Bipolar behaviour of D-Street may last longer: Anand Radhakrishnan, Franklin Templeton
- Till there is no broad-based demand and earnings recovery, megacaps to dominate.
- We are still a few quarters away from having turned around
- We remain bullish on private banks and insurance companies.
There is a lot of noise in the market about a revival in animal spirits post the tax cut, what is your view?
There are two kinds of revival we should be looking at in the next few quarters. One is the revival of the consumer sentiment. Over the last three or four quarters, there has been a marked drop in consumption sentiments and this is indicative in various numbers including consumer durables, automobile sales etc. With the credit situation normalising and the flow of money coming back into the system, we would see some bit of revival in the consumption sentiments.
The other revival is with respect to investment sentiments. We are in the early stages of fixing the problem. The government cutting corporate tax cuts should to some extent spur the sentiments towards it if not the actual numbers. The numbers should follow and in due course of time but directionally, we are taking important steps towards reversing the sentiments in the investment climate.
How would you map the current risk reward ratio? Do you think somewhere markets have run ahead of themselves because markets in the short term are a function of sentiment ? The economy is a function of mood, animal spirits and also a cycle. Have the markets already started celebrating a new dawn in earnings? Is it actually true in terms of level and positioning?
We can look at it in a few ways. One, on the pure sentiment perspective, markets have gone through a significant correction beyond the top 20 or 30 stocks. We have seen meaningful loss of value and you can say that is a reasonable sentiment correction. From outright optimism, we have moved to an era of scepticism bordering on pessimism and that is a big change over the last couple of years and it should change for better with drop in interest rates and better availability of credit.
Many of the sentiment indicators will definitely change for the better, but corporate earnings is a different story. Even after the first quarter, we have seen a significant correction or moderation in corporate earnings growth with downward revision trend which was supposed to stop in FY20, but surprisingly continued in the first quarter. In all probability, it may be there in the second quarter as well.
The big driver of corporate earnings recovery is the not only the banking sector which had gone to a significant erosion in profits but also many domestic cyclicals. Earnings recovery in some sectors which have gone through some demand destruction -- like real estate, construction, cement, some cyclical sectors where we were expecting a good earnings recovery -- is getting pushed back. Fundamentally, we are still a few quarters away from decisively saying that we have turned around the corner. But sentiment wise, with the government taking steps to move toward more moderate corporate tax rates, we can expect this to be followed up with bolder steps in terms of moderate personal taxes to spur consumption and sector-specific moves book to boost aggregate demand.
Do you think the polarised nature of the market is here to stay? It is not about largecap stocks. It is about mega caps and within mega caps, there are 10-15 stocks which are sitting at an all-time high which are making the markets look good. Are we in for more of the same? Would investors continue to pay a disproportionate amount of premium for near term visibility?
Till there is no broad-based demand and earnings recovery, this phase will continue and this may not be a very healthy phase, but that is the way the market is. The investors will continue to prefer earnings certainty and low volatility despite high valuations. However, if there is a broader recovery and more sectors participate in growth and more companies come out of sluggish earnings growth phase, we would see a normalisation of this trend. For that, we need to move away from slow economic growth to more moderate economic growth environment and also much more moderate interest rates. This would allow the benefits of cheaper credit to trickle down.
A number of companies would benefit out of it and this will require a much larger momentum. If the current sluggish growth phase continues, we would see investors’ preference towards companies that are profitable even during tough conditions, companies that are generating good ROE even under challenging macroeconomic situations. Only those companies or stocks will be preferred and the more challenged companies, businesses which probably have good businesses but may be having bad balance sheets or are not able to benefit from the current economic environment. Despite the best efforts, we would see that this bipolar behaviour of the market may last longer.
So a lot depends on how the economic growth progresses. We have reasons to believe that the growth will get more broad-based over the next four quarters and we would see that some of the companies which were struggling earlier, might slowly come out of that struggled earnings growth phase. The valuations will get normalised over a period of time.
Clearly, there is a benefit to remain a little more diversified today than about a year back. But we will have to wait and how the trends play out.
Why do you think the mass majority of fund managers and strategist and analyst have gone wrong in predicting the earnings recovery? We started the year with the assumption that this year will be a V-shape recovery for Indian markets but we are nowhere close to that. When you say we could be staring at a broad-based recovery in the last four quarters, what is so different this time?
Anand Radhakrishnan: In our mental models, we look at the economy as an engine with four legs; consumption, investment, government and net exports. For the last few years, the economy has been running on only two out of the four legs; consumption to some extent, government expenditure and to some extent corporate investments. But we have not been having very robust investment to GDP growth in the last few years. We expect that over a period of time, this also will normalise and the benefits accrue to corporates that benefit from the growth in investment or capital formation in the economy. Therefore. we would expect a bit of an earnings recovery. That is the broader thinking.
The longer it takes for this recovery to take place, the disappointments from the downward revisions of earnings will come in. That is where the consensus earnings keep getting downgraded. Portfolio managers or investment managers have a slightly more optimistic view of the world. They think that growth will improve and more companies will participate in economic growth and in that sense no one bets for a very narrow corporate growth; no one is thinking that only a few companies are going to make all the money and the rest of the corporates are going to struggle. It is the innate behavioural aspect of being more optimistic that is probably leading to this kind of an earnings expectations and subsequent disappointments.
What do you make of the NBFC problem? Is the problem behind us or is it a train wreck which will continue to drag consumption, investment and credit down?
The problem is not behind us. We are right in the middle of the problem. We are yet to extricate ourselves from the situation. At some point of time, NBFCs has stepped in to fill in the credit void that was there in the system when the banks stepped back. They also overextended in specific sectors and unfortunately there is no easy way out. It is a slow grind.
The regulatory and resolution mechanisms are taking much longer because of inherently conflicting nature of our financial systems. Even under NCLT process, we have a tough time in finding resolutions. So, it is not a surprise that the NBFC crisis resolution is taking longer. We are not yet out of the woods. We have some more way to go and probably a clearer risk off the table, before we can clearly say that NBFCs are out of the woods.
We all know that consumption is going through a slowdown. But how much of a near-term or cyclical slowdown problem is priced in autos, consumers and durables? Is this headline slowdown a buying opportunity for a long-term investors like you?
Yes, I genuinely believe that some part of this is cyclical. It is not structural and therefore any erosion in value of the businesses because of near-term slowdown is an opportunity whether it is in automobiles or consumer durables. Even in specific consumer staples, in retailing companies, there are opportunities. We have seen some meaningful correction in valuations because of the ongoing turbulence in the consumption growth.
One should use that as an opportunity because the longer-term structural drivers are still in place. I read that a couple of online companies have recorded record sales on day one of their festival sales. So there it is not as if consumption trends are broken. It is a bit of a sentiment setback. It will normalise over a period of time and therefore it is a bargain hunting or investing opportunity in those specific sectors.
Your outsized bet for many years now has been private banks. That has worked well for the last 10, 12, 15 years. Will that positioning change because with each cycle, there is a different leader? Are you looking at a pure big market leader in coming years?
Private banks have done very well over the last couple of decades. So, they are partly structural plays. India was dominated by government-owned banks in terms of market share. We took an initial call that over a period of time, the private sector will chip away bits of the market share. Apart from participating with underlying credit growth, they will also grow a little faster because of this relative shift in the market share and which is playing out. It will play out for the next 5-10 years as well. It is not as if this journey does not have hiccups.
There are private sector banks which have gone through periods of slowdown or trouble and some have come out, some have not been able to come out. Even investing in private sector banks is not without its risks. However, there are winners even in that space and therefore we need to be aware of that that just taking a simple call between private and public sector does not necessarily particularly solve the problem.
If you ask me, it is a structural trend and will continue to play out. The drivers for public sector banks relatively outperforming the banking sector is still not there. The government is trying to move towards consolidation of this sector. You have a few potentially better run backs over a period of time. We are yet to see that in terms of actual numbers or outcomes. Till we see evidence that the government is trying to create a more vibrant viable public sector banking situation, we would like to maintain that bias towards private sector banks.
Are you looking at insurance as a very large structural multi-year theme? Is there merit in buying both life and general insurance stocks?
We remain positive and constructive on that sector. It is a sector which is relatively under penetration, both on the life as well as on the general insurance side. People have divided opinion on the life side, but there also, India is relatively underpenetrated and therefore offer a reasonable long runway in terms of growth ahead. Therefore, the situation calls for a structural investment opportunity.
Having said that, if you rollback a couple of years, many of these companies made a début or has IPOs in an extremely optimistic market. The IPO valuations and subsequent valuations remained a bit elevated and some of them have gone through time correction while some of them have gone through some value correction as well.