Disappointment from central banks of developed world can spoil party in stock markets: Nischal Maheshwari

If the US Fed were to resume the rate hike cycle, it could result in capital flight from the domestic market, says Nischal Maheshwari, Head of Institutional Equities, Edelweiss Securities. In an interview with Amit Mudgill of ETMarkets.com, he said a Fed rate hike could result in higher interest rates and trigger a big selloff in stocks. Excerpts:-

ETMarkets.com: The benchmark indices have been hovering at 52-week highs. Some believe this is liquidity-driven and in line with global markets. But how do you see the prevailing valuations? Do you think the difference between valuations and fundamentals is rising and a valuation bubble is in the making?

Nischal Maheshwari: The recent rally in the market does have a lot to do with global liquidity and global markets. The ultra pro-activeness of developed world central banks has lowered global bond yields and, thus, financial conditions across the world. In such a scenario, a re-rating in equities is inevitable. Hence, while valuations are definitely stretched, a large part of it can be explained by lower interest rates across the world. Further, given the improving growth prospects ahead I don’t think that there is a valuation bubble per se.

ETMarkets.com: The analyst community these days is a bit bullish on domestic plays. FPIs’ exposure to domestic-oriented sectors has risen in the first half of CY2016. But this is not the first time when the sentiment has turned positive for domestic plays. Yet time and again earnings recovery has disappointed. What is the difference, if any, this time?

Nischal Maheshwari: Over the past four years, domestic plays have indeed disappointed on the earnings front. However, we think this time it is different due to a couple of reasons. First is the improved monetary response, which includes improved liquidity conditions as well as lower interest rates. Market rates namely, 10-year US bonds and corporate bond yields, are all falling sharply and should lower lending rates in the economy. Secondly, exports which have been disappointing for last 4-5 years now could start to improve. A lot of emerging markets are easing monetary policies and there are some early signs of improvement in data as well. Third, the reforms momentum is gaining pace. With the GST bill passed, good progress on UDAY, DBT, etc. one should see an improvement in domestic demand going ahead.

ETMarkets.com: Earnings are expected to pick up pace, but how fast? What is your growth estimates for Sensex/Nifty50 in FY17? Based on growth expectations, what is your March-end target for the indices? Which developments could make a difference and what may spoil the party?

Nischal Maheshwari: Over the past two years, earnings growth has been zero. We expect this growth to be in low to mid-teens. What could spoil the party is disappointment from the central banks of developed economies. This could result in capital outflows and domestic interest rates could head higher.

ETMarkets.com: One should buy only quality stocks. But how to you define as quality? There is a debate over midcap valuations, which are at a premium over largecaps. Can this be justified? Initial numbers of some midcap companies have been good. What should one do?

Nischal Maheshwari: Well, for me a quality company is one that is able to deliver consistently good growth with decent profitability. With regards to midcap valuations, they are stretched. However, one should keep in mind that we are living in a world where interest rates are low and growth is extremely scarce. Hence, if companies are able to deliver growth, high valuations will sustain and one must continue to remain invested in those names.

ETMarkets.com: Do you think the composition of Sensex/Nifty50 would be quite different five years down the line? Name a few new sectors, which you think may play a good part of the benchmark indices by 2020, 2021.

Nischal Maheshwari: Sensex and Nifty have seen significant changes over the last 20 years. Over the next five to seven years, we should see some churn. Some of the potential companies that could enter would be from e-commerce, retail and insurance sectors.

ETMarkets.com: What if the US Fed resumes the rate hike cycle and earnings do not accelerate as per expectations? Will it mean negative returns in the market?

Nischal Maheshwari:At present the biggest risk is if the US Fed resumes the rate hike cycle. This could then result in capital flight and higher interest rates and result in a big sell-off in the market.

ETMarkets.com: Name a few pockets you think investors can make money.

Nischal Maheshwari:Over the next couple of years, some of the themes to play would be shifting of unorganised market to organised and lower interest rates. Hence, one must keep a tab on banks, consumer durables stocks.