Bloomberg Quint, Mar 14, 2017
U.S equity indices may be at lifetime highs but there are headwinds that the market has not priced in, cautions Sunil Sharma, the chief investment officer at Sanctum Wealth Management.
There is a recognition that fiscal stimulus in the U.S. may not through in the manner that most market participants were expecting. This coupled with the fact that emerging markets are beginning to look positive, has resulted in a return of fund flows into these markets, Sharma said.
Here are edited excerpts from that conversation.
Q: U.S. indices are at lifetime highs and they are pricing in possible tax cuts and large infrastructure spends. Are there concerns that the market is yet to price in?
A: What we have witnessed in the past six months is a consensus trade away from emerging markets and into developed markets in anticipation of a very strong fiscal stimulus by President Trump. We believe there are several headwinds. Primary amongst them is three U.S. Federal Reserve hikes which will be a headwind for the U.S. markets. Valuations of U.S. markets are at extremely high levels relative to historical benchmarks. The consumer balance sheet is relatively weak as a result of some of the policies that have been in place for the last two decades. We would think that inflation ticking up as well as a strong dollar are both additional concerns that investors are just now recognising. Finally, we would suggest that there is a lack of clarity at this point in terms of what the stimulus is going to look like and how effective will Mr. Trump’s efforts to launch stimulus will prove to be.
Fund Flows Into India
Q: What is your outlook on the dollar? How will it impact flows in India?
A: There is a recognition, and there was a lack of recognition earlier, that the fiscal stimulus would be implemented relatively effectively. Today, there is recognition that fiscal stimulus will not come through in a manner that markets were expecting. There is also a recognition that some of the factors in emerging markets are quite attractive. So we are seeing a rotation of the money that left emerging markets come back over the past month and this month, back into the markets like India. So clarity will emerge as details of President Trump’s fiscal stimulus plan emerges.
‘Positive On Earnings Growth’
Q: How are you reading earnings and valuations given the run-up in Indian equities?
A: This quarter was impressive for us. Particularly in the face of demonetisation. The ability of Indian corporates to deliver earnings growth which was far better than the previous two quarters is a good sign for the prospects of earnings. We are also seeing better transmission (of interest rates) coming through as a result of demonetisation which will help margins. As a result of demonetisation, there will be marginal improvement in operating profitability and that bodes well for earnings as well. We would add that the fiscal prudence demonstrated in the Budget will also contribute to earnings prospects for the year. We are quite positive on earnings growth.
Debt Versus Equity
Q: You have said you are not shying away from debt. But fixed income looks riskier than equity right now.
A: Fixed income, that is government securities, has a level of risk associated with it that we have not seen in the past few years. We have been working in a declining interest rate environment. With the RBI’s decision to move to a neutral policy stance and the uptick in inflation, we are now looking at a cycle which has possibly bottomed out. Our call was that it will bottom out sometime in late November to early December. And so fixed income becomes a class that must be approached with a different perspective compared to the past few years. Taking that into account and the level of the interest rates today, equities is a relatively more attractive asset class.
Q: You prefer private sector banks over public sector banks. There is a lot of speculation of possible mergers and consolidation in the sector. Do you see benefits should some of this come true?
Absolutely. First of all, we have been participating in the private sector bank space and it has been doing very well for us. We are closely watching developments in the public-sector banking space because reforms are finally coming through. Efforts are being made to make these entities more effective. As those efforts come through, we would certainly look to participate. We need the banking system to lend effectively and rapidly.
Bullish On NBFCs
Q: In financials, you also prefer select non-banking financial companies (NBFC). Would they be housing finance companies or microfinance companies? Where would your preferences lie?
A: We do not have exposure to microfinance companies. We were heavily invested in NBFCs over the course of last year. We are sticking with that position for now. We would not be looking to add to financial exposure as this point in time just because of where we are in the business cycle. We are sticking with our exposure in housing finance. Capital markets is another area we are looking at that we also own in the financial sector.
Q: You say this is a stock pickers’ market. What are those areas which may still be undervalued or which may offer good returns going forward?
A: One sector which is finally getting the recognition that it deserves as a growth sector is energy. We have participated in the energy space over the past year. In the oil and marketing companies and natural gas space. We think the growth prospects for the sector remain bright. The recognition is finally coming through in terms of the global environment from an alternative energy perspective.