Steadying global events a big positive for fund flows

Vikas Khemani, president and co-head, wholesale capital markets, Edelweiss Financial Services,
believes that the markets have come to a point where they have stopped reacting to incremental
news flow and are betting on government action. He
says that though corporate earnings for the coming quarter may be depressed, the risk of further
earnings downgrade for the fiscal is limited. Excerpts:

What are your expectations on the likely changes in domestic macro situation over the near term?
With the recent changes in the government, expectations are building around some actions to revive growth as well as sentiment. However, one needs to wait and see how things evolve. I firmly believe unless investment activity picks up in the country, it will be very difficult to revive growth and sentiment. For investments to get a boost, we need many policy actions, supportive regulatory regime and a strong political will. One big positive that is emerging is the fall in crude oil prices. If this trend persists, it augurs well for India’s macro parameters, be it inflation, current account deficit and fiscal deficit. Stabilising international situation is also positive for liquidity in India.

Markets have stood resilient all through this month despite a slew of negative news, both domestically and globally. What do you make of this?
Yes, Indian markets have been relatively resilient in June and have been facing a lot of headwinds over the last few months on all factors. The environment is full of gloom and doom on all fronts and has come to a point where markets have stopped reacting to the negative news flow incrementally. Price correction in oil and other commodities of late is a big positive for India, which has helped Indian markets outperform most of the emerging markets.
What do you make of foreign investor sentiment recently?
In fact, we began the year on a fabulous note with almost $8.6 billion in the first quarter of this calendar year which, in fact, was the highest opening quarter inflow on record. Subsequently, India fell out of favour initially because of the GAAR announcement and then because of the rupee volatility. It must be mentioned that perception of drift associated with the government also played its part. Of late, though it must be mentioned that sentiment has improved slightly. Apart from a stable global environment, any pick-up in the policy traction will be an essential ingredient to strengthen sentiment and drive back flows into India.
How do you see corporate earnings for the current quarter?
In our view, the growth expectations are not high for first quarter of this fiscal. Revenue growth has already slumped below 20% during the last quarter of fiscal 2012 and given a slew of incoming macro data, the trend of sub-par revenue growth could persist in the near term. The depreciating rupee could be another headwind as forex losses escalate. This will result in a depressed reported profit on top of an already weakening core outlook.

What do you make out of valuations when consensus corporate earnings are getting revised downwards almost every quarter?
On an absolute basis, Indian markets are undemanding. We are trading at nearly 13 times forward earnings, which is well below the historical average of 14.5 to 15 times. While there will be some further downgrades in fiscal 2013 Sensex earnings (currently at Rs1,280), we do not foresee more than 3-4% earnings cut, given that it has already been downgraded from around Rs1,380 a year ago. Even if we assume 10% earnings cut to top contributors, earnings will not slip below Rs1,220.

As mentioned, the overall demand in the economy is falling which has translated into a slower topline growth. As observed in previous downturns, profit before tax margins are likely to show a gradual uptick even if sales growth continues to slow. This reflects the adjustment process wherein businesses that are not confident of sustainable demand shift focus to profitability. It will be interesting to observe how corporates adjust this time around.

Which are the sectors you find attractive at the moment? On the other hand, any sectors you would avoid at this moment?
For the next couple of quarters, we would be playing on interest rate cycle theme. We are positive on sectors like banking, real estate and auto. We are also overweight on telecom, given its extremely low valuations and the possibility that likely consolidation in coming months could result in tariff hikes in favour of larger players. We continue to like IT as it is undoubtedly the biggest beneficiary of rupee depreciation. Meanwhile, we are cutting down the exposure on consumer sector as valuations are looking demanding.

On the investment banking side, how are you seeing the interest at a time when valuations have come off from exorbitant levels seen till 2-3 years ago?
There has been a lot of interest in private equity investments and on mergers and acquisitions side. Private equity funds are making investments and looking for good quality assets. Also, there has been decent interest in acquiring good assets, brands, businesses. Many international players have been looking to buy assets in India. I feel once the current policy and regulatory environment improves, foreign direct investment activity will go up significantly.

Which are the key triggers that may influence the market movement from here on?
Domestically, the RBI monetary policy would be very closely watched. A rate cut and a softer guidance could be a positive trigger for the markets as after last credit policy, markets have scaled back the rate cut expectations. The monsoon, too, will be closely watched as it is important both for growth as well as inflation outlook. Internationally, developments in Europe, particularly with regard to Spain, are very crucial. Given the silent bank runs in parts of Europe including Spain, authorities will need to act to stabilise the situation.