Recovery is on, but don’t expect corporate earnings to race ahead at 20 per cent plus, says Anand Radhakrishnan, CIO - Equities, Franklin Templeton India.

What is your reaction to the US Fed’s decision to hold rates? How will this impact foreign fund flows into India?

 The Fed’s decision seems to have more to do with global factors than the US economy.

Prior to this event, FT’s view was that economic conditions in the US were right for a hike. Many different kinds of foreign investors bet on India.

We have already seen some unwinding of the global dollar carry trade before this meeting. Then, there are event-led funds which invested ahead of the elections and may look to book profits now.

Globally, the bigger trend is that the emerging market story seems to be unravelling. Many emerging nations are either exposed to China or to the commodity cycle, both of which are going through a challenging phase.

Currency volatility in some EMs has been high. India too, as part of the EM basket, has suffered outflows.

Confusion around MAT, which has now been withdrawn, also impacted flows. Once this phase is over, investors may re-allocate to country-specific funds.

They may prefer commodity users like India. But this will take time to play out. 

There’s quite a bit of scepticism today about economic recovery. Does the fall in crude oil prices change the situation?

The math behind the crude oil price fall is very powerful. The government’s net revenue from the oil and gas sector 10 years ago used to be 2.5 per cent of GDP. When crude oil shot up to $100 a barrel, the revenue fell to 0.5 per cent of GDP.

But if you do the math at current crude oil prices, the government is now set to earn net revenues of 1.3-1.5 per cent of GDP.

That’s a lot of additional fire-power on spending. This is one reason why we feel confident of economic recovery. Clearing up the business environment has also helped the Index of Industrial Production, which was oscillating around zero per cent, pick up to 2-3 per cent.

Sensex earnings growth estimates, earlier at double-digits, are now being slashed. When will they recover?

Commodity companies have a significant weight in the index and this is muting the earnings revision story. Structurally, commodity prices may remain low over the next two-three years. In the earlier cycle, India’s earnings recovery was magnified by commodity prices rising sharply. We cannot expect that now.

So, for India to get back to 25 per cent earnings growth is out of the window at this point in time. But the earnings outlook for non-commodity companies is improving because of the fall in material costs.

With low WPI inflation, top line growth has to slow, but profit growth will be much higher. This is the converse of what happened in the last five years, when topline growth was 13-14 per cent but profit growth was only 7-8 per cent.

Are market valuations too high, with the Sensex PE over 20?

There is no science behind index valuations. It is better to assess valuations sector by sector and make comparisons with global peers. If you do that, you find very expensive stocks co-existing with cheap ones in many sectors. If you believe that the economic outlook is improving, there’s plenty of buying opportunity. But if you don’t, valuation is a concern.

Too many investors have been chasing ‘quality’ firms with zero debt and strong brands. Are they too expensive?

Yes, the pendulum has swung from one extreme to another. In 2007-08, cyclicals were at high valuations.

But the pendulum can probably not continue further up. In the recent weeks, we have seen defensive names correct. The market seems to be imposing a limit on their PE expansion. So, the quality trade is not yielding any upside now. But the cyclical recovery trade is yet to gather momentum.

So, while selecting stocks, do you prefer cyclicals or defensives?

We don’t swing one way or another. We look for profitability, quality and sustainability in any firm we buy.

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