Selling in the Indian markets may persist for some time, unless very big reforms are undertaken by the government, says Arindam Chanda, CEO, IIFL Securities. In an interview with FE, he says though valuation of select large-caps and mid-caps has come down due to a cut in earnings, they don't seem mouth-watering at this stage and earnings de-rating will continue for the next two quarters because of a tepid economic growth and expectations of a lukewarm festive season. Edited Excerpts…
Markets seem to be spooked by slowing economic growth and sharp cuts in earnings forecasts. What is your view on earnings recovery?
A large part of the earnings growth estimate this year was driven by earnings of the Bank Nifty, which was expected at 50%. However, now the estimate is down to 30% owing to consumption slowdown and dwindling consumer confidence, coupled with the GDP growth tumbling to 5% for Q1FY20. Also, the credit growth is decelerating across private banks and NBFCs and rate cuts are yet to have an impact. We believe that going forward, earnings de-rating will continue for the next two quarters because of tepid economic growth and expectations of a lukewarm festive season.
Despite a slew of measures, foreign investors have been selling Indian equities, as our markets continue to be expensive relative to others. Do you see this trend persist? If so, why?
Selling in the Indian markets may persist for some time, unless very big reforms are undertaken by the government. Foreigners have turned negative on the Indian markets due to the taxation announcement (however, FPI surcharge has recently been removed), lower GDP growth and a sharp decline in earnings during Q1. In addition, the recent opening of foreign investment in shares in China might increase allocation there. So, the relative weightage of India in the MSCI Emerging Market Index may reduce, leading to continuing outflows. Hopefully, we will see the government act as it has done in the past one month and ensure that there is a strong pull back.
How are retail investors in India behaving, considering a big number of retail investors from small towns are on your platform?
We saw surge in new accounts in the equity segment in Q1FY20-it grew more than 30% compared to Q4 of the previous fiscal. Considering a lag with which investors slowly build portfolios, we see this as a prelude of getting allocated when valuations turn attractive or the bottoming-out phase plays out during the current fiscal. If we look at recent MF data, we can see along with higher allocation in large-cap segment, there has been considerable recovery in small cap funds. Equity flows are robust and retail is showing good resilience in terms coping with this cyclical downfall.
Even though markets have corrected sharply, valuations are still elevated. Is there more pain left in the market in terms of correction?
Though valuation of select large-caps and mid-caps has come down due to a cut in earnings, they don't seem mouth-watering at this stage. However, because of better monsoon, loose monetary policy and some prudent fiscal measures, risk reward is favourable for accumulating mid-cap stocks from a three-year perspective.
Foreign brokerages also seem to have cut the overweight stance on India as they have reduced their earnings estimates. What is your view on opportunity in India from a retail investor’s point of view?
FIIs have cut their Indian weight due to reduction in earnings estimates and expectation of a subdued macro environment. We believe retail investors need to realise that just because a stock has fallen, it doesn't mean it has become cheaper, provided the fall is led by earnings downgrade. Having a portfolio approach or using SIP is a better way for retail to participate.
Many asset managers believe that debt will deliver better returns over the next couple of years compared to equity. What's your view?
In case of debt, credit spreads have increased despite the fall in interest rates owing to concerns post the IL&FS crisis. We believe, from an asset allocation perspective, debt should be a critical part of a person's overall portfolio. One can look at putting part of the allocation in select REITs, tax-free bonds, and bonds as we expect investors will get decent post-tax returns on these instruments. Low-rate regime will persist for long than what is factored now, thus there will be considerable opportunity for picking up suitable debt funds.
Even after the finance minister removed the FPI surcharge, the equity markets continue to see outflows. When do you see the trend reversing?
I don’t think surcharge was the only reason for FPI equity outflows. At the current juncture, we are at the most bottom level and the revival is not in sight. So, the hot money that used to come is not coming in. We need further changes in government policies to propel growth similar to China, which has recently removed limits on buying of shares by foreign funds for the trend to reverse.
With the Nifty being expected to be more expensive with high P/E stocks like Nestle entering the index, what is your view of the Nifty P/E?
Yes, the way the index is constructed, multiples will rise with the inclusion of Nestle, but then the RoE will also increase to justify the same. Nifty earnings growth, which was expected to be ~ 27% in FY20, is now reduced to 16%. We expect this may further fall to ~12%. Hence, we expect the Nifty to be range bound. If you look at the average EPS growth in Nifty over FY13-18, it grew by 4%, but the estimated EPS growth over FY20-22 could be around 18%. Thus, if the EPS grows by this rate, the P/E tends to become cheaper. We estimate the FY21 Nifty P/E to be at 16.7x from the estimated 20x in FY20. Over the next few quarters, participants will focus more on FY21 PE to decide the future course of market.