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Indian economy to see real turnaround in 6 mths: Madhu Kela

Madhu Kela of Reliance Capital is bullish on Indian equities from a three-year horizon and expects the asset class to outperform others like real estate, fixed income and gold in that time frame. In a Diwali special interview Samavat 2071, to CNBC-TV18’s Latha Venkatesh, he says many investors are feeling left out in this current rally and are waiting for dips to participate. 

Continuing his positive tone, he says that earnings growth over the next three years will take many market participants by surprise. He foresees earnings growth crossing 20 percent from FY16 onwards.

Speaking about the macros, Kela says that India is coming out of a dismal phase of capex and investment cycle. Also, there are early indications of improvements on stalled projects, but the real turnaround in India’s fundamentals will happen significantly over the next six months. He expects the Modi government to surpass most expectations in next five years and sees accelerated policy actions over the next six months.

Despite this, he feels that the current market rally is not as compelling as the one seen 2003. “The market is not as cheap as it was in 2003. The market in 2003 was literally undiscovered with company valuations on the lower side,” he adds.

Meanwhile, sharing sector bets, he recommends investors to have exposure to export-oriented sectors like IT and pharma. Nearly 70-80 percent of one’s portfolio should be skewed towards companies with 15-20 percent earnings growth visibility, he said. One can also consider investing in beta bets from sectors which have not done well over past three-four years.

Further, investors should strive to have a balanced approach while approaching the market, he says.

Below is the verbatim transcript of Madhu Kela’s interview with CNBC-TV18’s Latha Venkatesh

Q: The day seems very auspicious, we have got a mix of very good global cues and very good domestic cues but let me introduce a note of caution. Do you think this good bonhomie lasts, are we going to once again see a new high before 2014 is out itself or do you think now for the remaining quarter you would be a little cautious?

A: Yes I would say that is the message which I want to communicate that we are trying very hard to say where the markets are going to be in the next two months. While history has proven the returns are never being made in order to ascertain or understand where the markets are going to be in the next one or two quarters. I know so many people who are feeling really left out after such a big run which has happened in the markets and now they are saying that god give me a little correction so at least I can be inside this great India story which is going on.

So if you have a three month view I don’t know where the markets are going to be but if you have a three year perspective and equities is all about that perspective then I am sure there is more to come.

Q: What is the three year picture, do you have a view of say 20 percent compounded earnings growth which one brokerage spoke about earlier today this morning, therefore what does that mean for the Sensex or for the Nifty? In three years what are we looking at in terms of compounding gains?

A: Let us go one-by-one. First, as an investor when you are investing you have to look at what your comparative returns are. So I am very confident that over the next three years equities will outperform real estate, gold, silver and fixed income. Now that return, outperformance whether it is 5 percent, 7 percent or 10 percent I don’t know that.

Second I think earning growth is likely to surprise many people over the next two-three year timeframe. Right now even consensus still is building somewhere around 15 percent earning growth even for next three years. But you look at all the policy making as we saw yesterday was a big day for policy making. Once all these policy making comes together and give this year for that consolidation, I wouldn’t be surprised if earning growth for the next three years after this year is even upwards of 20 percent. Because we have had muted capex cycle so the capacities have not been added significantly. If the economy again starts to grow at 7-8 percent, then you can have earning growth upwards of 20 percent, that is clearly not been priced by the markets as yet.

Third most important thing for outperformance of equity is every household has real estate, everyone owns gold, everyone has a fixed income but who has equity that you have to go and see. Even most sophisticated people in the market who have been wanted to take risk, their weightage is also very small. I’ll give you some numbers, we did some back of the envelope calculation that if 3 percent of the overall saving gets allocated into equity over the next three years, and if we cover-up for the last three years the equity flows upward of Rs 2.5 lakh crore can come in the market in the next three years.

I don’t know whether that number is going to be 3 percent or 2 percent but it is clearly indicating the last three months flows which we have got even in mutual fund that people are now finally realigning and realising that they need to put some weight of equity in their portfolio.

I told you Rs 80000-90000 crore outflows have happened in last three years from mutual fund and insurance companies, this is the estimated number. Normal 3 percent, we are not even assuming what is going on in America and Europe where equities weightage is as high as 30-50 percent, we are only assuming 3 percent weight of equity in people’s portfolio.

Q: One more point on the macros, the numbers the performance of companies is not still giving you any hope. We are still living in hope. If you looked at the Index of Industrial Production (IIP) numbers even if you correct them to some one offs it still is like 1-2 percent and what is worst we spoke to Rajiv Bajaj after his second quarter numbers about the festival sales, very tepid, very cold is how he put it. When do you see that turn coming is it by end of 2014, is it only in FY16?

A: It is a very well taken point that the fundamental reflection on the ground is not yet there. But we have to understand that we are coming out of a three-four year absolute challenging times. Not only there were policy challenges within India but even the external environment what happened after the Lehman Brother to risk of trade generally. So these things will take a little bit time to correct. But I am sure the correction will also happen because of the markets.

Once the market becomes good let us say you are at 8000 Nifty only because of your 8000 Nifty lot of these banks which needs to be at re-capitalised will be able to capitalised and you will get into virtual cycle wherein people will be able to raise money, re-structure their balance sheet and then earning kick-off will happen. So that might be may be even six months I would not argue that is there another six months for real ground situation to improve, there is a possibility.

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