The Bombay Stock Exchange's benchmark Sensex surged over 300 points on Wednesday, but selling pressure in the second half saw some of the gains erased and it finally closed up 139 points or 0.4 per cent at 33,136.18 points. After rallying 28 per cent in 2017, India's equity markets have seen a lot of speed bumps in the past couple of months, be it concerns that faster interest rate hikes by US Federal Reserve would drive away foreign investors, to the levy of long-term capital gains tax in the Budget or the big fraud at Punjab National Bank which has worried investors. So far in 2018, the frontline indices are down around 3 per cent, while there has been a sharper correction in mid caps and small caps. Jinesh Gopani, head of equity at Axis Mutual Fund expects the equity markets to remain volatile this year and trade in a range for some time. The fund house, which had over Rs 73,371 crore in assets under management as of December 2017, is betting on companies with strong earnings visibility and corporate governance, but overall it's better to remain cautious right now, Gopani tells THE WEEK in an interview. Excerpts:
Jinesh Gopani
There has been a lot of volatility in the equity markets in the last couple of months. Do you think this volatility is going to be the new normal in 2018?
Yes...We have been saying that the volatility will be there. Globally you have many issues, domestically you have now issues around election, fiscal deficit, issues around LTCG (long-term capital gains tax) and worst thing was this fraud (at Punjab National Bank) that shook the system and the nervousness has increased in the market. Everything coming together has led to volatility. After the good run that we had, it's also good that markets are going into time correction. There was over exuberance, so in a way it's good that the momentum is slow. We were seeing that in many of the stocks there was only a concept and no real fundamentals to back it up. Stocks were just flying and people were making 50 per cent in two-three months. Look at the SME exchange... The way stock prices were going up, it's a scary situation. You raise Rs 5 crore, and market cap from Rs 50 crore becomes Rs 500 crore in three months, those are all indicators that greed is very high in the market. For long-term investors this (correction) is good. Long-term stock pickers get good chance in a steady market, rather than in a big bull run, where it becomes difficult due to valuations.
Post the recent correction, have valuations come down to reasonable levels now?
For large caps, yes. Now you are at a decent juncture. The large caps are now trading at around 19-20 times, I am talking of the index. You have seen 15-25 per cent correction in small caps and mid caps, but still valuations are high corresponding to their earnings growth profile. In the third quarter, the expectation was that because of the base effect (demonetisation in the year ago quarter), earnings will be very good. But, surprisingly, while large cap was okay, in mid caps, all companies have not delivered to the extent expected, which is a disappointment.
From a fund perspective you will still not bet big on mid cap stocks?
We are more multi cap specialists and as of now, we would like to back more large cap stocks. But, it is not that we have sold-off our mid cap or small cap ideas. Wherever we are comfortable with the business model, where we have clarity of earnings coming further, and there is a correction of 10-15 per cent, we are buyers there. But, we are not aggressively going out and buying.
There are several concerns right now. The US Federal Reserve has hinted at faster rate hikes, back home there are fiscal deficit concerns...
The good part of the global is economies are doing well. The flipside is that because you are doing well, obviously there will be inflation and central governments will have to take a call at some point of time whether it is over heating. If inflation goes out of proportion, they (US) will have to raise rates very fast. Then the steroid money, which was floating around in the system will have to reverse. Our take is that if the US 10-year bond yields cross 3 per cent and remain at those level, there will be a global reversal of flows.
Domestically, if oil prices top $70 a barrel, then trade deficit numbers will be pretty bad. There will be concerns on fiscal deficit side. How the government will maintain fiscal deficit at 3.2 per cent of GDP, the numbers are not adding up. On one side the oil and import bill is very high and on the other there is the GST revenue collection. We will have to see how much GST collections can go up, once the e-way bill is introduced. If it rises to around Rs 1.10 lakh crore per month that the government is expecting, we will be in a better shape. But, if it doesn't go that way....that is why there is a nervousness in the market and that is why in India, the 10-year G-Sec yield is not coming down. Lastly, you are going into an election season... So, it is better to be cautious rather than go all out and be bullish on the equity market.
If the foreign fund flows reverse, how of much of an impact do you see on Indian markets?
If FIIs are pulling out Rs 500-700 crore, Indian markets will absorb that. But, if there are massive redemptions on a particular day, then depending on the intensity of sell-off, markets can go down 1-3 per cent as the domestic investors will also stay off and wait for good opportunities to invest. Our thinking is that the market will remain in a range for some point of time. You have domestic flows from mutual funds, insurance companies, pension funds... So, we don't expect a massive sell-off, unless there is a big event that ruptures the market.
If you look at particular sectors, information technology and pharma haven't done well for some time. Is the view changing now?
We were underweight on IT sector for around two years. Their dollar revenue growth had come-off from 10-13 per cent to 7-8 per cent. Plus, their business models were getting challenging; there were pricing pressures in existing business and new digital projects were initially taken away by companies that were innovating. Now, the transition phase is over and for the first time last quarter we saw some positive incremental vibes on businesses turning around and there could be a trajectory of higher growth. Between IT and pharma, IT is a better bet right now.
In Pharma, the jury is still out on how the business model will pan out. The business models have gone for a significant change right from the US FDA issues to consolidation of distributors in the US. It has led to significant pricing pressure on companies' product portfolios. Since there were US FDA issues across top four-five large companies, the momentum of introducing new ANDAs (abbreviated new drug applications) and maintaining growth momentum has come-off. Competitive intensity has also increased. We will have to see how things pan out. There will, maybe, another one year of transition and then we will understand who stands where.
What are your views on the PSU banking space, which has seen a sharp correction in the wake of the fraud at PNB?
We never participated in those banks. Generally, it doesn't fit into our criteria of companies with strong management pedigree, steadiness in the management and board and strong governance, which has been our philosophy when we select stocks in our portfolio, plus growth and return on equity etc. Barring one or two, it (PSU banks) has never fit into our basket. We have always participated in retail-led private-sector banks. It's not that they don't have issues, but they have managed those issues well. There will be some more pain, depending on how some of the insolvency and bankruptcy cases get resolved, how much haircuts the banks need to take, how much capital the PSU banks get from the government...When we were just hoping that things were getting sorted out, you had this scam (at PNB). So, even if two-three cases get resolved in the National Company Law Tribunal, your provisioning level is not coming down.
What are the sectors that you still remain bullish on?
From a portfolio perspective, where we are playing it, is private sector banks, niche non-banking finance companies, auto, auto ancillaries and consumption (B2C companies). This should be forming 80-85 per cent of the portfolio. Some of the other things we are playing is some new segments like staffing solutions, where you have three companies listed, that could be a good growth opportunity. Some of the companies are expensive. Unfortunately in India, you only have 100-200 beautiful stories to play, that are long-term in nature, giving you secular growth and where you can at least vouch for the managements. So, if you want to participate in some of those companies, you end up paying slightly higher premium. Premium comes, because you have delivered on growth, delivered on ROE and delivered on corporate governance.