'The financial services have a huge growth potential'

What are the key factors that will drive the stock markets in 2010?
The sharp bounce witnessed in 2009 was largely due to increased risk appetite caused by the improved economic environment. This happened due to the aggressive monetary/fiscal stimulus measures, which also led to a sharp rise in global liquidity and pushed up asset prices across the world. Any monetary tightening or change in investor sentiment could lead to a reversal of flows over the short term, but long-term investors will continue to focus on fundamentally strong emerging economies. In India, economic data and earnings growth will be closely watched as current prices are factoring in higher earnings. Other key factors are likely to be the level of commodity prices, especially energy, and increased issuances by Indian companies.

How will growth be affected if the stimulus measures are rolled back?
Unlike most countries, the stimulus efforts in India haven't been large due to a high domestic component and fiscal deficit. In this sense, the roll-back of stimulus measures might not have a large impact on earnings; economic growth will be the key factor. We have seen strong manufacturing growth, which could mitigate the slowdown in farm production to some extent. Overall, we expect earnings to be better in 2010 as GDP growth moves towards 8 per cent levels. Also, investments from the government and companies are likely to be an important driver over the medium to long term.

Which are your sector favourites for 2010?
We believe that sectors that can piggyback on the domestic consumption and investment themes are good opportunities from a medium to long-term perspective. These sectors will take advantage of the structural transition in India. The country remains under-served in terms of financial services, but the strong growth in personal incomes has led to increased demand. Given the low penetration of banking and financial services in India, we believe companies in this sector have a huge growth potential.

What has been your reading of the earnings growth in corporate India? Also, what are the key parameters investors should consider while investing?
Corporate India's healthy track record in terms of return on equity (RoE) as well as greater proportion of domestic demand component in earnings is a positive, helping the country enjoy a valuation premium over other emerging markets. There are also clear signs of higher demand for consumer durables and capital goods, which would suggest that earnings growth is likely to be positive. However, investors need to watch out for overpricing of growth in certain pockets.

Indian technology and consumer-oriented sectors lead in terms of RoE due to relatively lower leverage, higher profit margins, free cash flow and efficient use of capital. One needs to look at RoE along with other parameters such as profitability, asset turnover and growth potential, while analysing a company. We need to look at RoE from a sectoral dynamic perspective as well. Traditionally, companies in the investment space have had relatively lower RoE, due to the role of debt in their balance sheets.

Structural growth drivers such as positive demographics and rise in income levels will support earnings growth in many of the sectors over the medium to long term and we expect earnings growth to average around 12-18 per cent over a three to five-year period.

What is your advice to investors on buying global equities?
Various international markets have delivered varied returns in the past, so investors are best advised to take exposure to global equities based on their risk appetite. The expected returns will differ based on the choice of market. An investor can get exposure to a single country or multiple country funds such as Asia, emerging markets, frontier markets, BRIC and Latin America, which could potentially offer risk-adjusted returns similar to those from India. There are also sector specific funds such as global real estate, natural resources, etc. In the recent turmoil, emerging markets have displayed resilience and posted stronger gains. These economies are likely to retain the positive growth momentum in future and are, therefore, attractive investment destinations. Nonetheless, one cannot rule out volatility over the near term, given the various imponderables pertaining to the global economy.

What is your view on interest rates and how is it likely to affect an investor's fixed income portfolio?
With strong economic data coming in and inflation numbers moving up, expectations have increased for monetary tightening. However, the rise in inflationary pressures is predominantly due to supply side constraints and rate hikes are expected to have a limited impact. The government is unlikely to risk a growth slowdown, so any tightening will be calibrated. Hence, investors are better off putting money in higher accrual products and those with lower interest rate risk.

Any lesson on investing that you would like to share with our readers?
Keep extreme emotions out of investing and stay focused on good quality funds and companies that you have invested in. 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 adhere to a customised asset allocation plan that is tailored to their risk appetite and financial goals.

Sukumar Rajah is the CIO of Asian Equities, Franklin Templeton Investments