Continued correction in market could reverse ex-SIP flows

Indian benchmark indices like the Sensex and the Nifty were the best performing indices globally this calendar year, but a weakening rupee and rising bond yields could upset the Indian equities apple cart. The local market may get into the correction mode as the domestic liquidity is getting squeezed, which have been sustaining the market so far. But for this correction to be short lived, the government needs to give more comfort on macro and level of rupee at which it is comfortable, said Viral Berawala, CIO, Essel Finance, in an interview with Ashwin J Punnen. In a worst-case scenario, he expects the market to bottom at a PE of 18x FY20 EPS, which translates to 10,800 on the Nifty. Excerpts:

How do you see the rupee’s record fall affecting the market in the medium-term?

The premise that a weakening rupee should increase the competitiveness of the domestic industry is valid since exports tend to benefit from a falling exchange rate. But a sudden steep fall in the currency could spook the market as it may shake the faith of investors in the economy.

Is the macro economic situation at risk due to fall in rupee and rising crude prices?

Depreciating rupee runs the risk of increasing domestic inflation through costly imports. This along with rising crude oil prices will be a double whammy once the exchange rate is considered. Oil marketing companies have so far been passing the cost to consumers through fuel price hikes. India is the 3rd largest importer of crude and as fuel permeates almost all sectors of economy, retail inflation is likely to rise. A sharp rise in inflation will be detrimental to growth, especially when investment is just reviving. The Reserve Bank of India (RBI) estimated in its monetary policy report in April that for every 5 per cent fall in rupee, retail inflation will increase by 20 basis points. Rising crude prices could also lead to the government missing their fiscal deficit target of 3.3 per cent of the gross domestic product (GDP) forcing the government to cut capital expenditure as it has happened in previous years.

Which sectors are going to gain or suffer die to rupee’s fall?

Major sectors to benefit from the rupee’s fall would be export-oriented sectors like IT, pharma and textiles. The sectors to be worst hit would be oil marketing companies and electronics & engineering.

How is the rupee’s fall going to affect Indian companies?

Information technology (IT)  companies like Infosys, TCS and HCL, and export-oriented pharma companies like Cipla, Sun Pharma and Aurobindo should benefit from the falling rupee. Oil marketing companies’ margins may take a hit if the increasing crude import cost is not passed through with increasing fuel prices. Some auto companies with import content, like Maruti, will see some impact on margins while rising gold import prices could impact sales of jewellery companies like Titan.

Do you expect earnings downgrade to rise in the coming quarters?

We don’t see material downgrade in earnings in the next few quarters primarily because the corporate earnings trend is showing some improvement after the double-whammy of demonetisation and GST, certain indicators like credit growth has started showing signs of improvement, and the NPL cycle is close to peaking out. With majority of the Nifty earnings being driven by banking, consumption and IT, we don’t expect any major cut in earnings.

Is the market getting into a correction mode? How much downside do you expect for the Sensex and the Nifty?

The Nifty has been one of the best performing indices globally this calendar year and is trading at a PE of close to 20x one-year forward. Weakening rupee and rising bond yields could upset the apple cart in Indian equities leading to outflows in domestic flows, which have been sustaining the market so far. So, to say the market might be getting into a correction mode but for this correction to be short-lived, the government needs to give more comfort on macro and level of rupee at which it is comfortable. In a worst-case scenario, we expect the market to bottom at a PE of 18x FY20 EPS that translates to 10,800 on the Nifty.

How should investors approach the mid- and small-cap space? Are the valuations reasonable after the recent correction?

In case of a weak macro, mid- and small-cap companies would be the first ones to take a hit. Signals that are emerging suggest that one needs to be stock-specific in this market. Though there has been some correction in the mid- and small-cap space, we are still some distance away from having good margin of safety to be bullish on mid-and small-cap space.
Do you expect the foreign flows to get tightened? Will domestic flows into equity moderate after correction?

India has been “remarkably resilient” in the recent turmoil in emerging market equities, largely driven by macro stability, low policy uncertainty, improving growth and domestic flows while FPI flows have been on a downward spiral.

The continuing uncertainty on macro front, elections and risk of other emerging markets outperforming India could lead to foreign flows getting further tightened. Domestic flows have been strong as we have not seen a sustained correction over a period of time and have also been backed by stable systematic investment plan (SIP) inflows. Continued correction in the market for a few months could lead to these ex-SIP flows reversing.

Which sectors are you bullish on? Are there signs of pickup in consumption demand?

The auto industry is on a strong footing. While demand is broad-based across markets, rural India appears to be doing particularly well, which is reflected in sales of two-wheelers and tractors. Companies such as Maruti Suzuki and Ashok Leyland are taking advantage of stronger demand by passing on higher prices to consumers.

Another bright spot is the sector for fast-moving consumer goods. It’s recovered well from the demand-disruptive and chaotic introduction of the goods and services tax (GST) last year. Additional support for the sector is seen coming from higher wages for millions of government workers as well as expectations of a recovery in farming due to higher guaranteed prices for some crops and a pick-up in public spending ahead of elections. So far, there have been signs of consumption recovery in the economy due to stable macro and pro-consumption policies of the government before elections.

Ashwin J Punnen