Jyotivardhan Jaipuria, founder and managing director, Veda Investment (Source: BloombergQuint)
Jyotivardhan Jaipuria, founder and managing director, Veda Investment (Source: BloombergQuint)

Equities Stand To Gain As Economy Goes From Black To White: Jyotivardhan Jaipuria

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The case for equities will only get stronger as India moves towards to an economy which is more white than black and the Goods and Services Tax (GST) is implemented, says Jyotivardhan Jaipuria, founder and managing director of Veda Investment on BloombergQuint’s weekly series Thank God It’s Friday.

He expects equities to trump real estate and gold as the preferred investment destination for households in India.

Here are edited excerpts from that conversation.

Nifty and Sensex are currently trading at lifetime highs. How much higher can the indices go, at least in the short term?

How much more is always a question of “when” we are talking about. Because even though the indices are at lifetime highs, essentially for the last two years the market has done nothing. So we were more or less at these levels in the beginning of 2015 also. Markets have been consolidating in the last two years because before that we had a major run in the market. And so maybe in near term we could possibly see a consolidation phase, we’ll see a correction. But 2-3 years later, we’ll probably be much higher than where we’re today.

What can trigger the correction you spoke about? Do you see any geopolitical risks? The U.S., for example, just launched a missiles strike on Syria which drove oil prices higher and higher oil prices is bad news for the Indian market. Do you think the market could use some of these events as correction opportunities?

I think a lot of the correction will be global. If you see the current rally, even though it seems like an India rally, it’s an emerging market rally where India is a participant. A lot of the correction will also be global where emerging markets will come off. If we step back a bit and see, from 2008 to now, there were two-three things which were happening. One is that growth was missing. Second, liquidity was aplenty and all central banks were expanding their balance sheet and they were cutting rates. Third, it was a very synchronised move by central banks across the world. This year, we’re going to see a lot of that start to change. So we’re going to see some central banks cut and some central banks start to tighten. The U.S. Fed will start to shrink their balance sheet and hopefully we’ll also see growth coming back. For me, the most critical part is if liquidity goes off but growth starts coming back, then it’s great for markets because then we finally get the earnings we’ve been waiting for. But where the markets will correct probably is, one, I think is political – it’s not the Syria strike which I’m worried about because that normally is an event which people tend to forget – but Trump’s ability to get tax reforms through both houses because after the fiasco on Obamacare, that’s a bit of a question mark. The second could be Europe. If something goes wrong in the French and German elections – the lesson from last year is a lot of these things tend to go differently from what the markets expect – then you could see some turmoil in Europe which will lead to a correction.

The state elections are out of the way. GST implementation has more or less been factored in. Are there any other risks that the market is currently not factoring in such as the monsoon season?

Every year and we treat the monsoons as a big event. If we see a correlation in the last 15 years – take a poor monsoon season and how the market performed – you’ll probably find there is no correlation. So it’s something which everybody wants to talk about, it’s important, but we probably make it sound more important than it actually is. Ultimately, what we come back to is that we’ve had very benign inflation but RBI has a very stiff task on inflation, they want it down to 4 percent. To that extent, one risk is inflation spikes up. The other risk is a short-term risk. GST is great for the long-term but probably in the next few months we are going to see some disruption in trade and industry. There will be a de-stocking. The macro-numbers may not look very good. Those are the things one needs to keep an eye on.

The recent rally is also said to be driven by domestic flows. In the month of March we’ve also seen foreign portfolio flows return to emerging markets but domestic flows have been the key drivers. Do you think that’ll continue?

Yes, I think domestic flows will keep becoming a bigger and bigger part of the market and that’s probably good because if we see FPI flows, they account for 45 percent of the free float. So the Indian market is very vulnerable to what happens globally. It has a very strong correlation with emerging markets. So if domestic flows get bigger part, at least this correlation will come down a bit. Domestic flows are probably here to stay because of two things. One, real estate and gold used to be two places investors would flock to and both are not looking as good as they have in the last many years. With demonetisation and GST, we’re moving to an economy which is more white than black. Part of the reason for investing in both these segments earlier was people had black money and once that eases, people can invest in equities. The other is, interest rates are coming down. They may go down even further from these levels, but they are already low. To that extent, the case for equities gets better. Ten years later, equities will probably account for a much bigger part of household savings than it does today.

What are your expectations from fourth quarter earnings and what are the key themes where you would expect outperformance?

Nearly half the earnings come from outside India. They have nothing to do with India, they’re basically global commodities or stuff driven globally. The key is to see whether the India part of the earnings is going to go up, and that’s my real theme, that over the next two years we’ll see the India part doing better than the global part. And demonetisation led to some slowdown at the retail level. The third quarter probably didn’t reflect it because the listed companies which you look at, the manufacturers managed to sell to the dealers. So the fourth quarter will probably be a little weaker for the domestic players than the third quarter was. But there will be some areas such as global commodities which will do better. I think we’re again headed for single-digit earnings for the fourth quarter.

On an aggregate basis, when do we see relatively robust numbers? If you expect GST to disrupt earnings to an extent, it will be another 1-1.5 years before we see double-digit growth?

This has been like ‘crying wolf’. For the last 8 years, we have been saying earnings in the second half of the year will be better but that’s never really come through. I have been a little more sceptical than probably the Street on earnings. Again we are starting with the assumption that FY18 will see a 17-18 percent earnings growth. I think we will see downgrades from that number but I am hoping that FY18 will end with at least low double-digit growth. Probably by the time this calendar year ends, I think we will have more robust numbers for the quarter because by then GST will be out of the way and people would have gotten used to the system. In addition, the base would be favourable owing to demonetisation. So the December quarter and the two to three quarters after that will see double-digit growth. We may end up with around 15 percent by the middle of next year.

How are you viewing sectors which are linked to capital expenditure? Are you looking at some amount of revival there and how do you see them from an investment point of view?

I like the sector but I don’t believe we’ll see a revival in capex, at least not in the next I 12-18 months. Some part of the capex is improving. The government is emphasising on some areas such as roads, construction, maybe defence. The part which is not improving is power generation. If we go back in history, power generation used to account for a third of the total infrastructure spend. And that part is not going to improve for quite some time. What we are really playing in capex, and the reason I like it, is that some of these elements which are improving, you play companies which are geared to that. Second thing to remember is that from the manufacturers of capital goods are all sitting on capacity. They are not going to expand in a hurry. So even if they get an incremental 10 percent growth in sales then leverage is huge. And ultimately, we play earnings. So then the operating leverage is huge. It’s a small increase in topline but a lot of it just flows to the bottomline because the fixed costs are already sitting there. So I think some of these companies will surprise on earnings. The ownership is very low in these sectors. And that’s why my view is the low P/E sectors which have underperformed for the last few years may do much better than the high-quality, high PE sectors.

The public sector banks ended with gains after the Uttar Pradesh farm loan waiver announcement. This has implications on credit discipline and possible contagion. Are markets not factoring in a potential downside or is the optimism with respect to non-performing assets (NPA) way too high?

For the market, there is some resolution coming in on the the NPAs and that is critical. If you actually get resolution on the NPAs, you can get some more capital for these PSU banks and that is great. Then problems are solved and we can get rolling in the economy. There has always been a lot of talk and when the resolutions finally come, they are disappointing. We will probably end up with a similar situation.

The farm loan issue has been ignored a bit because the net impact on banks is zero in some sense. It’s all been taken by the government. The reason I think it is still negative is what you are doing is giving an incentive to the farmer to never pay money back. The moral hazard is that there will be a farm loan waiver every two to three years. The only loser is the person who paid the farm loan back on time. He will think that he lost out totally.

Do you prefer private banks to state-owned ones?

That has been a very standard trade. We have also invested in private banks. We didn’t do enough in PSU banks which in the last six months have done very well. At these levels, I do not like PSU banks because, to some extent, the bond rally played out in the third quarter but it has reversed in the fourth quarter. That will hurt them. Things like loan waivers are never good because those who are paying on time will look for waivers and never really pay on time.

NBFCs weakened substantially on account of demonetisation. Stock prices have recovered since then. What does one do with sub-themes in this sector?

Taking of on the old conversation of loan waiver, it does not hurt the banks but where it may start hurting is the microfinance companies. That is a segment I would get worried about owing to loan waivers. I would be cautious on them. There are some other NBFCs we like which are more geared towards lending in certain other areas. It’s a toss-up between the private banks and NBFCs. I would say we are 50-50 in both of these areas.

Where do you see buying opportunities now?

The way we run our portfolio is that we look for the three ‘U’s. We look for ideas which are undervalued, under-owned and under-loved. We try and look at what will be the big themes 12 months from now. That’s the reason I said these high price-to-earnings stocks are of very good quality but they have had a great run. As the economy turns, people start thinking these are the stocks which are not going to give me big delta. Let me go to the delta. That’s the reason we like infrastructure and capital goods companies, some names in auto, banking and NBFCs.

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