The Economic Times daily newspaper is available online now.

    From 2000 till now, India has seen earnings upgrade only in 2009: Sanjay Mookim, BofAML

    Synopsis

    India commands premium on expectations of growth, not actual growth but the potential exists.

    Sanjay Mookim-BofAML-1200
    Sanjay Mookim, India equity strategist, Bank of America Merrill Lynch (BofAML), believes none of the election result scenarios imply further upside for Indian markets. In a conversation with ETMarkets.com, he said that in the case of a fractured coalition government, the market will be disappointed. Mookim was of the view that it is fairly evident that India commands higher valuation because there is higher growth built in analysts’ forecasts. Expectations of growth, not the actual growth, help India command a premium, and the potential genuinely exists.

    Edited excerpts:


    How would the market play out in different scenarios: a) NDA having a majority; b) the UPA having a majority; and c) a hung parliament. How do you think markets will react in each of these scenarios?
    Sanjay Mookim: There are various scenarios for the outcome and we think, very few of them or none of them actually imply further upside for Indian markets. The only way Indian equities can continue to rally is if EMs continue to move up. What do markets want? Markets want eventually two things – a stable government, a government that does not have too many coalition partners, that does not have too many compromises to make.

    Unlock Leadership Excellence with a Range of CXO Courses

    Offering CollegeCourseWebsite
    IIM KozhikodeIIMK Chief Product Officer ProgrammeVisit
    IIM LucknowIIML Chief Operations Officer ProgrammeVisit
    Indian School of BusinessISB Chief Digital OfficerVisit
    The second thing they want is more investment over distribution. From a pure economic point of view, markets would like investments in roads, infrastructure, power plants and capacity building rather than in social welfare schemes because economic theory states that those kind of investments are good for long-term growth of an economy. If you look at the math on the political situation today, it seems that the opposition or a Congress-led government will not qualify for either of these dimensions, simply because they will likely have far more coalition partners and have already promised a lot more in distribution than the existing government.

    This is why, the market’s base case seems to be that the NDA or the BJP comes back to power. Opinion polls suggest a NDA coalition is likely to return and the event along the border has led to a big move in the markets. If you look at the behaviour of Indian markets for the last six months, we have had very violent moves relative to the EMs. When oil was rising, India underperformed EM dramatically and when crude corrected, India had a massive catch up late last year. Then again India underperformed because of electoral concerns followed by the Balakot incident leading to a rally.

    The problem is that having built in those expectations, if the NDA and the BJP come back to power, there will be big questions – what now and we don’t have an answer. Unlike in 2014, the BJP this time does not have new proposals on its plate like GST, bankruptcy code, RERA. There is nothing new on the cards at the moment.

    If instead, you got a more fractious coalition, whether it is Congress -led or a third front, the markets will be disappointed because you have now priced in favourable electoral outcome. If you do not get that, you can keep arguing that elections do not matter for the economy, that long-term India is structurally growing and all that is fine. But the market will have downside on the day that the outcome is unfavourable.


    What are your thoughts on foreign and domestic flows coming into the market going ahead?
    Sanjay Mookim: Foreign flows are not specific to India. We have seen flows into EM out of DM economies but this can be fickle. It could change in a short period of time depending upon the world view on Chinese growth or US growth or currency movement or something that the Fed does or says it will do. It is very difficult to predict at least the short-term movements on these flows. India has not seen specific buying by foreigners. Our sense is that much of the flow is passive money, which is not by active managers but by ETFs and it is money that is not coming into India ETF but is coming to an EM ETF and India is getting its share of that EM ETF. So it is very unreliable in that sense.


    Domestic flows are relatively weak because domestic portfolio investors or mutual fund investors have not made money for 12 to 18 months. If you had invested that same sum in debt, then even on a post-tax basis, you have beaten inflation, because inflation is very low at the moment.

    Therefore, it makes sense that the momentum into domestic equity funds is currently muted, especially getting into the election uncertainty. The other point we keep making is that people focus too much on the gross inflows whereas they should be looking at the net flow, which is the flow into funds from foreigners minus the amount of equity paper that is being supplied.

    Even at this peak, that number is zero. The net flow was nothing because the supply of equity matched the demand for equity, which is the money coming in. We are getting into is a period where you may not have so much of supply if the foreign flow slows down even when the pipeline of equity issuances is reasonably robust.

    Talking of the pipeline for equities, two huge rights issues are coming from telecom companies. Do you think these funds will last for more than a couple of years?
    Sanjay Mookim: I cannot comment about specific transactions here but from a telecom industry perspective, what we can say is that the additional capital means that the competitive pressure in telecom can last for longer than expected. It typically means, the returns would be lower than you expected. Whether one of these or both of these companies or the telecom sector is able to survive this competitive pressure remains to be seen. But you can argue conceptually that the longer the competition lasts, the lower the returns you get.

    Talking of sectors, which sectors are you overweight in India at this point of time?
    Sanjay Mookim: We have been overweight financials for a while. We have been saying that for some, financials look good because the macro was better, the NPA cycle had ended. Very demonstrably, most banks have recognised the majority of the stresses on their balance sheet. Banks were also favourably placed because the corporate bond market was receding and the NBFCs were no longer competing with these banks.

    Loan growth, which has come back, was visibly going to improve for these banks and many of these banks had resolved whatever management issues or capital issues that they had. The last point in favour of financials was late last year or mid last year, they were the only space in the country where the stocks were trading at their average multiples. Almost every other major stock in the country was trading above its own average multiples. So, a combination of a top-down turnaround plus reasonable valuations made us reasonably positive on financials. That is unfortunately no longer the case.

    While the turnaround still remains intact, almost every financial is now also well above its historical average price to book or price to earnings multiple.

    Any particular preference in the financial space?
    Sanjay Mookim: We can argue structurally that the private banks will continue to gain market share from the PSU banks for the next several years, perhaps a decade going forward and therefore your structural favourite, your liking for private banks remains intact.

    And what are your thoughts on the NBFC sector?
    Sanjay Mookim: Our sense is that for many of these NBFCs, business has returned to normal and our feedback from credit markets or participants in the credit market is that even the cost of funds for many of those are at pre-September levels already. That is also because many of these NBFCs are operating niches and have very specialised business models, which can be demonstrated to be robust or have an advantage over a bank. But there are certain NBFCs which are very large and perhaps do not have an edge over a regular bank in the country. It is a fragmented space in that sense and that is why, we would not classify NBFCs in general as being troubled but certain companies still need to find or create confidence in the market, so that the market starts to give them money.

    Which are the sectors you would clearly stay away from at this point?
    Sanjay Mookim: We are underweight the energy and material space in India. Although there is a recovery happening in China, but our pitch for investors is that they probably have more beta in global sectors and global companies, which are cheaper than they are in India. So yes, the Indian stocks will also benefit if there is strong demand in China but it is not necessary for you to invest in India to gain from that. We are also underweight telecom for precisely the argument made earlier that if we are seeing more capital and substantial amount of capital into the business, then possibly the returns will remain low for an extended period of time.

    What about the defensive space; IT and pharma?
    Sanjay Mookim: We are slightly overweight on IT now and our argument is very simply that there is not much in India to buy. Also, there is a big dichotomy in the country today. While from top-down, everybody is buying EM and we are getting our share of flows for that, but with the bottom-up approach - there is a massive disconnect. Almost 70% of stocks in India are well above their own average PEs and for almost 70% again, the consensus is forecasting an acceleration of growth. Therefore, the growth rate going forward will be higher than the growth rate that the companies delivered previously. That makes us nervous.

    We have just headed into the earnings season and what are your thoughts on the Q4 earnings season? We have been talking about recovery in earnings for the last six, seven years and that has not really come by. Do you think a concrete earnings recovery is round the corner in FY20 or FY21?
    Sanjay Mookim: Arithmetically, the recovery should happen principally led by the banks. Now the banks have been booking a lot of provisions over the last two to three years because of the NPAs. These provisions will not immediately disappear but they also depend upon how aggressive managements at each bank want to be in reducing their net NPAs.

    If they decide to pace it out, then the reported earnings will look better. If they decide to clean up or reduce the net NPAs at a faster pace, then the provisions will remain elevated. So frankly, in the near term, whether it is Q4 or FY20 forecasting these earnings is tricky because it depends on management choice for provisioning.

    If you take consensus numbers for the Nifty, of the forecast of about 22% growth next year (FY20), 70% broadly out of that comes from four stocks, three large banks and one large energy company. And that is the earnings recovery that we are talking about. Otherwise, from a broader market perspective, you are not looking at any improving momentum.

    If earnings are not coming by for such a long time, then what really drives the case for India story?
    Sanjay Mookim: On a trailing basis, MSCI India has never really delivered better earnings than MSCI EM. Our multiples are significantly higher than MSCI EM in general. It is fairly evident that India gets these higher multiples because we have higher growth built in our forecasts. So expectations of growth, not the actual growth, help India command a premium. I do not expect that forecast or that exuberance for the country to go down because the potential is genuinely there. We are a 60% consumption economy. Consumption is growing, our demographics are favourable whereas the Chinese demographics have turned negative. You will nevertheless see disappointment because in India, we start with very high expectations and you see lower returns as a result.

    Is it fair to say that earnings downgrades will keep on continuing?
    Sanjay Mookim: Yes. From the year 2000 till now, India has seen earnings upgrades only in 2009 i.e. once in the 19 years. The 2009 upgrade around the global financial crisis came because everyone was bearish that we finally got an upgrade.

    And that does not seem to be, it does not look like it is going to change for a while?
    Sanjay Mookim: It does not look like it would change for a while because in India, analysts always start with very high numbers.

    Is this an India specific problem or is this global?
    Sanjay Mookim: There are a couple of other countries which have similar trend but in India, it is stronger I would argue because the long-term story is genuinely favourable.

    Private capex has not picked up. We have seen a slowdown for a very long time. Would private capex pick up significantly over the next one or two years?
    Sanjay Mookim: The answer is no. Corporate capex happens only on basis utilization levels. Even if you get a change in government stance and approvals come overnight upon application or all approval regulatory hurdles are taken away, nobody is still going to build a massive capacity because their existing plants are not busy.

    In certain sectors such as steel perhaps we are turning net importers again because steel plants in India are running 85-87% capacity utilisation but broadly across the country the output gap remains negative and utilisations remain low. Historically, evidence suggests that corporate capex picks up only after the economic cycle has picked up - it is a lagging indicator, it is never a lead indicator.

    What leads the economic cycle actually is household capex and household capex essentially is real estate. So, what we should look is actually the real estate cycle in the country because that is something that can pick up in a period of slow growth when liquidity is abundant and interest rates are relatively low.

    Whether the real estate cycle in India is picking up or not is very difficult to pick out because the data is very weak. There is not enough data for me to draw a line and tell you that yes real estate in India is trying to move up. But anecdotally, that is more important for us to track than corporate capex.

    A lot of economists have been questioning the economic data that has come by. Are you of the camp who believes the data is fine or are you also questioning the data?
    Sanjay Mookim: Well I am in the camp that follows whatever data is available. There are enough reasons for the government to have moved the methodology the way they did. I can also suggest that in India, capturing data is very difficult because India is extremely large and extremely diverse. Surveys are expensive and we must realise that because most of this government data is based on surveys, especially the quarterly data, we need to think about how you condense the whole economy into one number with a three month, four month frequency. I would argue that yes, you can have volatility in those numbers quarter to quarter, but if you take a longer timeframe, then the numbers are fairly representative of where the economy is from a cyclical point of view.

    What are your thoughts on the midcap and smallcap space?
    Sanjay Mookim: Midcaps have never on a trailing basis as a basket, delivered better growth than the largecaps. If you look at what happened in India after the election of the current government, there has been a significant linear rally in the midcaps up until a point and that was principally led by a multiple expansion.

    If you look at the PEs for midcaps, the premium is falling dramatically, because a) the growth has not come through b) getting into political uncertainty and getting into a little bit of a sentiment weakening maybe around equities itself that premium is coming down radically. It is now down to 14-15%.

    Do the benchmark indices -- Nifty or Sensex project the Indian economy right or are they projecting the state of Indian market correctly or are they too concentrated indices to in a way project the right state of Indian markets?
    Sanjay Mookim: First of all, do the equity markets convey the state of the economy in the first place? My argument would be no. The equity markets do not fully capture what is happening in the unlisted, in the SME space. There are 63 million non agri SMEs in the country, which contribute to 30-35% of India’s GDP and none of them is represented or a very few of them are represented in the stock market.

    So, first of all, I would be careful in using the stock market as a barometer of what the economy is doing. But yes, there has always been a constant debate about the composition of these indices. There are estimates that almost half the revenue of the Nifty is not even linked to the Indian economy -- be it through IT companies or through oil and gas or energy. Coal companies has nothing to do with India and those revenues or profits are driven by global cycles or demand elsewhere.

    But if you flip this argument, in a way, it does not matter because if the driver for the market has been passive flows into MSCI India, not Nifty or Sensex, then MSCI India is more relevant from an external point of view. But then, it does not matter what the composition of that basket is because the flow is driven by the basket and not by stocks.

    And that is very volatile money, right?
    Sanjay Mookim: It is.

    It can go out at the same pace as it has come?
    Sanjay Mookim: To your point, do I take this rally that we have seen since Feb 19th as an indication that the Indian economy is recovering, the answer is no. It is just that we have got money into that one basket. Now, whether that basket has 50% link to external demand or not is irrelevant.



    ( Originally published on Apr 22, 2019 )
    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more


    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
    The Economic Times

    Stories you might be interested in