Indian markets in sweet spot; earnings growth to improve in H2 FY16: YES Securities CEO

The Reserve Bank of India (RBI) in its monetary policy review on June 2 cut  repo rate by 25 basis points (bps) to 7.25 per cent. With this, the central bank has now effected a total cut of 75 basis points in key rates so far in 2015. RBI Governor Raghuram Rajan is back where he began: In September 2013, when he had taken charge at the helm of the central bank , repo rate was 7.25 per cent. Since the rate cut on June 2, the key benchmark index BSE Sensex declined over 1.5 per cent to 26,768 on June 5. YES Securities CEO Kapil Bali spoke with Businesstoday.in on why the rate cut failed to cheer the equity market this time. Excerpts:

Businesstoday.in: How do you see the latest 25 bps rate cut by RBI?

Bali: Our group was expecting a 75 basis points cut for the entire year, which we have already seen. Going forward, further rate cuts would be difficult given the outlook on monsoons, global crude prices and expected hike in interest rates in US.

Businesstoday.in: Why did it failed to cheer the market?

Bali: There were a few things that caused the jitters in the markets.

First was the relatively cautious commentary of the RBI that indicated that the room to cut rates further this year was restricted. Second, his (Rajan's) outlook on inflation, which he expects to go up for reasons like unseasonal rains.

Third, the statement by India Meteorological Department (IMD) on an expectation of a rainfall deficit this year, which was a bigger cause of worry given that 70 per cent of the total agriculture is still dependant on rains. Again, this is an issue that we believe needs to be seen in the context that now services form a larger part of the GDP so the dependence on agriculture to sustain GDP growth is not that high. Nevertheless, there is a direct impact of rainfall on inflation (food prices) and rural income (and consequently on rural demand), so it was a cause of worry for the markets.

There was quite a bit of negative noise in the global markets, too, related to Greece and Euro zone that in our opinion further exacerbated the fall.

Businesstoday.in: How much further rate cut do you expect in the ongoing financial year?

Bali: We do not expect any further rate cuts at present. However, if crude prices were to dip further and monsoons were to be normal, i.e. inflation continues to remain way below expectations, then a further 25 basis points cut could be seen.

Businesstoday.in: What are the present headwinds for the domestic stock market?

Bali: We believe the biggest concerns for the markets are of course related to the monsoons as well as the expected turnaround in the corporate earnings.

From the fundamental point of view, India and Indian markets are in a sweet spot. There is an expectation of economic recovery driven by measures to strengthen infrastructure, smoothen out supply chain bottlenecks; all driven by the government, which is trying to come up and enact reforms that would be conducive to the economic and capex recovery. And as such the expected benefit of this recovery for corporate India is what has been driving investors' interest in the country.

We do agree that the last quarter earnings growth for BSE 500 is one of the lowest in almost 16 quarters. It clearly reflects the impact of the slowdown in the economy that we have seen till now (based on old series GDP data). However, we believe that earnings should turn around going forward.

We believe factors like government's focus and commitment towards improving infrastructure, pro-reform attitude, improvement in economic growth, lower commodity prices and interest rates and a benefit in corporate taxes should lead to better earnings growth going forward. However, the benefit of these measures would take time to translate to better growth. We expect visible effects of these on earnings only in the second half of the current financial year.

Businesstoday.in: Where do you see the Sensex and Nifty by December?

Bali: We do not set short-term targets. We believe that investments yield best results when they are made for the long term. And for the long term, we expect equity investments in India to yield healthy returns.

Businesstoday.in: In the present market conditions, which sectors may give lucrative return to investors and why?

Bali: With the focus on infrastructure, it is an area we are very optimistic on. However, sub-sectors are likely to witness different trends. We believe that road sector should be the first off the block, given the good order pipeline from the National Highways Authority of India (NHAI) and the Ministry of Road Transport and Highways( MoRTH), with minimum land acquisition and clearances issues. Road companies that have raised funds or monetised assets which makes them relatively better placed to capitalise on the opportunities in the road sector. Power sector is yet to sort out some of the issues and may take some more time to revive.

However, renewable (wind, solar) energy may witness good demand given the government's focus on the same. But, the most interesting story can be railways. There is a huge scope of up-gradation and expansion of the railway network and this may fuel the economic growth over the next decade, provided good planning and execution of the same. Eastern and Western Dedicated Freight Corridors (DFC) are steps in the same direction.

Another area we are optimistic on is the auto and auto ancillaries' space. Autos tend to enjoy a multiplier effect to GDP growth. Therefore, they are one of the first to see a turnaround when there is a shift in the economic growth. We are already seeing some signs of recovery in the numbers. Leading from autos, auto ancillaries too should benefit from the turnaround in the sector.

And finally we are optimistic on the private banking space. The cut in interest rates combined with expected increase in capex and investments should help drive credit demand for the banks. Private Banks in particular have done a good job of keeping their asset quality under check and maintaining healthy cost to income ratios. Therefore, they are well placed to benefit from the growth in banking space. They do not have the asset quality overhang or capitalisation issues which still continue to haunt the PSU banks.

Businesstoday.in: What is your take on small-  and mid-cap stocks? Can we see further rally in these stocks?

Bali: Mid-cap companies tend to have higher risks associated with them on account of smaller bases, niche business models, cyclicality in earnings and liquidity. All these factors also tend to make them attractive investment opportunities as they are able to deliver a higher growth and consequently a higher return when times are good. This when compared to the stable earnings performance of larger cap companies makes mid cap outperform the larger cap peers during bull runs. However, the same risks tend to make them react equally sharply to any downturns. Keeping these risks in mind is crucial when it comes to investing in midcaps.

In our opinion the theory behind investing remains the same irrespective of whether the company is a mid cap or a large cap. If fundamentals are strong, then it makes sense to use any sharp selloffs or knee jerk reactions as an opportunity to buy these stocks.