'Slowdown will reverse in a year'

Lakshmikanth Reddy,
executive vice-president and head - equities, ICICI Prudential Life Insurance, believes that the global economic slowdown may persist for the next 6-12 months before it reverses. In an interview with Sachin P Mampatta and Nitin Shrivastava, Reddy, a key member of the company which manages assets worth Rs36,265.40 crore, shares his optimism on equities, never mind the fact that market valuations for most sectors are at multi-year lows. Edited excerpts:

This was the second most terrible year for Indian equities in three decades. What is your vision for 2012?
We expect the macro headwinds prevalent this year to turn favourable next year, though growth and earnings data could be weak.

For instance, though for most of the year inflation was on the higher side and interest rates too remained high, we expect favourable trends on both counts starting from the first quarter of the next financial year.

Likewise, high commodity prices as well as weakness in the rupee could reverse next year.  The positive outlook we have for equities is based on our assessment that favourable macro indicators will support a revival during the later part of the next financial year or early part of FY14.

Of course, a revival alone does not make a case for investing. But, if the valuations also capture this, then it warrants optimism.

In our view, the current market valuations of most of the sectors, barring one or two, is at multi-year lows. Hence, if fundamentals improve, so will market valuations.

Which is the one sector that you would bet on in the New Year?
We make investments based on long-term fundamentals, and not on a year-wise outlook. Of course, weightages have been built in, depending on valuations and future outlook.

Currently, we remain optimistic on sectors that have been adversely impacted by the economic slowdown, like companies with discretionary demand or those impacted by the high cost of funding.

Similarly, we also remain optimistic about companies where valuations have been depressed due to high fiscal deficit or are in the midst of significant disinvestment by the government like oil PSUs. Economic weakness and high fiscal deficit are cyclical in nature and that would be mean reversion eventually.

We have already seen a drastic drop in IIP numbers and predictions of slower GDP growth. What are your expectations?
Economic growth has already slowed down from 8.3% during the last financial year to 7.3% during the first half of the current fiscal. We expect a further slowdown in the second half, so the full-year’s growth will be at least a percentage point lower than last year’s growth figure.

Also, we expect this trend to continue into the first half of next year. We will see revival only towards the end of next year as economic headwinds turn favourable.

All in all, the belief is that this cyclical slowdown, which began about a year ago, will see a revival in about a year’s time. 

A number of Indian companies are sitting on cash. Do you expect inorganic expansion routes to gain significance in the days ahead?
A lot of acquisitive growth happened the previous cycle when Indian companies went global. There, however, has not been significant inorganic growth over the last couple of years. We do not expect many acquisitions in the current environment. As a matter of preference, we do not favour investing in companies whose organic growth is tapering and where acquisitions are the only way to grow.

Do you believe stock prices of banks adequately discount a possible deterioration in asset quality?
The banking sector in general, and state-owned banks in particular, have seen severe correction in valuation on worries of asset quality. We are of the view that even in a worst-case scenario, the current net worth of the banks will remain protected.

So, as such, banks with an otherwise good track record, which are currently trading at a significant discount to net worth, will do well as the cycle revives.

Our view is that banking is a macro sector. A good time to invest in it is when the economic cycle is about to turn, which could be anytime in the next six months.

Do you see any signs of fatigue in the consumption theme?
Over the last two years, consumer companies have reported profit growth significantly ahead of volume growth, what with a combination of price increases and slower promotional spending.

In recent times, however, consumer durable sales have already witnessed a slowdown and consumer staples might also witness a dip in volume growth as we head into the next year. Consumption growth is happening on account of a higher per capita usage by existing consumers as well as entry of new consumers to the pool.

In a slowdown, one or both of these will be affected. Given this, it is tough to believe that growth will remain immune to these factors and continue to remain sturdy. Slowdown in profit growth will impact their share prices negatively.

How would the coming elections, and welfare initiatives accompanying them, impact rural demand and consumer stocks?
If the government pursues strategies that are supportive of consumption, then some stocks will benefit. However, while we do not have any indication on what the government is likely to do during the elections, the current high fiscal deficit and high inflation offers limited scope to pursue consumption-stimulating policies in general.