad to worse. In the quarter ended December, the order flows was lower than even the worst quarter we saw at the time of the great financial crisis. So, overall I think the earnings outlook for the next twelve months remain weak and we think that the earnings downgrade momentum remains intact.
More than that, I think in the last six months, we had the benefit of the liquidity flows and there was a general risk-on environment. I think the liquidity flows are ebbing and we have already seen a jump on spreads slowly moving up and that is not a good sign at all for the market.
Q: That is basically the two pillars on which the market was running till we stepped into this year, one expectation is that liquidity will remain quite benign and second that this quarter would be a sign that earnings were troughing out. If you disagree on both those counts, how bad do you think it is going to get even in the medium-term for our market?
A: Forecasting liquidity is like reading tea-leaves. It is very tough. India has been a disproportionate beneficiary of the changes in the liquidity environment over the past six months. We have had more than USD 20 billion of inflows and we couldn't have asked for more.
However, it is fair to assume that the flows are going to decelerate and we would be lucky if we see a billion dollar of flows a month over the next few months. Even for the rupee to hold on, crude prices need to come off a bit. Otherwise, that could be an added irritant. The big support from global liquidity, to my mind is that the tide is now ebbing.
Q: On earnings, specifically whether you have seen more contraction in valuations for the market or you think that process has already happened and the market has adjusted through earnings season for the disappointments we saw?
A: There are pockets where the pressure is still continuing. As I mentioned before, the earning cycle remains weak and therefore, we would continue to see downgrades. Particularly on the investment side, what we have seen till now is a massive slowdown on the short cycle but we would now see even on the long gestation cycle, companies like Bharat Heavy Electricals Ltd (BHEL) and Larsen and Toubro (L&T) for example, have still held up their margins because of the fact that the orders that they won in 2010-2011 were playing through.
Now, because of the deceleration in order flows there, we would see heightened margin pressures. Overall, I would think that if you look at sectors like metals, all the global cyclicals and add a few more domestic cyclicals, the downgrade momentum is still intact.
More to come.
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