‘Stock valuations are fair, but also a bit misleading’

Nitin Rakesh, managing director and chief executive of Motilal Oswal Asset Management, believes that markets are trading at fair valuations. Only disastrous events like, say, disintegration of the euro zone could cause further fall in market valuations.

In an interview with Nitin Shrivastava and Sachin P Mampatta, he explains why he doesn’t foresee any easing of major headwinds that markets are now facing in the next two or three months. Foreign flows, he says, may remain muted in spite of valuations being compellingly inviting. Excerpts:
  
Q: Of late, the volumes have been lacklustre. Markets don’t seem to be going anywhere. What do you make of the market sentiment?
A: Market sentiment is quite low. Foreign investors are put off by the rupee depreciation and by the absence of signs of it appreciating in the near future.

On the other hand, domestic investors are fatigued due to overall negative returns in the last three years, coupled with high yields in FDs (fixed deposits) and debt instruments in the same period.

Q: People are worried about India’s economic growth rate. How would it impact corporate earnings in the coming fiscal?
A: Focus today has shifted from inflation to growth. It is very hard to see how GDP growth can increase beyond 6.5%. That would be 1.5-2% lower than what we have seen in the last four years. On top of this, we are living in a period of inflation topping 8% in the last three years.

Clearly, there is going to be an adverse impact on consumption and savings. Investment cycle has anyway taken a hit. Corporate earnings are at risk because of falling top lines and margin pressures. And now, on top of all this, a falling rupee! As such, the market seems to be pricing this in.

Q: How do you see markets at this point in time, from a fundamental valuations perspective? Have markets factored in all the negatives, including any further earnings downgrade to FY13?
A: A shock-and-awe event like the Lehman blow-up is all that is left to be factored in, as far as the Indian market valuations are concerned.

Overall valuations of the market are a bit misleading. A bunch of defensive sector stocks are trading at extremely high valuations where as the rest of the market trades at utmost distressed valuations.

Nonetheless, even if one were to look at the valuations on a holistic basis, one can only say that they are very fair at 14xFY12 and 11.5-12xFY13 basis. I think analysts are starting to project bear case scenarios in most estimates.

Q: What are the near-term triggers you see for the markets, say, from a three-six months perspective, for them to break out on either side?
A: A possible blow-up event in Europe with ultimate monetisation of their debt is, to a large extent, getting factored in already. Such an event would be a clear message to global markets to break out on the higher side.

On the flip side, if the Euro zone disintegrates, it could be catastrophic for global markets. On issues specific to India, we need to see concrete action from government on its fiscal policy, as well as some progress on key reforms, in the absence of which India would continue to underperform.

Q: What are your views on the major macro headwinds facing the markets at this point in time? Do you foresee some of them easing?
A: Fiscal imbalances, policy paralysis and electoral populism are the major challenges to deal with. I see none of them easing in the next three months. But we are hopeful of some progress in FY13.

Q: Does passive investing make any sense in this kind of market environment, when the macro indicators themselves are weak?
A: Investors can use ETFs (exchange traded funds) and create an asset-allocation approach to balance their portfolio for any market environment. ETFs, or passive investing, take away the manager- and performance-risk, but give a low-cost way to build portfolios.

For instance, a mix of large-cap, mid-cap Indian equities and the NASDAQ 100 ETF has performed much better in 2011 than a pure play active India portfolio.

Q: Which are the sectors you are overweight (or underweight) on currently? And why?
A: We remain defensive in all our portfolios and are having bulk of our allocations in the consumer staples, consumer discretionary, information technology, telecommunications and pharmaceutical sectors. All the other sectors are an underweight at this point in time.

Q: What are your views on sectors like auto and banking that are sensitive to interest rate?
A: I strongly believe that interest rate-sensitive sectors would start to do very well once rate cut is effected by the RBI. I, however, also think we would have ample opportunity to shift our portfolios to an overweight stance on ‘rate sensitives’ as and when the RBI starts to cut rates. It may be a bit premature to position ourselves to that stance right away.

Q: Among debt funds, which category would you recommend to retail investors?
A: We believe that investors need to move selectively into income funds and duration as the interest rate cycle starts to turn. As such, funds like the ten-tear gilt fund we launched last month remain one of the best ways to play the interest rate cycle.

Q: Most of the foreign brokerages are underweight on India and are expecting markets to tank further. What kind of foreign flows and equity markets do you foresee for this year?
A: FIIs (foreign institutional investors) are still hurting from the currency depreciation and the sharp selloff seen in 2011. They are also waiting to see some positive signs on the macro(economic) front. Unless and until there is some sense on these issues, FII flows will stay muted, even though valuations may make India a compelling investment destination over the next two to three quarters.