Expect 15-20% earnings growth for FY18: Lucy MacDonald

Watch the interview of Lucy MacDonald CIO Global Equities Allianz Global Investors with Latha Venkatesh on CNBC-TV18, in which she shared her expectations from Budget 2018 and Indian economy.

Below is the verbatim transcript of the interview.

Q: Do you guys really look at the Budget very closely? Is it a serious policy document that can make or break your attitude to Indian equities?

A: What we are really looking at is the impact that it will have on earnings because at the end of the day, it is earnings, liquidity and valuations which drive the various markets that we are looking at. So the impact of taxation on earnings is something that is going to be of importance to us.

Q: So you must have picked up a lot of straws in the wind before the Budget. What would you want to hear on fiscal prudence, on corporate taxes?

A: We want to see some prudence is something that we favour but we also want to see any impact where taxes can be looser and that will benefit the tax, the earnings of the underlying companies. So that is really what we are focusing on.

Q: The announcement that there would be larger than expected government borrowing this year has already pushed up yields. Of course, yields were headed higher also because of higher oil prices, higher commodity prices. Would you worry is interest rates were increased by the RBI probably because of the deficit or probably because of other reasons?

A: We are seeing everywhere a shift upwards in long-term interest rates now. And in the short-term, we are beginning to see rising in the US, we are beginning to see it rising in the UK. So it is beginning to be a bit of a trend and we are watching it very carefully. The valuation of earnings of companies versus bonds has given quite a good buffer for the relative valuations. So, that has meant that bond markets can underperform and in fact fall, but still equity markets have support because of that earnings support. As we get towards some of the higher level of yields, that buffer begins to be quite narrow but as we see it at the moment, there is still an equity risk premium which is supporting equities over bonds.

Q: Which brings me straightaway to your earnings expectation. What are you expecting? In the current season itself, the third quarter numbers for several consumer companies, for Reliance Industries have all been above expectation. What is your earnings expectation for FY18 and more importantly for FY19?

A: It looks to us as if the mid-teens to 19-20 percent is possible this year which, if achieved will support the current valuation on the market. And as I said, the earnings momentum does seem to be now better supported in India relative to the rest of the world, where it has been for the last few years. So that is encouraging and it will be good to see that catching up with the strong topline economic growth.

Q: How are you looking at Indian valuations now? The Sensex and the Nifty have had a 30 percent gain in 2017, the midcaps 40 percent and the smallcaps over 50 percent. Are valuations at discomfort zone at all?

A: Valuations are very much midrange at the moment in India and that is certainly on a price to book, probably the best place to look at the moment because of some of those issues with earnings over the last year that I mentioned. So it is neither a strong buy nor a strong sell and there is enough upside there in valuation terms if the earnings come through to provide a decent return in the market.

Q: What are the sectors that incrementally look attractive to you given both, valuations and earnings expectations?

A: It is the more cyclical areas of the market look as if they have got more upward potential in valuation. And that is still the case elsewhere interestingly. So in our global portfolios, what we have been doing over the last few months is taking some profits out of some of the high momentum areas like technology which has done extremely well and that is also the case in India and in Asia more generally. So that is what we have been doing and then, investing those proceeds in some of the more cyclical areas, in some of the energy related and also in financials which should benefit from those rising interest rates that we mentioned earlier.

Q: Let me put India in the context of emerging markets. Where is it in the pecking order for you?

A: It is rising because of the earnings momentum, and the relative earnings momentum improving certainly means that it is more attractive. The valuations are midrange and therefore, that is not a barrier. And I think it is offering idiosyncratic growth, so domestically generated as well as externally and that is always interesting in terms of a global portfolio.

Q: How do emerging markets stack up vis-à-vis developed markets for you especially given that in the last few days, we have seen the US rates ticking up, 2.66 as I speak.

A: The undervaluation of the emerging markets which was clearer a year ago is less the case now. So there has been some revaluation. However, the earnings momentum is still quite good and there is decent yields which is available in the emerging markets too. So I think less attractive than a year ago in a relative sense, but still probably more attractive than average.

Q: Let me come to the growth issue. We had the piece from Mohamed A. El-Erian asking if the global growth is now in a new paradigm, in a new normal where growth was much higher than it was in the last 10 years when it was in a new normal of slow growth. Would you say that equities have some more legs to run?

A: We think equities overall are still supported, but we do think we are towards the end of this very strong run and valuations would suggest that. But also, coming to the end of that big liquidity push as I mentioned. So we still are positive, but we do think that the normal returns are likely to be lower going forward than they have been in the last few years. Now as far as growth is concerned, we think that growth is still likely to be held back in the mature world by the levels of debt and the levels of debt have not come down, in fact they have gone up and so, that is a constraint on the growth rate that can be generated. Elsewhere in emerging markets, the debt issue is not so widespread outside in China in particular. So it does look as if there is more potential for decent growth. So we are seeing decent growth, but it is not going to be high levels in those areas which are still constrained by debt.