The recent correction in commodity prices is a big relief for the Indian economy and has eased some pressure on macro concerns like current account deficit and soaring inflation, but fall in commodity price alone is not a solution to India’s growth woes , which are structural in nature, believes Prabhat Awasthi, head of equity research & MD, India – Nomura Financial Advisory & Sec.
”The consumption cycle is still very slow. It has slowed down progressively because of the fact that the past measures of reducing the deficit has led to a burden on consumers. CAD is improving also because of growth coming off. So there is interest rate story compared to growth story. That’s why the upside will not be runaway market,” he said in an interview to CNBC-TV18.
He expects earnings growth to remain muted for atleast a year. “I don’t see earnings picking up before 18 months. Earnings growth from cyclicals may also remain weak, but defensives may continue to contribute to growth,” he added.
On sectors, the broking firm remains underweight on metals. It has changed its outlook on cement space to positive.
Below is the edited transcript of his interview to CNBC-TV18.
Q: Is the recent improvement in macro due to commodity prices good is enough to re-rate the market or do you think the growth issues remain unaddressed and they will limit upsides?
A: Both these statements are true to some extent. Obviously, there is a big stress. If the commodity prices remain at the current level then it’s a big relief from Indian perspective because India is right now facing one of the biggest issues of current account deficit (CAD).
Commodity prices feed into current account, feed into interest rates because of inflation, they feed into government fiscal deficit because of the subsidy debt which government provides. Many issues are sorted out if commodity prices stay down.
Commodity prices moving down automatically do not relieve the growth stresses in the economy which are more structural in nature because of the fact that the investment cycle is not only held hostage by interest rates but by policy.
Currently, there is no clear announcements from companies which suggest that investment cycle is starting to look up. So, on that side, we will continue to exert the pressure on the growth down. The consumption cycle has slowed down progressively because past measures of reducing the deficit has led to a burden on consumers.
So growth engine doesn’t seem to be firing. We are seeing improvement in current account deficit because growth is coming off. So we have an interest rate story compared to growth story. So, the upside will not be runaway market. But commodities have relieved a lot of stress.
Q: You interestingly pointed out that growth is causing some relief to CAD. In that context, how much more protracted do you think the growth resumption will be for the equity market itself? How many more quarters of very poor earnings growth performance you think?
A: Basically, earnings growth is dependent on the performance of GDP because earnings growth
Earnings growth basically depends on how GDP growth does because earnings growth has very strong linkage to how much output we are producing and the pricing part of companies therefore. I think there is at least one year before we see any recovery. Elections is another problem that we are about to face next year as it might slow down policy as far as investment cycle is concerned.
Q: How do you think the global growth will look like over the next three-four quarters, we keep analysing the local situation and globally the other market has been very strong. Is there a possibility that global growth will disappoints over the next two-three quarters which might have ramifications for global equities generally including our market?
A: Data points out that Chinese growth have disappointed. So they are three separate parts of the world. The data from the US is very good except last few data points.
The European growth is muddling and the same is expected to continue even though it seems to have stabalised. The Chinese data from where the commodity prices are driven has been much worse than expected. For example, the PMI data which recently came out was worse than expected. If everything is put together then it looks like that while US might be doing well, it really doesn’t have that much of bearing on commodity prices.
If China doesn’t do well then China is trying to upgrade and turn the quality of growth into less driven by investments amount and more by consumption plus at this point of time they are also on austerity drive. The essential point from India’s perspective is that if US does well then I think it is generally a positive as long as commodity prices don’t go up which extremely depends on Chinese growth.
But overall, I think growth is too not accelerating. Secondly, all the monetary accommodation could come off and that may not be as great from India. So, from Indian perspective, right now the situation is probably the best.
Q: Would you expect to see an even narrow earnings performance. Some of these companies with global exposure whether it is IT or a few auto or metal companies have done better than the domestic companies because of this global linkage. Do you foresee that over the next few quarters, earnings performance will get even narrower along with poor in quality?
A: The expectation from consensus is around 14-15 percent and that is a usual trend when you start the year. We were at 18 percent when we started last year, we have delivered 5 percent. I think the same 15 percent will probably support, some of that might fade. So, it might not go to four percent but might be 8-10 percent because the growth is very slow. The growth is holding up due to defensive in exports like pharmaceutical and IT and defensive domestics like FMCG and banks. Banks earnings growth is a very large constituent of overall earnings.
Autos and industrials have shown very disappointing earnings. There might be some slowdown even on the consumption side but recovery on the industrial side looks unlikely. Defensives will continue to post decent growth.
We are getting into elections. For last six months, the government has withdrawn a lot of stimulus and lot of expenditure and that might start coming back post the passage of financial bill.
So there could be some added momentum in terms of government spending which might flow through into stocks and sectors like cement along with some rural consumption plays, etc. There might be some recovery due to government expenditure coming back on line in next six months, otherwise I don’t think there will be a massive recovery across sectors.
Q: What is your advice to your clients on IT because it did very well in the first quarter of the year and then post earnings, they have all started coming off significantly, not just Infosys and Wipro which disappointed but even TCS has underperformed. What’s your advice to them for the rest of the year?
A: Earnings have been a big disappointment. In the companies which have performed, there has been no massive upgrade or anything positive from the deals flow perspective. It is important recognise that a part of that is probably priced in. In the beginning of the year we had an overweight position on the IT sector. Event after the fall, the sector was outperforming but a lot of out performance has been given away. From valuation prospective, excluding TCS, the sector is trading at a discount to the market. Even if TCS is included, the valuation premium which is at 20-25 percent at the peak this year has fallen to about six percent.
There has been a huge amount of correction and lot of bad news is priced in. We are still advising investors to keep the faith and have an overweight on the sector primarily because if there is any recovery globally then there will be some flow through into Indian IT which will ultimately flow into in numbers. Valuations are building in fairly dismal performance going forward.
Q: How would changes in the commodity cycle would impact some of our listed metal players? What would you do with Tata Steel for instance?
A: Overall, we have been underweight on metals for a while now and we continued with that. Obviously, lowering commodity prices will impact earnings negatively. The thing essentially now with metals, the key call would be whether we have seen the bottom of the commodity cycle or not.
To some extent, one could argue that the non-ferrous metals for example have fallen to a level where it will be very hard to make money or lot of capacity globally. Therefore, at some point in time we expect some bounce back. But the process of correction can be elongated depending on the news flow especially from China.
If China slows down, then demand side is unlikely to recover. So at this point in time we are continuing with underweight outlook and we will continue to evaluate that sector because stock prices are cheaper. There might be some merit at a point in time looking at the valuations to look back at the sector. But I do not expect rosy news going forward so we continue with the underweight call.