Markets may see a correction if government delays reforms

Written by Jash Kriplani | Updated: Oct 15 2014, 07:48am hrs
Domestic institutions are buying into markets at current levels as valuations remain in line with long-term averages, says Hemant Kanawla, head of equity at Kotak Mahindra Old Mutual Life Insurance. In an interview with Jash Kriplani, he said the telecom, bank and auto sectors are likely to post strong earnings growth in September quarter. Excerpts :

Can markets see a sell-off if the government fails to live up to expectations

FIIs have certain expectations on the pace of economic reforms. If there is a delay in implementing them, markets can see a correction. A critical review of the government will start from December quarter. By then, the government will be more than six months old and investors will evaluate if measures taken by it are helping the economy revive. Market participants will also start building expectation from the next Budget, which should be much more serious than the first one as the government will have sufficient time to announce a more detailed agenda to revive the economy.

What are the major headwinds for markets

Major headwinds for the markets can arise from global events. So, as and when US interest rates rise, it could impact emerging markets negative ly. Even RBI is worried and is trying to build its own war chest against it. Geopolitical events and slowdown in China too are a concern. On the positive side, commodity prices are coming off.

Are the valuations slightly on the higher side

We are sitting on 3-4 years of a slowing economy where earnings have not grown. While markets are at new highs, in the past 5-6 years they have just been consolidating. So in the past 5-6 years, two things have happened: First, valuations which seemed expensive in 2008 have corrected and moved in line with long-term averages (i.e. 15 times one-year forward earnings); second, excesses in the economy have also corrected.

When the economy grows at more than 7% for a long period, inflationary pressures build and capacity addition is not in sync with demand. And thats when the economy needs to slow down. The slowdown in our case has been more than what we would have liked. Current valuations seem reasonable if the economy revives and there is a strong earnings growth for the next 3-5 years.

Are domestic institutions like yourself going to continue to buy into markets at these levels

Institutions get money with a mandate to invest with a medium-term view. The economy is likely to revive and can accelerate earnings of corporate India. At current levels, valuations are more in line with long-term averages. A combination of these two factors provides a potential of good returns from equity investment in the medium-term. Also, most schemes have an objective to not maintain very high levels of cash. Hence, domestic institutions are deploying funds at current levels.

What is your expectations from the Q2 earnings season Which sectors could see significant growth

The earnings season for Q2 is likely to show double-digit earnings growth for corporate India, led by improvement in margins. Sectors which benefit from revival in the economy with a strong operating leverage are likely to report significant growth. On that basis, telecom, banks and the auto sector are likely to report strong earnings growth.

After the RBIs recent monetary policy report, a rate cut in FY15 looks unlikely.

A: RBI has re-emphasised that the trajectory of monetary policy will largely depend on the movement of CPI. The current target is to achieve 8% CPI by January 2015. It is possible that with current softness in commodity prices and measures taken by the government, CPI may be below 8%.

In this scenario, rate cuts are possible in the first half of CY15. Although debt markets are an obvious beneficiary of rate cut, it will also help equity markets as rate cuts will boost investment cycle and revive the economy.