Sanjay Mookim, India equity strategist at Bank of America Merrill Lynch, tells Puneet Wadhwa that this is not a time for investors to dabble in relatively small and illiquid stocks.
Your outlook for the markets?
There are two elements to how the markets will perform. The first one is the economy. The underlying economic drivers are looking good and the economy has begun to improve.
Over the next two or three years, it will be in much better shape.
The second element is the market itself, which has rallied on account of the global equity rally. There is significant flow into emerging market (EM) debt and other EM assets.
The correlation of Indian with EM equities is almost 100 per cent. While we are hopeful that the Indian situation will get better, the risk to prices is that the global rally might turn around. It is difficult to predict when this will happen.
Prices and valuations are never an indicator of timing but are good indicators of risk. If one is a long-term investor, this is not the time to add risk.
Investors should not dabble with relatively small, illiquid names. If there is a correction, such stocks will be hit the hardest.
Our recommended portfolio is defensive, less-risk styled.
While the economy is likely to do well in the next 18 months, the markets are susceptible to a correction. We have a December 2017 forecast of 30,000 for the S&P BSE Sensex. This, we think, is the fair value for the index.
How long can the global central banks continue to pump in liquidity?
The US Federal Reserve will start to unwind the balance-sheet to some degree. Logically, the central banks' monetary expansion cannot continue for long.
A large part of the global equity rally is based on the assumption that the quantitative easing taper is not happening anytime soon and will not be meaningful in size. That said, there can be many catalysts for a global risk-off.
For instance, a geopolitical event or a banking event that can play spoilsport. Which event catches the fancy of the market and triggers a risk-off will only be known in hindsight.
So, how do you see flows to the EMs? What about India?
External flows are linked to the external risk appetite. Investors, world over, are chasing growth and India is a prime candidate in this context.
We believe India can deliver on the growth promise and the visibility of growth is reasonably high.
In a low cost-of-capital environment, growth tends to get a premium.
While FIIs (foreign institutional investors) have withdrawn money to the tune of $3 billion recently, domestic flows have been supportive. This comes on the back of the government tweaking the debt segment norms to assess long-term and short-term capital gains.
The other thing that has changed is that inflation is low.
In such a case, money can go back to the debt segment. I believe liquidity strength cannot be the sole justification for high multiples.
One needs to take a more fundamental perspective here in terms of valuations and earnings. The argument that valuations are high on account of liquidity can turn on its head very quickly.
Your expectations from the coming results?
The second half of the fiscal year should be better. The first half was destroyed due to GST (goods and services tax) implementation.
The July-September quarter will also see a transition impact to GST. Activity levels in the economy might not be normal yet.
In the second half of FY18, we should get a bump-up from seasonal sales.
To cater to this, there has to be a restocking of goods. I don't think GST needed shopkeepers to destock, but it was a conservative reaction.
There should be some support from rural consumption and some (positive) impact of farm loan waivers.
The performance will also look better due to the low base in previous corresponding quarters. Arithmetically, we will see better results from India-focused businesses in the December 2017 and March 2018 quarters.
Growth in earnings should settle between 10 and 15 per cent year-on-year (y-o-y) in FY19. Earnings growth in FY18 should be 12-13 per cent.
Your overweight and underweight sectors?
We are overweight on financials, consumer staples and cement.
We are underweight on the information technology (IT) sector.
We, as a house, do not see a turnaround anytime soon in IT, as we are concerned about the recovery in demand.
Photograph: Shailesh Andrade/Reuters.