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Outlook positive, but 2015 gains to be lower: Prashant Jain

Returns from equity investments in 2015 are unlikely to be as great as those in 2014, feels Prashant Jain, ED & Chief Investment Officer, HDFC Asset Management. That is because the market has already priced in much of the expected improvement in macro fundamentals and corporate earnings.

In an interview with CNBC-TV18’s Latha Venkatesh and Sonia Shenoy, he says the Indian market is still not overvalued, but one will have to be patient with a 2-3 year investment horizon to reap the gains hereon.

He says ‘fast money’ among foreign institutional investors may have exited, but the ‘patient’ money is still invested.

Jain sees big improvement in the economy’s fundamentals, driven by a sharp contraction in current account deficit because of lower crude prices, and falling interest rates.

He says one of the reasons why India will be favoured by global portfolio investors is because we will gain from falling crude prices and that we are among the few large economies where interest rates are falling.

Jain sees economic recovery as one of the major themes for 2015, driven by a pick up in the investment cycle. He sees consumption growth lagging investment, contrary to the widely held view that consumption will be a key driver of economic growth.

He is bearish on FMCG stocks because he feels they are over valued and they benefit from high inflation and do not do as well in periods of falling inflation.

Jain says IT and pharma are fairly valued, but the valuations are justified considering they are secular growth stories.

In all other sectors, he feels there is scope for price earnings multiples to expand, driven by a jump in both profits as well as profitability.

According to Jain, corporate margins are at a 16-17 year low and a mean reversion is on the cards. That will lift aggregate corporate earnings well above the trendline of 12-15 percent earnings growth.

Also read: Market unlikely to see new highs in 2015, says Quantum’s Dutt

Below is the verbatim transcript of Prashant Jain’s interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Latha: How the year will pan out? We put behind a very successful 2014, 31 percent on the big indices and on certain sectors like public sector undertaking (PSU) banks or even banks, it has been a 60-65 percent gain, can we better it in 2015?

A: You can but I don’t think one should expect, I don’t think that would be a reasonable expectation because markets move in anticipation of – and I think to a reasonable extent markets are discounting the improving fundamentals but markets are clearly not overvalued. The quick money, the fast money, the big money is over but the patient money, the compounding money over time remains because multiples are still below averages, economic growth rate should continue to improve over the next few years. Current account will show a very dramatic improvement next year and even fiscal deficit is coming down and interest rates are clearly on the way down.

Latha: Given that would it be wise to perhaps diversify in terms of assets itself since people like you have to work on a year-on-year (Y-o-Y) basis as well as on a quarter-on-quarter (Q-o-Q) basis, would this year find the equity markets giving you just as much gains as the debt markets?

A: I have always maintained that equities is an asset class, where timing is extremely difficult and you can see the pitfalls of trying to time this market. When Sensex was 15,000-16,000 hardly anyone was investing or hardly anyone was positive. So equities are not amenable to short-term timing but if you look at the likely growth rates, if you look at how the markets are valued today, I think someone with a two-five year view, this is a very good investment opportunity. We must also look at not just absolute returns but relative returns of equities versus other categories. There equities will clearly score. So if you compare it with the outlook on gold or real estate, they are definitely far superior.

Sonia: What is the one big trigger almost important factor to watch out for in 2015, will it be global, will it be earnings or do you think the reform momentum will overshadow everything else?

A: We have always said that it is very hard to pinpoint one-two factors and that too in advance but as we look at this year, I think there are no serious worries in our understanding. All prices at these levels should lead to a saving of 2 percent on current account deficit (CAD), which will start showing up by the April to June quarter because the spot prices have fallen, the price at which India buys will fall with 3-6 months lag. So on that front, we should be very – and that will lead to a good saving on fiscal deficit as well. Bond markets are already pricing that in and we think the yields will fall more from here. So the outlook by and large to my mind is quite good and one concern, which is there for everyone is the US interest rates. At some point, they will rise but if you look at the gap between US rates and India rates, it is at an all-time high.

So I think India is in a very unique position. If you look at the large economies in the world, probably India is the only country where interest rates have to move down. It is one of the few countries where inflation has to – we are still fighting inflation, everyone else is fighting deflation. So growth rates have to clearly pick up. India is one of the very few large emerging market economies, which benefit from a falling oil price. A lot of countries are going to come under immense pain. But we are a beneficiary. So I think even global investors realise all of what I am saying. India appears to be in a very good position.

Sonia: Does it still make sense to invest into those companies which will benefit from falling oil prices, your paint companies or oil marketing companies (OMCs) or tyre companies?

A: Markets are always acting in anticipation. That is true for markets in general, that is true for companies also. It is true that falling oil prices are good for these companies but it would be very difficult for me to comment whether one can invest based on this news alone because not a lot of it gets priced in.

Latha: How would you use this to pick stocks, the macros that you mentioned that current account deficit will improve, fiscal deficit will improve, when the macros reset for the better, inflation is falling and growth is rising, what is the stock market takeaway for that?

A: Though quite a few people disagree with me, I feel any improvement in growth rates will have to be led by an improvement in investment cycle and some people feel that consumption will bounce back. I think that can happen but only with a lag. So the key is lower inflation, lower interest rates and at some point the investment cycle will have to improve. So I would look for these three factors to create my portfolio.

Latha: Just yesterday I had a conversation with two of the best representatives of Make in India on manufacturing or even infrastructure for that matter, the head of  Tata Steel and  Larsen and Toubro (L&T), the feeling seems to be that there is — steel is not in the best of times at this juncture but the feeling seems to be that capex is not happening till March 2016. If that prediction is right, if they are reading the tealeaves right, would you say that this year cannot be a very great year for stock markets?

A: It is very hard to price in or to forecast stock markets on a one year basis and we have consistently maintained that but if you look at likely growth rates and likely current P/E multiples, I think the outlook is good with two-three year view.

Sonia: I was just going through a list of your holdings and in that it looks like you have reduced your holding in the FMCG space, is that a sector that you are now turning a little cautious on or do you think that there are better opportunities in cyclicals?

A: We have discussed this maybe one year back also. We have been reducing exposure to that space for quite some time and the reasons are quite simple. We are optimistic on economic recovery. In my opinion, the investment cycle has to recover before the consumption cycle and the valuations are of course quite rich and finally I don’t think that low inflation is good for these companies. These companies have benefited immensely from very high inflation, which increased their nominal growth rates but if inflation remains low for few years, I think the nominal growth rates will certainly be impacted.

Latha: Before we started this conversation, you were saying that 2015 will be a good year for the economy, you are not so sure it will be a great year for stock markets. If that the philosophy with which you are looking at the market, at this point in time typically which would be the stocks that should do well, would it be infrastructure?

A: What I said was that the economy is clearly on a path to improvement and each successive year should be better than the pervious year and equities I don’t think we can say it will not be a good year but I think it is unlikely to be as good a year as the last year but outlook for equities is clearly good because fundamentals are improving, interest rates will move lower, growth will improve and valuations are reasonable.

Coming to sectors, all I can say is that in my opinion, the consumer non-discretionary sector is unlikely to see any multiple expansion. I feel growth rates may disappoint because of lower inflation.

I think IT and pharmaceutical seem to be fairly valued but they are secular growth sectors so they are reasonable I would say. Most of the sectors than P/Es have room to expand because the aggregate P/Es are about 16 times and if you remove the higher P/E multiples of these three sectors, what that means is that the other sectors P/Es are meaningfully lower and that is what points to room for improvement in P/E multiple.

Latha: You say economy is likely to do better and better, would you therefore stick with the banks, would you stick with non-banking financial companies (NBFCs) because you have been talking about lower interest rates?

A: I think banks and NBFCs are pretty much close to each other. The key variables, the key drivers of businesses are same so yes the outlook for banking over time should continue to improve.

Sonia: What is your view on how to approach some of these metal names — not getting into individual stocks like  JSPL etc but now this coal action process will begin etc, how do you approach this space because metals were clearly the big underperformers last year?

A: This space is a global cyclical and the India factors are relevant definitely but I think one should also take some view on the commodity prices and it is not easy to do so. Clearly, commodities are coming off. So even I don’t have a clear view how steel prices globally will behave.

Sonia: So it is better to just avoid that sector for the moment?

A: I don’t think we can generalise for everyone. So each one will have to make their own assessment but this is clearly a risk factor. It is more of a global business than a local business.

Latha: Because the metal and the commodity sectors are in such distress, is this the time to get into them especially because our economy, you are saying, is clearly correcting?

A: The volume growth outlook for some of these sectors should improve overtime but the impact of price is much more than the impact of volumes on profitability. That is what makes it challenging and that is why people like me are confused, we don’t have a clear view because it is extremely hard to take a view on global commodity prices. Let us keep in mind that P/E multiples in cyclicals can be deceptive because if selling prices falling 10 percent, earnings could collapse 30 percent.

Sonia: What kind of Sensex EPS are you looking at in the next one-two years on an average and I know it is hard to forecast returns but on an average what kind of returns should one expect in the next couple of years for the market?

A: If you look at the corporate margins, they are at 16-17 years low, the EBITDA margins of companies and I think as inflationary pressures reduce as currency stabilises, interest rates move down, the way the inflation reduces and as capacity utilisation picks up as we discussed new projects are not coming up but the economy is still growing so what that means is this capacity utilisation is slowly going up. So I think corporate margins will do a mean reversion and therefore margins should improve overtime. Therefore profit growth should be quite decent and lower interest rates will impact profit growth quite significantly. So I would say the next two-three years, profit growth should be above the trendline growth, which is 12-15 percent. So it should be higher than that. Multiples are while not very cheap but they are not aggressive, they are still below averages and as interest rates move lower, multiples themselves can move up. So we hope to make some money from both earnings growth as well as from P/E multiples going up even from the current levels.

Latha: At what point would you say earnings growth will improve in FY16 itself you think because you are looking at things at a two-three year perspective?

A: I think that process has begun. As we speak also, we are in that process. So every successive year, as the economy improves, as margins revert to normal, as interest costs moderate, the profit growth over next two-three years should be reasonably good in my opinion.

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