While 2015 has disappointed the markets, the New Year could be better if the government and the RBI loosen the fiscal and monetary policies.
2015 has been an eventful year. What are you expecting from 2016?
2015 in some sense has been a year of disappointments. We started the year with lot of hope and expected returns but near the end most of these expectations have not been met. In fixed income space, we saw policy rates coming down, but not getting converted into market yields coming down and hence the expected returns were coming more from carry rather than capital appreciation, which was the hope. In the equity space, we were hoping that index will continue to do well on the basis of what it did in 2014 where it delivered fantastic returns. The expectations were also supported by good macros and even continue today. But good macros did not get converted into bottomline and the stock prices. Yes there were exceptional returns in the midcap front, which delivered great performance. But overall equity fund return was less and could not have met investors’ expectations.
In 2016, certainly the number and quantum of policy rate cuts would be far lower than what happened in 2015. It will not be wise to accept that policy rates will go down by another 125 bps. So to that extent we will have to focus far more on carry rather than capital appreciation in the fixed income place.
Which means credit accrual funds will do better than gilt and bond funds. In case of equity, today midcaps, after two years of great performance, are trading at a valuation which is higher than the large caps. So from the valuation point, large-cap and multi-cap funds should do better than the midcap funds. Few midcaps will do very well but I am talking about portfolio of midcaps which, after two years of performance, may probably consolidate rather than continue a hat trick of good performance. It is far better to invest in gold bonds which give a coupon of 2.75 per cent. So, gold bonds might be better than physical gold. In real estate, it is far more location-specific but overall environment of real estate portrayed a picture that the luxurious segment do not give returns but affordable housing or the bottom end of the market may still provide little bit of return.
We have seen a good amount of support coming in from the domestic investors itself last year. Will that continue in 2016? Do you think there is still a strong case that local investors will come to the equity market?
We hope and believe that domestic investors will continue to participate in the equity market but now we can’t take them for granted. We will have to work very hard to engage with them and retain their confidence. In the last 18 months, we have received more equity flows than what we received in the previous 10 years and certainly in last 18-24 months flows haven’t got the returns, which they expected when they were investing. Now we need to engage with them. If they redeem today because their expectations have not been met, they will go back as unsatisfied consumers. We can’t afford that.
How does the case of earnings really play out?
Recovery is far slower but definitely is in place. Let us first understand the reasons why the recovery has been slower than expected. Last year, the Sensex earnings estimates have remained the same. This is primarily driven by a couple of factors.
The first factor — India followed fiscal tightening policy. We brought down our deficit from 4.9 to 3.9 per cent of GDP between FY13 to FY16. This tighter fiscal policy, in order to bring our house in order, is obviously good for government finances and ratings of our country but the industry paid short term price for the same. The RBI also wanted to control the inflation and for that they followed a tight monetary policy.
We have seen whole of 2015 with negative WPI inflation, for the first time in our history, we are seeing nominal GDP which is below real GDP.
So the tight monetary policy also had an impact on economy and corporate earnings. This tight fiscal policy, tight monetary policy, high interest rates and delays in project execution impacted our corporate earnings recovery cycle. Which is why now if we need to see corporate earnings recover, we need to follow slightly looser fiscal policy. We should be little more accommodative. The RBI set the trend by cutting interest rates now. Banks should transfer it to the borrowers.
We need to provide liquidity to the economy to that the tightness in the economy loosens. So, accommodative fiscal and monetary policy along with the government spending can create this corporate earnings recovery.
The private sector investment because of high debt, high interest rate and delayed projects, are on the back foot. It is only the government that is spending money from the savings of oil price and other targeted subsidy. We need to accept that this revival will be slower but a gradual one.
Out of the factors you mentioned, which ones will actually play out in 2016 and why?
One, the interest rate cuts (of RBI) should be transmitted to the borrowers. The RBI has been working very hard on it and has changed the base rate formula. So, interest rate transmission will happen faster in 2016 — may be in the first half itself. Fiscally, the mid-year review has talked about government becoming more accommodative.
They also realise the situation that while it is important to control the deficit, it is also important to ensure that the growth is maintained. The third thing is the ease of doing business, which will encourage entrepreneurs to set up new projects and revive investment. Unless these three things come together, the private sector investment revival looks a bit difficult. Today, the economy is running only on public spending.
What are the themes of 2016?
In 2015, we learnt that within a sector there is a strong divergence.
etail-focused private sector banks did extremely well but corporate sector private banks did not do as well. The PSU banks actually underperformed the market substantially. The metals and commodity space got hammered out but within that steel and aluminium got far more hammered than zinc. Clearly it is far more stock specific calls rather than sector specific calls. But within that limitation of finding the right stocks within the appropriate sectors, we think there are certain themes that are worth playing on. The first is government spending. Where are they putting their money — roads construction (construction stocks multiplied 3-4 times), railways, defence, ports and ‘Make in India’. Companies which are focused on these will do well. The second spending of the government will be the implementation of 7th Pay Commission.
About 0.7 per cent of GDP will be put into the hands of the government employees. Certainly, this money will be spent on some things — it could be automobiles, consumer durables and affordable housing. So, this is the segment worth capturing.
The third is the proxy to government spending — basic materials like cement might benefit from affordable housing boom as government employees spend money on housing. One dark horse which we will focus on is rural consumption related sectors. We hopefully we will see a good monsoon. And that could provide a solace to rural consumption.