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Broader market attractive from a 3-5-year perspective: Tushar Pradhan, HSBC Global

The bond market as an asset class, also looks attractive over the next two or three years.

ET Now|
Nov 01, 2019, 11.03 AM IST
Tushar Pradhan-1200
There is a need for risk on and given that there is a fair bit of interest globally for assets including emerging markets, India has been a recipient of some flows lately, says Tushar Pradhan, CIO, HSBC Global. Excerpts from an interview with ETNOW.

Markets are telling us that the worst of the economic print is behind us. Would you believe the market or would you believe your analysis of macro where the core data is not stabilising and the IIP data is not stabilised. What is the right analogy in this market?
The answer is somewhere in between because I do not think the entire market move is due to some expected turn in the economy as such. It is a combination of factors. There is a lot of demand for risk assets all over the world, as the interest rates and yields across the world are coming to zero. There is a need for risk on and given that there is a fair bit of interest globally for assets including emerging markets, India has been a recipient of some flows lately. On top of that, we continue to receive very strong flows in the mutual funds into the Indian equity markets as well.

A combination of demand as well as some improvement in sentiment is leading the market to where it is. It remains to be seen whether the economic turnaround is around the corner but clearly, if the early indications of earnings growth has any sign of recovery, that is where the bright spots are, aided by the fact that there will be a much lower tax rate for most Indian corporates going forward. So, there is a combination of factors. There is a little bit of a push from the economic side and a lot of pull from the investors putting money into the asset class and wherever there is demand. Obviously, the price of the asset class does go up a little bit. I would think the answer lies somewhere in between.

Going forward, it is going to be difficult for an investor to figure out whether or not to take that jump. Clearly sentiment seems to have shifted and a propensity for risk that has come in as opposed to what we were seeing just a few weeks ago. Where would you look for opportunities to buy in this environment?
One has to be cautious in terms of asset allocation. This is clearly not the market to load up in terms of one asset class and one preference. One has to balance the expectation in terms of over what period you are expecting that return. If your period is clearly above five years, equities as an asset class clearly look to be very attractive -- especially the broader markets, not essentially the narrower more visible indexes.

The broader market clearly looks very attractive from a 3-5-year perspective. If you look at interest rates, that is a very interesting situation. If you look at the current yields that we are getting, there are clearly much lower than what we expected in India and we see how interest rates have actually gone in the past.

But if we look at inflation and how consistently it has undershot in the last few quarters and if we believe that India structurally is now a lower inflation country than where it was maybe 5-10 years ago, then our interest rate scenario also needs to be adjusted a little bit.

Keep in mind that the real rates in India continue to be one of the highest anywhere in the world, which means that even interest rates here are at risk. That means the bond market as an asset class, over the next two or three years clearly looks a lot attractive even if in the last one year or so, bond funds have probably given between 12% and 15% purely on duration. It is a very interesting time to allocate asseta. I would focus on the fact that the investor needs to decide whether he wants a diversified approach to investing and within equities, the broader market in terms of where the valuation are very attractive, is where I would really look to begin with.

We were having a discussion earlier this morning that one should look at individual stocks or individual sectors that have been bear market survivors. Is that a strategy that you would concur with when it comes to approaching names in the current environment?
A lot has changed in the world and one of the biggest investors in the world has looked back and decided that 10 years ago if he was to have invested in companies which have created the biggest market cap today, they did not exist. Whether it is Google or even Apple which existed in a different form that we see it today. So should one look at the current low valuation compared to what these companies used to trade at in the past and try to take a punt?

I would still feel that a diversified approach, keeping a little bit of that in one’s portfolio but looking for new ones and new trends in terms of market cap is likely to be pretty attractively valued in the future. It has to be a mix in terms of the newer companies and one of the more traditional ones weathering all cycles, which also need to be part of the portfolio, but not exclusively.

The opportunities are clearly somewhere from now in the next five years. They maybe already in the works or not even there in the markets today. So one should keep an open mind and look at the trends as they develop. One should be very fairly compensated for the kind of risk that you will take right now.

Is the current market level worth a risk in largecap stocks? I am not talking about specific midcaps and beaten down smallcap stocks, but for the largecap stocks, at a time when Nifty and Sensex are touching all time highs, does it make sense to take a risk?
I would nuance that question a little bit. I would say that even within the largecaps, there is a concentration of companies which are ever popular and they are clearly trading at valuations which are even higher than their historic highs on an average. So clearly, there is a risk there, though currently the popularity seems to converge there.

The only spanner in that argument is the fact that when you get institutional investors and allocators, they do not go down to stock specific levels. Who can say that these companies may not sustain and not even grow from here? It is very difficult to predict where it is likely to go because demand also is a function of the whole valuation piece and at the top level, if they continue to buy one of the largest, most liquid, most market leading kind of companies, then these companies will continue to not disappoint.

But that is a risky bet. I would think that the risk reward is not in your favour, given the valuation. That does not mean that it is going to be a sell. One has to be very circumspect. We have seen that in the last two years, these companies sustained valuation and continued to remain popular across all portfolios.

They have been expensive two years ago. I think two years is a longish period to not have them and continue to have an underperformance versus having them. It is a difficult question to answer but clearly there is an absolute nature of valuation and some of them are reaching there.

Last five years with the exception of an ITC or one or two staples stocks, most of the consumer stocks have given good double digit CAGR returns. Next five years, are we in for no returns or single digit returns or even double digit returns from some of the Nestle, HULs and Colgates of the world?
In the very long run, price is a multiple of the profits and the rate of growth in the profits that we look at. The rate of growth in the profits of these companies in the last few years have been much lower than the rate of growth and their stock price. That has led to this multiple expansion as we see. Going forward, two things will emerge -- whether the earnings growth will be much higher which I feel is not likely or whether the popularity continues to remain there. In this case, if it sustains the multiple, you are going to make no return or may be flat return over the next few periods.

If you feel that the rest of the economy continues to suffer and we are looking at a very prolonged period of a slowdown in the economy, then they will continue to outperform relatively, even if they do not give you an absolute return. It is a portfolio allocation issue. They are clearly overvalued but as a portfolio strategy, they may form part of a portfolio given your view in terms of where the next few months or the next few years are likely to be. If you think that we are in a period of pretty significant economic growth and that the broader economy will sustain and improve, then clearly they needed to be underweight. But if you think that it is likely to remain for a much longer period, then they need to be a significant part of your portfolio. That would be one way to look at it.

Currently everyone is focussing on them with the divestment agenda being top of mind. Of course, we have also seen a fantastic move in some of the key names like BPCL, SCI and Concor, that perhaps are slated to be put on the block. Also, what are you making of the rally that we have been seeing on some of these PSU names?
There is a lot of value there. I do not think anybody disagrees about the value but the thing is how would it be realised? What is the kind of monetisation that one gets out of the value? Is it going to be by way of a complete privatisation or is there autonomy?

Some of the PSUs have a quasi monopoly in the markets that they operate in and given over to a much more autonomous management and given the monopoly, these companies are worth a lot of money. But if the monopoly goes away, the implicit support which is there as part of the government owned company goes away and if they have to standalone on their own given the fact that some of these prices at which they sell and the commodities that they deal in are also mandated by the government. It is not a very clear picture.

It is easy to say that they are cheap and they will definitely get a rerating, but whether all of that rerating is captured and what kind of company will this be 5-10 years from now, remains to be seen in terms of what you know in terms of of autonomy, government regulations and what sort of freedom does the market let these companies operate in?

The spectrum of the PSUs is also very wide. There are companies in the petroleum sector, companies in gas, banking sector so on so forth so difficult question to answer right now but yes there is clearly value comparable to some of the like companies abroad where these companies command a little bit of a premium than what they are trading right now here in India.

All of us have in a sense been fooled a couple of times in the last two or three years on prospects of an earnings recovery. This year everything has gone wrong. When do you think the the real capex/the corporate recovery will happen?
Corporate recovery is clearly being helped by the corporate tax cut. Reported earnings clearly will be on a much safer trajectory in the next one year at least. What remains to be seen is whether that translates into a much broader economic move which again leads to corporate profits being strong and robust for the next couple of years.

There have been moves in the external context which also has had an impact on companies which are exposed to these markets. Every quarter, there is one thing or the other which puts things off and that is because of a lack of concerted economic turnaround. We have seen patches of growth within the economy and some companies do well and some companies do not do well. But all that we need is for these earnings growth recoveries to happen and sustain in order to have a complete turnaround which has to cross the broader market and be across all sectors. That is when we can say that earnings recovery is here to stay. Otherwise, it is going to be pretty stock specific, and at times even sector specific. This is likely to continue and these cancelations will on an aggregate tell you again that earnings have been flat.

But for some companies, profit growth has been pretty significant and in double digits. For Some companies, profit growth has been flat to negative. When you put that all as an average, we tend to jump to the conclusion that the earnings have been flat which they have on an average, but the economic recovery has not been very uniform and that is what we are waiting for.

What is the outlook when it comes to the liquidity situation? While we have seen a pickup attributed to the corporate tax rate cut, the kind of environment that we are seeing right now with earnings being better than expected, global flows being supportive as well, how do you see the trend in terms of liquidity from foreign flows shaping up?
Clearly, there is a risk on. The yields that most of the foreign investors are looking at in their domestic economies are very, very low. There does not seem to be any hope of inflation again returning to these economies. There continues to be a very difficult growth scenario especially in Europe as we see.

So given all of that where does one allocate assets, clearly the emerging markets are also struggling, it is not as if there are bright spots either. But given the demographics, given the potential for growth in emerging markets, clearly some of that capital will get attracted into these assets. In a sense, liquidity is pretty much out there and there does not seem to be any quantitative easing. The quantitative tightening was there for a very short period and we are not seeing any economy, any central bank signalling that we will take liquidity back out. So, liquidity will sustain. It will continue to remain adequate at least for the foreseeable future.

Also Read

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