ET Now
ET Now caught up with Navneet Munot, CIO, SBI MF, for his take on the current market scenario, economy, global liquidity and some sectors. Excerpts:
ET NOW: Technically, we have all the signs and signals of a bull market. Fundamentally, do you think a new bull market has started?
Navneet Munot: Yes, it started a couple of quarters back. Earlier, there were signs of macro bottoming out, people had concerns on the current account side, currency was depreciating, and there were concerns on the fiscal side. After serious efforts over the last one-and-a-half years, currency has stabilised significantly on the fiscal side, reducing the deficit. So overall, macro has bottomed out and that has played a big role in reviving the confidence. There are expectations from the political perspective to unleash better execution of policies. Going forward, we can look at the overall recovery in the economy.
ET NOW: The markets are always a forward-looking mechanism, but some would argue that a lot of good news and a lot of key assumptions are already in the price because we are at 6800 on the Nifty. What are your views on that?
Navneet Munot: The markets are always forward looking. If you see the history of the last 30 years, during most of the big regime changes, whether it was 1984-1985, when bulk of the returns was in the year 1985 and people did not make any money for the next four years, the returns were a little front-ended. Likewise it was in 1991-1992, 1999-2000, and 2009-2010.
There has been a significant shift in terms of the current account. We have just crossed the $100 billion in foreign exchange reserves and the currency has become stable now, barring a couple of days of volatility. So, concerns about the external side have receded. In terms of the IIP, the inventories are going down overall, but if you look at the GDP and the IIP data of the last three years, we see better numbers.
Overall consumption may not go, but maintenance capex has started. Look at the machine tool orders and the order books of construction companies in the last two or three months, there is a significant improvement. So, there are several signs that the economy is bottoming out. In terms of corporate profitability, the big beneficiaries have been those people who have the dollar earnings and the rupee cost, with the bulk of the earnings growth coming from that. While most of the domestic sectors have not done that well, but if you believe in the cyclical recovery, then those sectors would start contributing much more to the profitability growth going forward.
ET NOW: The core building block of this market rally is global liquidity. Given what is happening to Russia, China, Brazil, Argentina, we have been lucky, but tapering is likely to gain more quantum. So, one would argue that we should not take liquidity for granted.
Navneet Munot: Destiny has probably helped us. All these economies have their own set of issues. With the geopolitical risk, money may not go to Russia and some of the European countries. Similarly, all the other commodity producers are going to get impacted one way or another and India is reaping its benefits.
The quality of companies that you get in India compared to most other emerging markets has also been responsible for ensuring a large flow coming to India. It is unlikely to change in a very big manner. If you get a better political outcome, the attractiveness of India goes up.
Even otherwise if you look at the global liquidity situation, FED is likely to taper a little bit, but if you watch European Central Bank, ECB is going to print a lot more money. Their money supply is not growing, inflation is 0.5%. So they have to print a lot more money. BOJ will continue to print more money to get their inflation objective. The global liquidity scenario is unlikely to change.
Looking at the valuation of most of the assets in terms of developed market equities, junk bonds, high grade bonds, government bonds, asset classes, we will continue to get more capital flows. It may get bulged up if we get a favourable political outcome or may face a bit of volatility if we do not get that, but ultimately in the next couple of years, we deserve a lot more money than what we have got.
ET NOW: Now let us assume that flows are strong, but historically we have seen that global investors have always bought into quality stocks. You are not bullish on those groups. So one assumes that flow is here, money is going to move into quality, it is not going to chase industrial or economy related stocks.
Navneet Munot: First of all, industrial does not mean they are not quality, there are several quality names there. There are ways to play the cyclical recovery and buy more cyclicals. We could probably include pharma, but that is a bottom up call, not a top-down call just because you want to have defensive versus aggressiveness into the portfolio, but individually when you look at these companies, you like these companies.
ET NOW: So there are enough quality industrial names available.
Navneet Munot: Not only industrial, there are quality names within IT and pharma and financials as well. There are several domestic players in the industrials too. As the overall economy recovers, there are several names to look at from that basket too.
ET NOW: Do you think somewhere even after the recent run-up, the margin of safety for a long term investor in IT is still supportive?
Navneet Munot: Yes, in the last couple of months as the rest of the market has gone up, the relative premium for IT has gone down. That is also the case with some of the other defensive sectors. But again, we are like purely bottom-up. Wherever we see that companies that are getting bigger deals, companies that are looking at newer geographies, newer segments, newer businesses, investing into what can potentially be bigger businesses going forward, those are the ones that we are betting on. In terms of the extent of overweight above the benchmark would have gone down in our case.
ET NOW: For the moment you are ready to trade-off and the fact that you are neutral on IT, it is more like a tactical trade?
Navneet Munot: Yes, it is tactical. We like IT companies as they have been a big beneficiary of the rupee depreciation. They have really invested well into building their business.
Navneet Munot: High-quality engineering companies occupy one category. Some of these companies have invested well, their balance sheets are intact. These companies do not usually have full leverage because in some other parts of the industrial space, their balance sheets are still saddled with huge amounts of debt. So, their ability to participate in the next cycle of growth is very limited. Talking of infrastructure, it may be a little early to use the word ‘boom’, but we are going to see the whole economy, particularly India, shifting a lot more from consumption to investment. This means we have to invest a lot more. The new government, whosoever comes to power, has its task cut out; it will have to deliver on the jobs front and bring inflation down. These are the two big issues for which the young voters, or probably all voters, are voting for. It’s for job creation. So, the new government has to increase the productive capacity of the economy. For this to come about, various types of investment — whether it is railways, ports or any such infra thing — will have to happen.
ET Now: So, broadly, you are betting on economic or proxy players whether it is a port company, a player like CONCOR or whether it is a company which will benefit if industrial demand returns.
Navneet Munot: I am betting on several things. I believe sustainability is going to be a main theme. The coming times will be marked by water shortage. Companies that have invested in this segment are at an advantage, because when the time is ripe water is going to be a big business. India will need a lot more potable water than it can supply to its people and to its industry and to its agricultural fields. Similarly, the globally dominant theme, I think, will be various countries' and regions' efforts to tackle the current economic mess that many countries currently find themselves in. This, along with some capex- and manufacturing capacity-related issues, will dominate global discourse for several years to come. The US, euro zone countries, Japan — all of them have already printed as much money as possible, but they still struggle to post the desired level of growth. How that growth will return and how jobs will come back? The answer is: they have to invest in infrastructure.
For example, look at the condition of the airports and the roads in the US. They have done nothing for their railways. Talking of electricity, the grids will have to be changed, and investments will have to be pumped in solar and the other new types of power. So, you will need new kinds of grids. I think a tremendous amount of investment is going to happen globally.
It may be a little early to talk about it. But if you think a little longer term, there are companies in India which can benefit from the global cycle. It is not going to get confined to India but will spread to several other parts of the world.
ET Now: For the longest time, you have run a very consumer-centric portfolio — Page Industries, United Spirits, some auto replacement stocks. Your portfolio has a pronounced consumer theme. Is that consumer wave over now?
Navneet Munot: No, not at all. There are several of those companies. Their portfolios have many different parts. We have a fund named Magnum Global where we buy quality companies with a much longer-term orientation. Some of the names that you mentioned are still very much part of that portfolio and some of the other portfolios. Even in terms of a consumer-centric theme, there are opportunities on the cyclical side of business. But even in consumption, the penetration is very low. There are several names for which you can easily forecast 15-20% growth for the next 20 years. The markets are so under-penetrated. So you have to pick and choose. But in terms of valuation, if you have slightly longer term horizon, there are several plays in that segment. That is the beauty of the Indian market. I mean there are lots of opportunities for bottom-up stock pricing across spaces — whether it is technology, pharmaceuticals, consumer, or be it the whole range of new businesses like media, auto ancillaries, or the whole lot of industrials that we discussed.
Nikunj Dalmia: Given the fact that you are bullish on industrials or economy-related stocks, are you not worried about the election outcome? Because let us be realistic here: the election verdict will be a 10-15% swing event for our markets.
Navneet Munot: That is why I mentioned that they are buying quality industrials, not sacrificing on the quality, and not buying those companies where there is a tremendous amount of financial leverage. We are looking at, as I mentioned earlier, a capital-like model. Regardless of whoever comes to power, I believe investment as a percentage of GDP has to go up over the next several years and so will the maintenance capex. So, let us say we have lots of these bearing companies that have handled the downturn pretty well. What happens in a downturn? Companies whose management has vision and ability look at restructuring their balance sheets, companies that take the right steps — in terms of operation, resource allocation, investing in future and the like — during lean phases, will have opportunities when the time is ripe. Recovery is a slow process, it takes time. Post a downturn, the operating leverage is so high that in the next couple of years, the opportunity for some of them could be very large.
ET Now: We have seen a one-way ride in Indian equities. From 5500, Nifty has moved to 6800. Do you think there is somewhere some froth in the system? There are lots of port names, there are lots of industrial names, there are lots of high beta names which have appreciated by more than 100% to 200% from the recent lows.
Navneet Munot: Not at all. Overall, considering the market as a whole, the PEs are on 15 odd times still in terms of price to book.
ET Now: Not cheap.
Navneet Munot: Yes, but it is fairly valued. You have to look at the earnings also. Compare that with the earnings. So, the overall earnings as percentage of corporate profit, the percentage of GDP is half of what it was a couple of years back. As I mentioned, the bulk of the earnings growth has come from very few stocks, very few sectors and a large part of the market is yet to participate. Earnings get normalised. Even if they go back to the normal long-term average, still there is a lot of scope. So, for the last five or six years, the corporate profitability growth has been much lower than the nominal GDP growth. Over the next couple of years it is going to catch up. I am not saying that they will exceed that. Even if they catch up, we are looking at a 15-18% earnings growth for the next five-seven years. And in that case with the currency if you get the right kind of stocks, a reasonable amount of return can be expected from equities.
Navneet Munot: Typically, the cycle is when you get earnings growth and the fundamental momentum catches up. Even the price momentum starts catching up and people start extrapolating the earnings. So, then the PE gets re-rated. On the other side, we have seen that over the last couple of years, the domestic economy was not doing well, apart from the earnings de-growth, and there was also de-rating.
In markets apart from the earnings growth and the PE rating, we also have to look at the portfolio positioning. When you see the early signs of earnings growth picking up, a large part of these portfolios have to start getting shifted. So, at the margin when people start looking at these stocks, the PE will also get re-rated from a combination of fundamental momentum in terms of earnings and portfolio positioning.
ET Now: So you are consciously positioning your portfolio in such a manner that if the economy recovers, you will capture the upside?
Navneet Munot: We will capture the upside. Having said that, the caveat is that we are going whole hog and taking a strong view that yes, the worst is behind us, there are still issues impending. A good part of corporate India is struggling with the balance sheet issues. There are parts of the banking sector which have got distressed. It will take time for some of the sectors to really show things on the ground and for that, we are fairly balanced.
The focus is strongly on the bottom-up and that is why whether it is pharmaceuticals, IT, there are names in consumer that we own, there are names in media that we own and there are lots of industrials that we have been able to find in last couple of months. There are plays of auto ancillary for domestic market as well as the global markets. So these are the variety of stocks that we are looking at, but again, the focus is far more on bottom up than the large macro call on a couple of sectors.
ET Now: On a YTD basis, Indian markets have underperformed. So how should one read or really understand the big wave in emerging markets?
Navneet Munot: Relatively we have done well compared to most of the larger markets. We have moved but looking at the whole debate between the DM and EM, at $1500-1700 per capita, our overall market cap to GDP is very small. We have a long way to go. In terms of global capital, the large sovereign wealth funds of the world are yet to allocate the portion that they need to allocate to an economy like India, both in the equity and the bond market.
We have a decent market structure in terms of our ability to offer a portfolio construction to most of the other emerging markets. Whether we will get the sufficient foreign capital is not a concern, but more importantly, we need to reduce our dependence on that foreign capital. The domestic investors in 2008 and 2009 have invested $30 billion and in the last two years have sold $20 billion. So, we were buying so much and also selling so much. It has to reverse. In the next several years, domestic investors have to buy a lot more, which is likely to happen because the relative attractiveness of financial assets has gone up. If the real rates stay positive, more money will come into the financial assets than the physical assets.
ET Now: I have argued this in the past that if earnings are expected to grow in the range of about 12% to 14%, does it make sense to buy into equities when a government bond is giving you a 9% assured tax free return?
Navneet Munot: Yes, it is not completely tax free the way it is for the equity, but I would argue in favour of both. The only thing is that at least in the very near term, rates are unlikely to fall. That is a bit contrary view we believe that we have understood from the central bank’s language. It seems they are looking to ensure real rates stay positive for some time. They believe that inflationary expectations have to be brought down significantly in India. CPI may go up or go down because of vegetables prices, but the inflationary expectations have got very entrenched and they have to be broken.
Also, RBI needs to improve the quality of its balance sheet. They have to reduce the amount of government bonds and buy more of foreign currency reserves they have. Because of these reasons, RBI may remain hawkish for a longer period than what the market anticipates, unless there is some magic done by the next Finance Minister in terms of his vision for bringing down inflation. I think rates may remain larger and that is why you will have opportunity in both the markets. Bonds will look attractive from a very long-term perspective, but in near term you may not make many.
ET Now: Is the thought of what could happen on 16th of May giving you sleepless nights?
Navneet Munot: Of course. I mean the decibel levels are so high. This time it is really different. We need a regime which can really take us to our potential growth rate, which is much higher than where it is today, and I am quite optimistic on that front, which is likely to happen. Probably you rely on the wisdom of 800 million investors/voters, particularly the young ones. We are hopefully going to get the regime which can make significant changes the way economy could be run.
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