Valuations decent, tap chaos to invest systematically

Valuations decent, tap chaos to invest systematically

Pradeep Gokhale, fund manager, equities and head of research at Tata Mutual Fund, believes that lower risk perception among global investors and expectation of further monetary easing in the US and Europe may keep the markets steady in the near term. However, he tells Nitin Shrivastava that for Indian markets to re-rate significantly, we would need sustainable improvement in return on equity and earnings. Edited excerpts: Markets have now gained more than 10% since June. What’s keeping them resilient? The low market valuation in June has certainly been one of the reasons for the recent rally. Simultaneously, there have been developments on the policy front, both domestically and internationally. The EU summit decision on direct recapitalisation of EU banks and ECB chief Draghi’s strong assertions on preserving the euro and buying government debt, have given confidence to markets. The resultant lower risk perceptions have caused a shift of funds from debt to risk assets and led to a rally in equity and commodities. In India, we are seeing efforts to resolve the power sector problems and other initiatives to improve policy framework. Has anything changed on the macro front drastically for markets to rejoice? The macro situation is not very encouraging. We are seeing a slowdown of growth both in India and major economies of the world such as the US, the EU, China and Japan. In India, the growth slowdown has not yet resulted in lower inflation and our twin deficits remain elevated. The market is not rejoicing a change in macro conditions, but the fact that respective authorities, be it the EU, China or India, seem to be working to address the issues at hand. Market probably sees the recent policy announcements which I mentioned earlier, as more constructive rather than the ‘kick the can down the road’ type steps it has seen for the past 12-18 months. However, while these steps are welcome, one cannot ignore the fact that much more needs to be done to resolve these issues. The CPI numbers released earlier this week saw some moderation. What’s your view on inflation in coming months? The WPI inflation has shown some moderation, but the CPI inflation has not yet reflected a similar decline. However, both these numbers are not fully representing the real inflation picture due to the element of suppressed inflation (due to controlled energy prices). Inflation in the next six months to a year may come down cyclically due to the slowdown in growth. However, the root cause of inflation in India is our high fiscal deficit and the resultant crowding out of investments in private sector. Unless we take effective steps to tackle the fiscal deficits by improving the quality and nature of our government spending, inflation is likely to remain high. What do you make out of market valuations currently in light of consistent downgrade in Sensex earnings estimates? The market valuations are below historical averages on price to earnings and price to book basis. This is definitely a comforting factor. However, our earnings per share (EPS) growth rates and return on equities (RoE) have also declined compared to the historical averages. Thus, unless we see an increase in EPS growth rates and sustainable improvement in RoEs, we may not see material re-rating of the markets. Your fund performance of Tata Pure Equity has consistently outperformed its benchmark. What do you ascribe this to? Tata Pure Equity Fund is focussed on large cap stocks. We continue to focus on high quality set of businesses or companies that have compounding characteristics, good governance, better management quality, innate strengths in their business areas and superior capital efficiency. At the same time, we do make tactical opportunity calls on businesses having a basic standard of quality, but make a good purchase at a certain valuation. In the past one year, the fund’s overweight positions in auto/auto ancillaries, healthcare, and cement and underweight in metals have helped it outperform. On which sectors are you overweight currently? The fund is currently overweight on pharma, cement and auto/auto ancillary sectors. Even within these sectors, we have taken a more stock-specific approach. These sectors offer steady earnings growth, healthy cash generations and reasonable valuations. You seem to be underweight on construction, engineering and services. What would be the triggers for you to change your stance? Me being underweight on these sectors is because we do not see economic growth improving in a hurry despite the efforts by governments and central banks. Concrete steps to address power sector issues and strong push for infrastructure spending would be crucial. What are the key events which may lead markets to move either way from here on? The key triggers remain the policy actions of governments and central banks around the world. There are expectations of monetary easing from the ECB/ Fed as also Chinese central bank which are partly built in the current prices. Also, there are key events taking place in the next few months such as the German Constitution Court’s decision on the European Stability Mechanism (ESM), elections in the Netherlands and the US and several state elections in India etc. These would have a bearing on equity markets. How should retail investors approach the markets from the medium term perspective? There are significant political schedules in the next few months, which may lead to higher volatility near term. However, the retail investor should keep in mind that India’s current economic problems are cyclical and not structural and thus likely to be resolved in the medium term. Today’s market valuations are not demanding and thus one can assume that at least parts of the problems are in the price. Equity investing is a game of patience and we feel risk reward is favourable for equities for investors with a medium term view. The risks are well known, but valuations and the secular growth potential of Indian economy are on the investor’s side. Thus, I feel investors should use this volatility to systematically invest in Indian markets.