Broader markets can rise in a healthy way going ahead: Neelkanth Mishra, Credit Suisse

In a chat with ET Now, Neelkanth Mishra, India Equity Strategist at Credit Suisse, shares his views on the market. Excerpts:

ET Now: The broader big picture is that India is the best performing market in the entire emerging market space. How would you map the current market setup?

Neelkanth Mishra: The emerging market space is not really the best benchmark. If you are look at many other markets, for example, Russia, Brazil, China, etc, many emerging markets are not in the best of shape. India, on the other hand, has had a welcome change in government, it has seen growth bottoming out, it has seen the currency stabilise for the right reasons and therefore, we have to look at the market with respect to other economies the world over which have done well.

If you look at MSCI India’s PE - the price to earnings ratio and its premium over MSCI World PE - there has not been too much of an improvement. There is 4-5 per cent improvement in the last run-up. What we are seeing in India is more or less a reflection of what is happening the world over in terms of asset prices, wherein the easy liquidity environment has pushed down

You have seen what happened to the US treasuries. We expected in the beginning of the year that yields would be upwards of 3 per cent. Now they are back to 2.5, whatever be the reason.

Then you look at other emerging markets as well where there has not been much of a change in regime. There has not been any improvement in the current account and those markets are also up, even if not as much as India.

That is one big factor - the global return of risk appetite, the fact that asset prices globally are going up. This is also something that has helped India.

The second factor that is helping India is that the economy has bottomed out. We are looking at a 5 per cent plus growth this year. When that happens, most investors and the market as a whole struggle to understand whether they should be valuing the market on FY16 or FY15 or FY17 even. That turnaround usually bumps up PE multiples and that is also helping India. It is not so much the change of government that is the cause for excitement as yet.

To answer the question that you started with, yes, there is still enough room for PE multiples to keep going up. The current numbers are too high and there will be downgrades, but we will still see 8 to 10 per cent growth in the index earnings. The broader market will move up very healthily even from here.

ET Now: What is the sense that you are getting? Is this all that you talked about in terms of the economic growth kicking in? Has the market already priced that in or do you think there is significant upside from current levels that we could see and within this calendar year itself?

Neelkanth Mishra: When you are looking at the broader market, very few people invest in the Nifty or the Sensex. I keep repeating that it is specific stocks and sectors where we need to invest. There is enough room for upside in consumer discretionary names, in autos, and even in staples. Plus, as a regular, steady grow as IT and pharma where earning stability is there, the stocks have not done much for the last six months and there is enough growth over the next two-three years.

Thus, there is enough room for upside in those sectors. There are sectors however, like PSUs, some of the midcaps, some of the over leverage companies, etc where there is a lot of froth, where the pace of change that is going to come around because of the change in government is most likely going to disappoint the market.

Things are not going to change as rapidly as people think because they cannot - these are very large complex problems that the government has to solve. That is where things are a bit frothy. But broadly for the market, 8 to 10 per cent earnings growth is sustainable. It has been done when the economy was decelerating. If you are taking a three-year view on the market, the broader PE multiple at about 15.5-16 times can actually go to 18 times as well. If it happens in the next six months, then you have over the next one year maybe an upside of 15 to 20 per cent for the broader market. If that does not happen, then it will take slightly longer.

ET Now: For the longest time, you have argued on various forums that you are not a big fan of cyclical and industrials. Now that the economy is making a comeback, has your view changed?

Neelkanth Mishra: Yes, we have been calibrating that remark over the past six-eight months that we are not big fans of deep cyclicals, meaning late cycle cyclicals. The first thing that usually turns around is autos, commercial vehicles and some consumer discretionary names, because this is where improvement in utilisation rise and that is something that we have continued to like.

There are non-banking finance companies which are exposed to some of these sectors overall. So beneficiaries of lower wholesale funding cost and this is something we have been pushing for the last six-eight months. This sector has done very well, but there is still room for upside there.

On the late cyclicals, many of the industrial names, say those exposed to the power capex or metals or even railways, the time taken for a pickup in orders and thereafter revenues and profits is going to be much longer than the market anticipation. That is where the run up has been very extreme - and that is where the risk of downside is the highest. I would include many of the banks in that category as well.

ET Now: You have got a positive overall view on cyclicals and high beta, but you seem to have a negative view on Tata Steel and L&T. Why is that? The stocks have doubled from levels that they were at when the year kick started.

Neelkanth Mishra: Yes, they have been and this is something that we have been flagging repeatedly in our notes that we crystallised in March, where we showed that if the verdict was going to be strongly in favour of NDA, the cyclical would keep moving up at least till August. Given that the verdict was much stronger than anyone anticipated, the upside can last for a few months longer.

The perspective that you are giving is that there is not going to be any fundamental improvement in steel, in long cycle industrials and that is the view I still maintain. There has been no fundamental change on ground. Odisha mining disruption has created some period of respite in terms of steel pricing, but once those mines are back up and running, even if partially, I would expect that the pricing pressure will come back on steel.

I fully acknowledge that some of these stocks have run up meaningfully and they have gone against recommendation, but when we recommend to our investors, we take a 12-month view as to whether you should be building on or rather taking a tactical view or building core positions in some of these stocks. I still believe that the pace of change and the earnings prospects going forward are negative.

ET Now: You are positive on banks as well. What is it that you are liking right now? Is it the private lot, the PSUs or the NBFCs, considering the RBI is now extending the scope of banking.

Neelkanth Mishra: We like the large private sector banks. We like the NBFCs and are underweight on some of the private sector banks and most of the PSUs.

In particular, NBFCs and the balance of payment surplus that India is likely to see for a while, means that wholesale funding cost will remain low. Hence, despite the fact that RBI may not cut rates, the effective interest rates for some of these banks will go down. They have no problem with loan demand, whereas for the banking system as a whole, loan demand is going to be an issue. If the capex cycle takes much longer to recover, then loan demand is going to be an issue.

Some people are becoming very constructive on banks in the hope that credit cost will come down. Even in this quarter, given the large transfers to asset reconstruction companies and the fact that kicking the can down the road is a favourite game in town, the reported earnings may not be as weak as what fundamentals would warrant.

But I still think that those risks, which are right now being forgotten given the euphoria around the elections, another two or three months is the time you see the disappointment in the banks starting to come through. It may be too early.

As I expected, even though my fundamental view on deep cyclicals is negative, we have been flagging that they will keep running up if the elections are good and they have been. Hence, what is happening is entirely anticipated. Our call will start working most likely from October or November, when the fundamentals start to play out.

ET Now: You have recommended your clients for the longest time that they should maintain an overweight stance on IT. Has the TCS and Infosys numbers and the strong management commentary endorsed your view further?

Neelkanth Mishra: Look at the size of TCS and look at the quarterly momentum that they have shown. The CEO has been making remarks about the importance they place on not being bogged down by size and these are remarkable changes.

We have been looking at the sector for more than a decade. At every stage, people thought that 100 thousand, 200 thousand, 300 thousand is too large. That they cannot keep growing at that pace, but they have managed to and that has been the only concern that has been meaningful among investors.

About whether the rupee is going to appreciate, I do not think the RBI will allow it to appreciate, because it understands very well that what is happening globally is competitive devaluation. We are not yet at the worst type of currency war situation, but there is clearly competitive devaluation happening. The governor himself has made a speech at the Brookings Institution where he highlighted how QE only works through the currency route.

What is happening in the US or in Europe or in Japan is that they are cutting interest rates. In this environment, we really want your currency to be appreciating and so the currency is not going to appreciate.

The worry about rising costs, that if inflation is very high, engineers would keep getting more expensive because you will have to give them hikes does not hold true because that has not been necessary because there is an oversupply of engineers. Also, the labour arbitrage that works between the US and India continues unabated, and given that technology is changing a lot, there is a need to keep investing for the customers in new technologies, on storage infrastructure, on social networking, etc.

That thesis is still very much on and will continue to play out. I agree that the reinforcement from management has helped. Second half in general, as our analysts have been flagging, is usually a good time to be in IT.

ET Now: Do you think the Indian markets currently are at a crossroad? For the moment, there is a strong visibility in IT and pharma, but from a three-year perspective, the incremental growth will not come in IT, it will come in cyclicals and proxy economy related sectors.

Neelkanth Mishra: It is very easy for us at this stage to start thinking FY17 because we know there is a strong government in power with at least the right intentions and trying to steer away from corruption, trying to do the right things for the economy and these are things that we should make us all very hopeful about the prospects over the next 5-10 years.

The problem with pricing in FY17 at this stage for many of these sectors is that a lot of things can change. What if India and China were to get close together? The problem with China is that if you build 50 years of infrastructure in 10 years, you have to find use for that capacity and not just in steel or in cement, but also in terms of construction equipment. The construction teams that you built up and trained, why cannot those teams come to India?

Thus, if you are looking at FY17 as a time when a lot of construction activity will pick up, why cannot that be done by Chinese companies which are going to be more efficient than Indian companies? There are going to be geopolitical issues, there will be political oppositions, there will lots of things that can change, but taking a three-year view is very risky. We are assuming that a certain direction will play out.


Hence, if you want to buy stocks in FY17, then you should be buying IT and pharma because that is where the earnings delivery is reasonably more certain.