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Nilanjan Dey

Sound fundamentals will prevail in the end

Kolkata March 26 With the markets displaying considerable volatility in the past weeks, several questions are being raised on market direction and the various factors that could impact it.

In an exclusive interview to Business Line, Mr Sivasubramanian K.N., Senior Portfolio Manager (Equity), Franklin Templeton, spoke on various issues such as market volatility, interest rates, corporate earnings and where the market is headed in the near and medium terms. Excerpts:

Is the volatility that we are seeing in the market now a temporary phase or is it something that we have to learn to live with in the future?

Volatility is an inherent part of stock market investing and investors need to keep in mind that market gyrations tend to be more pronounced over the short term.

Over the long term, economic and corporate fundamentals matter; they continue to remain healthy for India relative to most emerging markets. The flip side of the strong FII flows in recent years is that unlike in the past, Indian markets are now more integrated with global trends and will be impacted by any contagion, at least over the near term.

While markets have bounced back after the correction, it is too early to rule out further volatility over the short term. However, we are confident of the prospects of the Indian markets over the medium to longer term. The recent fall in the Indian markets has come about after a strong rally.

Apart from the global factors, domestic developments such as sector-specific measures in the Budget also had an impact on investor sentiment. Also weighing on the markets could be tightening liquidity, as the RBI looks to stem inflation through various monetary measures, and the rising risk premium due to the rising yields in the debt markets. Hence, the recent volatility is not solely due to global markets.

What is your expectation on interest rate movements in the next one year? Is there a range beyond which the market could be impacted by higher interest rates?

Interest rate cues from key global markets such as the US, Japan and Europe have stabilised, and oil/commodity price rises have also shown stability. While the debate continues in Japan and Europe, the overall sentiment appears to be bond-friendly. We will have to wait and see if this trend continues.

In India, over the short term, interest rates are likely to exhibit a firm trend, given the RBI's concerns over inflation and high non-food credit offtake. The apex bank has been emphasising the need for a balanced approach wherein India can witness sustainable growth with price stability. We do not see markets being impacted by this approach. At this stage, we do not foresee any sharp rise in rates barring unforeseen circumstances.

What are the factors that could potentially pull down the market or hold up its upward march in the near-to-medium term?

First and foremost is the global liquidity situation, which was one of the prime reasons for the rise in equity markets around the world. One needs to closely monitor the possible impact of interest rates in the developed economies on the flows into emerging markets.

Other risks include: energy prices, infrastructural bottlenecks, availability of skilled professionals, growing current account deficit and reforms becoming a prisoner of political wrangling.

Given the expected robust GDP growth and the relatively higher earnings growth that corporate India is expected to exhibit compared to comparable economies, while sentiment could be impacted over the short term due to these risks, we believe that sound fundamentals will prevail in the end.

Are you comfortable with corporate earnings performance in the third quarter and do you expect growth rates to be maintained over the next four quarters? Do you expect rising interest rates to impact earnings?

Third quarter numbers from most companies/sectors have been either in line with expectations or above estimates. The rise in borrowing costs can be mitigated to a large extent due to overseas borrowings by Indian companies, which have de-leveraged their balance sheets to a great extent by taking advantage of the buoyant equity markets.

There could be some short-term volatility due to earnings expectations - over the last five years earnings growth on an average has been around 30 per cent, which would not be sustainable going ahead. Typically the multiplier is not more than 1.5 times the nominal GDP growth and hence, we could see earnings growth settling at a sustainable rate of 15-20 per cent.

What is your projection for the market direction in the near term and medium term?

Over the near term, markets could be impacted by the tightening liquidity as RBI looks to stem inflation through various monetary measures and the rising risk premium due to the rising yields in the debt markets.

However, given the strong economic fundamentals, we believe that the medium- to long-term outlook remains positive. One of India's key advantages is that it does not rely excessively on external demand as a source of growth.

As a result, India has much better balance in its growth model than the rest of the Asian region - giving it a built-in macro-resilience that other emerging economies lack.

We believe this would help Indian markets over the medium to long term, as investors recognise the underlying strong fundamentals. Any sharp corrections from these levels can be used to increase exposure to equities.

For retail investors, the best course to follow is to stay focused on the long term, make disciplined investments in equity funds through the systematic route and to adhere to a customised asset allocation plan that is tailored to their risk appetite and financial goals.

For conservative investors, floating rate, short-term income, FMPs and liquid funds continue to be ideal for the current market conditions.

What are the sectors, in your opinion, that could turn out to be out-performers and under-performers in the market over the next one year?

Over a one-year period there are many imponderables that could impact the direction of the markets. Hence, it is important to take a medium- to long-term view while investing in the equity markets. We believe long-term investors are better off adopting a bottom-up approach and invest in companies with good fundamentals across market cap ranges and sectors.

However, we continue to believe that sectors that can piggyback on the domestic consumption theme such as retail banking, consumer goods and automobiles; trends in domestic infrastructure spending such as construction and capital goods; and companies benefiting from the outsourcing theme may offer investment opportunities for long term investors.

Do you expect mid-caps to join the rally, unlike the trend over the past one year when the rally was driven largely by the index stocks?

Mid- and small-cap stocks have under-performed the broad markets in the last year or so, after some years of strong performance. While this segment is likely to under-perform over the short term, we believe, at current valuations, fundamentally sound stocks in this segment are likely to deliver a good performance over the long term.

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