The worst fears will come true only if you have a very fragmented verdict in general elections. Ex that, markets will take 66840704 66839440 66827811 things in their stride, Bharat Iyer, Head, India Equity research, JPMorgan India, tells ET Now. Edited excerpts: Are things looking a little comfortable with crude receding or would you say it is still hazy because of the state elections and US-China trade row? There is the G-20 meet, the OPEC meet -- trigger after trigger. We have been fairly constructive since the beginning of this month and there are three reasons really. To start with, crude coming off the highs provides a lot of relief to most of the macro variables. We have already seen the bond and the currency markets giving this move a big thumbs up. It is a matter of time before the equity market appreciates this as well. Second, specific to the equity markets, there are two encouraging developments. a) The recent selloff has brought valuations down to about 17 times forward earnings and this is only marginally higher than the 10-year average of 16. So, the valuations are looking reasonably well anchored. Third, the earning story is finally coming back. We just had the second quarter reporting season and we saw earnings growth of about 15%. For the first half, we have earnings growth of 15% and given the improvement in the macro, there is no reason to believe that this will not sustain in the second half as well. It is a reasonably potent combination. Do you think the upside to the market would be a little capped? It depends on what you call upside. Our view is that you should see Nifty at between 11,500 and 12.000 in the first half of 2019, driven primarily by the earnings growth that we are seeing. Will there be volatility? Yes, no doubt about it. We are in a mature bull market. We have to contend with volatility and the event calendar that we had ahead of us does have the potential to create volatility. But over the longer term, fundamentals tend to prevail in markets and as long as the earnings recovery story continues, we will get there eventually. In 2017, the markets did not quite mirror the earnings profile and ran ahead of the earnings curve. For FY19, you are still keeping a trend of 15% on earnings. What convices you that we will make it to that mark? In the first half, on aggregate, Nifty earnings have grown by 15% and this is after three or four years of very anaemic growth. I completely appreciate where you are coming from in terms of being a doubting Thomas because we have had 5% or 6% earnings growth for four or five years. A lot of things have changed since then. A lot of leverage is coming back into the economy. What is important is that we have a reasonably low base effect because the economy is coming out of the after effects of demonetisation and GST implementation. Global growth is holding out quite well. It is quite a balanced growth profile. But given the overarching view for 2019 turning out to be cautious and that the upside maybe capped, what are the chances of 10-15% growth? This is where we are taking comfort from the fact that valuations have been reverted. I would be just as cautious as we were in late August because the market was trading at about 19 times plus forward earnings. I guess you have to marry the two valuations and earnings and with valuations having come back to mean levels, earnings has a chance to take markets higher. If we were trading at 19 times, this kind of earnings growth would not have moved the markets. Where do you find that marriage of earnings visibility and valuation? Which are the stocks that have let the markets higher from the October lows? Growth is still going to be the flavour. Investors will continue to pay a premium for growth. Liquidity is still reasonable both in global and local markets. The inflows into mutual funds continue at quite a good pace. Where do we see value? Financials, particularly the banks look good. We are backing those with strong retail franchise on the liability side and with broad-based financial services presence. Loan growth is coming back meaningfully. The bond markets were disintermediating the banking system. That is reducing. The economy is growing at a faster pace and this is a reasonable combination in terms of taking growth ahead. You are seeing credit cycle issues being resolved. The demographic story of those who can cater to a wide plethora of financial services continues. Financials is one place where we have a lot of conviction. Would you rubbish the market fears that the credit crunch is still on and NBFCs would tighten their purse strings before lending next time? We have been a tad cautious on NBFCs from the fourth quarter of last year. They had the perfect environment for them. The state-owned banking system stopped lending. A vacuum was created. At the same time, wholesale funding rates fell substantially and it was a very good recipe for the NBFCs to move in. On the margin, they were going to be under pressure irrespective of the unique issues we have seen in the last two months. We have to brace ourselves for higher cost of capital which tends to put them at a relative disadvantage. Second, once the credit cycle issues recede, it was known that the banking system would come back. The sweet spot for them is over. It does not mean that they are not going to do well. Some of them have very distinct niches and will do very well. But that said, banks are coming back and the NBFCs will have to concede a bit of ground.You like roads, railways, affordable housing and power transmission. Is that right? Suppliers to these segments. To be fair to this government, they have realised that they cannot pump prime the economy at large. They have chosen four or five areas and the areas you mentioned are highways and roads, railways, power transmission and affordable housing, particularly in rural India. They have done a lot of very good work here in terms of creating portfolios of bankable projects and making available reasonable sums of money. But there is a big problem with execution and funding. Exactly but that is why these are the areas where you have seen them put money to work. Let me give you an example. In the last budget, the outlay for power transmission was up 17%, whereas the outlay for power generation is down 15%. They have really not spread themselves thin. They have been very conscious of the fact that they need to take on battles which they can win. When you are saying suppliers, you are saying the L&Ts of the world…? We are talking of select capital goods manufacturers. We are talking of tractor manufacturers. We talking of cement manufacturers. In most of these segments, demand is growing at 10% to 15%. There is a lot of operating leverage because utilisation levels are at about 75%. You have both a top line story and a margin story. Do you see the sector churn play out in the market? Yes. What about metals? After global correction, metal prices are getting a little steep now. You can see that rub off on our metal stocks as well. Is it time to say goodbye to 2017 returns in metal names or do you find value there? The metals market is a conundrum of sorts because while the physical market is still well behaved, the issue really is the financial market which invests into this category has actually been receding in terms of interest because of the global macro, particularly with the dollar strengthening and some fears of a slowdown in China. The glass is half full if you ask me. Some would argue it is half empty. There are select Indian stocks which we believe will continue to do well. At the sector level, we have a neutral rating on the space but select stocks will continue to do well, especially those where there is a very strong restructuring angle. But at the sector level, physical demand is holding out but financial demand is receding. We prefer to have a neutral stance. Is the best behind us when it comes to exporters and in particular IT? We have had a neutral rating on IT services and an underweight stance on healthcare in terms of frontline exporters. We do not see very substantive enthusiasm in terms of fundamental demand improving in IT. The demand environment remains stuck in the 6-8% range. But what has definitely helped stocks is two things. One is buybacks by companies because of very good free cash flow. That has taken a lot of supply out technically and rupee depreciation is also helping initially because we have seen earnings upgrades in this sector on the back of rupee depreciation. But valuations have gone up meaningfully because the improvement in earnings has not been as substantive as the improvement in stock prices. We have a neutral weighting there. On healthcare, on one hand, we have been underweight because despite rupee depreciation, they do not tend to benefit as much because input costs tend to rise as well. Also, generic prices still remain under pressure and a lot of them are trying to make the transition to becoming speciality manufacturers, but that takes time. What are you telling your bosses globally about India’s elections and how that will influence the market trade ahead of elections? Six months before the Modi government came to power, there was a roaring rally. But emerging markets were rallying at that time. This was just after the taper tantrum and there was an emerging market rally at large. But would you agree that India outperformed within that pack? India did outperform that rally, yes. So I am very sure you get to calls with your bosses saying how do we sell the India story in the first six months. Six months is a long time in Indian politics. The issues, the personalities will all crystallise only into the later part of the second quarter as we get into the election mode. That is going to take some time. It is too early to really start worrying about the elections and the markets will have to wait and watch. The worst fears will come true only if you have a very fragmented verdict. Ex that markets will take things in their stride
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