Earnings ratios are bottoming out: Richard Gibbs

Last Updated: Wed, Sep 26, 2012 04:16 hrs

Markets have welcomed the recent policy decisions by the Centre. And, at a global level, measures by various central banks have boosted sentiment. Richard Gibbs, global head of economics, Macquarie Research, in an interview with Puneet Wadhwa, says foreign institutional investors (FIIs) are readying themselves to avail of the expected rise in equity markets. Edited excerpts:

Do you think another bubble is waiting to burst among risky asset classes, perhaps in a couple of years?

In all cases, the additional stimulus measures announced recently are directed at supporting real economic activity. In the case of the US, these are targeted at reducing the unemployment rate. However, to the extent long-term interest rates are being held down by monetary authorities, ultimately, there is scope for a bubble in this asset class.

Should long-term interest rates be held down in a climate of accelerating economic growth, a mis-pricing of the inflation risk premium for bonds would occur, and this would have the potential to create dislocation in long-term capital markets.

What, according to you, are the top three negatives from quantitative easing and stimulus measures?
We can identify three key negative risks associated with quantitative easing measures. First, these fuel inflation pressures in asset and general prices in economies and, therefore, distort the efficient allocation of capital and the employment of factors of production. Second, these increase the volatility of global capital flows, as liquidity is exported to ‘higher yielding’ economies. Third, these exert pressure on ‘trade-exposed’ economies to devalue their exchange rates to maintain export competitiveness against further weakening in the exchange rates of the dollar and the euro.

How do you interpret the Reserve Bank of India (RBI)’s recent move?
The decision to leave interest rates unchanged and to cut only the cash reserve ratio by 25 basis points reflects RBI’s concern on persistent inflationary pressures, even against a background of moderating domestic demand growth.

We continue to believe the Indian economy faces difficult supply-side conditions. If these persist, ultimately, the economy’s potential growth would be reduced. Needless to say, we continue to anticipate the government would pursue further measures in respect to its ‘reform and development’ drive, as it recognises building the economy’s productive capacity is the best form of stimulus that can be delivered.

How are FIIs positioning themselves with respect to India?
In the wake of the recent quantitative easing measures by the US Federal Reserve and the European Central Bank (ECB), FIIs are positioning to take advantage of the expected boost in equity markets. Previous instances of global liquidity easing have led the Indian market to an average 8-10 per cent rise in a three-month period. We expect this uplift to continue, owing to the new global liquidity easing measures.

FIIs are also interested in Indian markets due to the government’s recent announcements on liberalisation of the retail and civil aviation sectors. Investors would also be interested in whether the government maintains its ‘reform and development’ drive ahead of the elections, particularly in respect to the loan restructuring of state electricity boards, clarity on coal blocks, divestment of public sector undertakings and the fast-tracking of large infrastructure projects.

What are your earnings estimates for India Inc for FY13 and FY14? Have overall estimates, as well as those of particular sectors, seen an upward or downward revision?
We anticipate 9-10 per cent earnings per share (EPS) growth for the Sensex for FY13, and 12-13 per cent EPS growth for FY14. For the MSCI index, we anticipate 11-12 per cent growth for FY13 and 13-14 per cent for FY14. Overall, our estimates have been scaled down, in line with the earnings ratio downgrades in the past few months. That said, Indian markets are now showing signs earnings ratios are bottoming out, with downgrades now running at a snail’s pace. We have made some downward adjustments to our EPS forecasts in the materials, telecom, utilities and information technology sectors.

Recently, defensive bets have fared quite well. Do you see the momentum continuing, or should one look at high beta names? If so, what are the sectors and companies one should consider, from a year’s perspective?
Given the strong performance of Indian markets after previous global liquidity easing measures, we are now looking towards higher beta sectors. Fundamentally, steps by the US Federal Reserve and the ECB have inspired another episode of ‘risk-on’ trades. So, we expect foreign and domestic investors to focus less on defensive sectors.

We believe stocks in consumer discretionary, automobiles, banks and public sector undertakings geared to infrastructure capital expenditure spending would be a rewarding way to play the boost in Indian markets. We also expect these stocks to fare relatively better in the post-correction period.

It may be worthwhile screening for cyclical stocks trading at cheap valuations, relative to history and the market, which may be ripe for picking from a relatively longer-term perspective.

In April, when we spoke last, you were underweight on the financial services and capital goods sectors. Are the order book positions in the capital goods sector and the non-performing asset levels of banks still a concern? Do you see any scope of improvement over the next few quarters?
Being underweight in the financial services and capital goods sectors in the first half of the financial year served us well, as we were about to limit our exposure to the sharp earnings downgrades and the generally ‘risk averse’ global investment climate. That said, we are mindful of the likely over-reaction in the Indian markets to the earnings downgrades and earlier episodes of ‘risk aversion’.

Now, it is likely there is some light at the end of the tunnel, particularly if the government continues with its ‘reform and development’ agenda and more global liquidity easing measures encourage greater and more stable risk-taking by institutional investors.

Which are the companies within the new allocation you are overweight or underweight on?
We have made some changes to our portfolio to reflect our preference for cyclical sectors in the aftermath of the recent global liquidity easing measures. We have now moved to an overweight stance in the consumer discretionary, healthcare and industrials sectors, while maintaining an underweight stance in the consumer staples, energy and information technology sectors.

Please identify the stocks in these sectors.
Mahindra & Mahindra, Maruti Suzuki India and Tata Motors in the consumer discretionary space; Dr Reddy’s Laboratories, Ranbaxy Laboratories, Glenmark Pharma, Wockhardt in the healthcare pack and BHEL, Cummins India and Larson & Toubro in the industrials segment. Sugar, cement and fertiliser stocks have the potential to provide good contrarian trades in the current global climate.

How do you see the commodities space panning out in the remainder of this financial year?
We continue to expect commodity prices would be supported by pro-growth liquidity easing measures (with the exception of bulk commodities---iron ore and thermal coal---as these would continue to be leveraged to expectations on China’s fixed asset construction growth). With respect to agricultural commodities, we expect we would continue to see robust prices, reflecting crop production issues emanating from the drought in North America.

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