Would Be A Big Buyer In Financials If Stocks Weaken Further From Here: DSP BlackRock

First of all, it’s a great move for the country in long term, there’s no question about it. In the short term, I’d say there would be a decline in demand, maybe for two quarters but after that I expect things to normalise. Longer term, I think the benefit will be that as you see more of the parallel economy shift into the mainstream economy, the GDP goes up, tax revenues go up, fiscal deficit declines to that extent, all of that will be hugely beneficial for the economy I think. As far as corporate earnings are concerned, for fiscal year 2016-17, the estimates initially were 15 percent, then they got pushed down to about 12-13 percent. Maybe that number comes down to 8-9 percent based on the expected decline in consumer demand in the next 3-6 months. For fiscal 2017-18, initially the expectation was for earnings to grow about 20-22 percent. Perhaps in the next month or two, analysts will downgrade those expectations down to 17-18 percent. But that’s still some time away. The impact in terms of stock prices and sectors will largely be in the consumer discretionary sector, to some extent financials, possibly autos. But I think the compression in demand will be short lived. Even if you assume it lasts till March, I think that as you look into fiscal 2018, things should normalise and we should be back on track of accelerating corporate earnings as we look into fiscal 2017-18 and fiscal 2018-19.

The immediate impact is obviously that the amount of small change to conduct daily transactions is a problem area but that will improve and normalise as you get more small denomination currency back into circulation. So maybe that resolves in the next couple of weeks or a month, at most. In terms of the hit to sentiment and decline in demand, that also should not last for more than six months at most I think. It may as well normalise after 3 months or so. I am hopeful that things will normalise latest by March and I look forward to fiscal 2017-18 with a greater degree of optimism in terms of demand improvement.

As far as land prices are concerned there are some views that prices will fall which is not a bad thing. If you do have a decline in real estate prices, what you will likely see after some time is that affordability increases and demand comes back. So maybe prices will remain flat-to-down, I think sales volumes will likely increase and that’s not a bad thing at all from a demand perspective.

Prior to demonetisation, I held this view in early 2016 and even in the middle of the year, that the fourth quarter of the year would be somewhat tumultuous for the global markets. Largely due to global factors like the possibility of a Fed rate hike in December, the referendum in Italy that would have ramifications in the euro zone, U.S. elections, general anaemic demand in some of the large economies, etc. And certainly, as we entered October, markets were somewhat tumultuous globally and I felt that these factors were having significant impact on the market sentiment globally. As we look ahead, some of those factors still remain. There is the possibility of further turmoil based on the outcome of the Italian referendum in early December, and the U.S. Fed may likely hike rates.

My own view is that if there is considerable market turmoil, they (the Fed) may actually hold back. But that’s my personal view. Considering that bond yields in the U.S. have gone up quite significantly, the dollar has been very strong – and that was also another view I had that the strength of the dollar would cause a fair bit of currency volatility across the world in the fourth quarter and the first quarter – that in itself, would have some ramifications for equities around the world. As I look ahead, it is going to be tumultuous because of all of these international factors and we have to brace for volatility both on the currency front and as well as in equities from a global standpoint. Now, specific to India, in addition to these global factors, we have the issue of demand slowdown in the near term due to demonetisation. So I think It could have some bearing on equity prices. They could remain weak for some time before you know people say hey, as we look into fiscal 2017-18, stock prices are looking quite attractive and we have some kind of a nice rebound in the early part of the next financial year next year, that is, April-June quarter of next year.

I don’t think retail investor flows, whether it be lump sum or SIP, will be impacted by demonetisation. These are all payments that are made by investors. In case of SIP it’s a monthly payment through banks. These days the banking system’s efficiency is excellent in terms of electronic transfer of funds etc. So I don’t see that being impacted. I think investors, if they need to finesse the investments they make, will make a determination on near-term stock prices. If prices keep declining or the index keeps declining, they will take a view on it. But, by and large, what I have noticed is that SIP investments are pretty steady and retail investors are fairly disciplined in their investment approach. So I don’t see too much impact on retail investor inflows. The margin may be a little bit more or less but by and large what we have seen in terms of healthy inflows over the last two years, I think will continue.

In the near term, there has been a huge increase in deposits and the credit demand is weak. So that money are being invested by the banks, I presume, in short-end treasury bills and long-term government bonds which has pushed the yields back down. There is also talk that because of slowdown in demand, inflation will be lower and it will possibly result in a rate cut. My own view is, that at the same time, we have to consider whether the volatility in the currency can cause more than normal selling of bonds held by foreign portfolio investors if especially they respond...currency volatility more than the possibility of a rate cut considering that in the past month or so we did see a fair bit of selling by them in the bond market. That’s one issue. But the question is if you will possibly get a 25 basis point rate cut. I earlier thought in the first quarter, that maybe we get it in December itself or sometime in the next three months or so. To those who say that we will get a 50-75 basis point rate cut, I think that’s a bit too optimistic.

I don’t think I have too strong a view on the rate cut trajectory. I’d say near term, anticipate another 25 basis point cut. I would not be too optimistic about a bigger cut. Also in terms of this liquidity coming into banks, we have to see how much of this liquidity was in hands of individuals or small businesses as precautionary liquidity. If you had Rs 50,000 and you deposited it into the bank, now you can only withdraw a part of it. Once it is allowed you’ll probably withdraw all of it because it was your preferential liquidity, that you held with you. So whether some of these deposits remain or they all get withdrawn over time just because businesses and individuals need that liquidity in hand remains to be seen. Therefore this compressional yields is warranted given the amount of deposits that have come in and the fact that credit demand has been somewhat lacklustre but I think that a 25 basis point cut, in my opinion, will happen in the next 3 months. But for someone to argue that yields will continue to go down further from here, I would not entirely agree with that. I think they will bottom out around the current levels.

I think financials have done very well in the past few months. They are facing some weakness in the near term. If they weaken a little more, I would be a big buyer of the financials sector. Because as I look ahead into fiscal 2018 and fiscal 2019, I do see GDP growth rate accelerating and earnings improving year after year. And what we’ve often noticed is that as the economy does well, the financial sector does well…generally does better than the bellwether indices. So I think if you see some weakness, be confident and buy equities, take a two-year review, that’s the first point. Second is, within the marketplace, financials, to my mind ought to do better than the bellwether indices especially if you get them even a little more cheaper than what you’d have to pay now. Then would be autos, where again, because of this drop in demand, if stock prices correct more than warranted, then I think it would be a great time to buy. Again, this is from a two-year point of view, one can’t say you want results in 6-9 months. That may or may not manifest. Consumer discretionary has been hurt again. If you do see disproportionate selling and again, if you’re as confident as I am in my outlook in the next 24 months, then you can buy it.

Well, there isn’t much. Commodities for example, still have a period of weakness ahead of them. We had some weakness, then we had a period of rebound. I think the world economy in general is looking weak. If you look at the developed markets as well, the growth is patchy here and there. Unless they resort to big-ticket fiscal stimulus, which is still sometime away, I would say that the outlook today is of anaemic growth and to that to me implies weaker commodity prices.

You’re talking of the Indian fiscal stimulus? I was referring to the fiscal stimulus in the U.S. of which a lot has been talked about, and also in the Europe. Monetary policy is not really proving to be that efficient incrementally so why not look towards fiscal stimulus. And I think bond markets around the world have reacted to that even before such a plan has been announced. Bond yields have gone up in the U.S. from 1.7 to 2.3 percent. As far as India is concerned, we do have a significant amount of government spending in infrastructure already. If you notice, the consumption part was chugging along okay. As far as investments were concerned, private sector capex was anaemic. In fact people said it will take 12-18 months before it picks up again. But the offset was the significant government spending in the areas of railways and roads and so on and so forth. I think you will see more of it in the next 12-24 months even as we wait for the private sector capex to pickup, which is already happening in India.

See, the view I had at the beginning of the year when I spoke to Bloomberg, also in the middle of the year when I spoke at another conference, was that if you take a 2-3 year view, I thought, the price performance of public sector banks ought to be relatively better than a private sector bank. Both will do well, but this is from a price performance view. Reasons were that they are under-owned from price-to-book point of view or any other valuation metric. Yes, they had they had the issue of non-performing loans but they were receding incrementally and the intensity of the write downs would be less and less. More importantly as we looked ahead in the next 2-3 years if the demand picked up, you would focus more on interest margins as opposed to the NPL issues. Two other points I made which I repeat now - one is that the customer base of PSU banks is huge even though the unit volume of business done by customers may be much less than what you see in private sector banks. I thought that customer franchise was unappreciated at a time when all these banks were improving their digital platforms. It’s one thing to say that we’ve got a million customers, they have small balances and have to come to the branch. There’s only so much you can do in terms of business and customer service. But once you move to the digital platform, you’re able to interact with your customers more often. They also have it easier, they’ll probably transact more, is what I had in mind. Now you see these articles in newspapers today, they are ramping up these stories. The digital platform is not the unique preserve of one of the other banks, everybody pretty much has it, some more efficient than others. I think customers are embracing it, and after demonetisation I am sure more and more customers will take to these internet banking and mobile banking. That will increase the volume of business done, engagement with the customers, possibly higher fee income, and all that will be better appreciated in the price performance of PSU bank stocks.

Let me give you the near term and the 2-year plus view. In the near term, given all the risk factors and other issues that I see internationally, plus the possibility of a slowdown in demand lasting 3-6 months, you should prepare for some more downside, could be 5 percent, could be 10 percent from current levels. You should use that decline to buy equities and don’t miss the opportunity. Any correction should not be missed and used as an opportunity to buy. If you fast forward to two years later, late 2018, I think the markets ought to be much much higher than where they are. One could argue that once the base growth picks up and the earnings growth begin to show improvement, you could look back at the 3-4 year chart of earnings growth in the corporate sector. To my mind, there is a reasonably good probability that we could be trading at 18-20 times by fiscal 2017-18 or fiscal 2018-19 earnings, is my opinion at this point of time. So I am very bullish two years out but in the near term prepare for more weakness,  but use that weakness to buy.