Revival of capex cycle key to re-rating of market

Written by Devangi Gandhi | Updated: Dec 4 2012, 07:39am hrs
Corporate earnings may have bottomed out, but a revival in the capex cycle may be needed before re-rating, believes Prasun Gajri, chief investment officer, HDFC Life Insurance. In an interview with Devangi Gandhi, he says the market may get nervous if it fails to see meaningful actions on the reforms announced since mid-September Benchmarks posted more than 20% returns this year. Can this continue next year

We have had more problems this year than we will probably have next year; so, our view on the market remains constructive for 2013. We know there are issues related to governance, NPLs in the banking system, muted action on the investment side. Even global headwinds including problems in the US, China and Europe are very well known. The question is the whether these problems become bigger, smaller or remain the same. Domestically, there seem to be some constructed efforts by the government for things to be moving on policy front.

On the macro side, weak rupee, high inflation, high interest rates have persisted throughout the year. The worst-case scenario can be that these things continue, which is less likely. Interest rates are most likely to fall this year and we believe people's 2012 anticipation on the interest rate cuts will play out in 2013.

Growth may continue to surprise on the downside, but the market appears to have discounted for growth rates of about 5.5%. In fact, it may be deemed positive as it may take the RBI closer to start cutting rates. The limitation that may come at this juncture is from the point of valuation. Today, valuations are very close to the long-term means. My sense is that this is not the market one would want to stay out of.

Do you think earnings downgrades have bottomed out

Corporate earnings seem to be stabilising as there are not many downgrades happening. While the downgrade cycle may have bottomed out, upgrades do not appear around the corner as yet, but may start improving over the next twelve months. The capex cycle is still weak. A revival in the capex cycle would lead to re-rating of the market.

Which are the key overhangs for the market

The key variables to look out for are the ones that can affect the domestic earnings, the first being crude oil prices. Secondly, if inflation fails to come under control, it would limit RBI's flexibility to deliver rate cuts.

And lastly, if the signs of governance that we have seen in last two months fail to lead to any meaningful actions, it could weigh on the market heavily. People are looking for more Bills being passed, formation of National Investment Board, expedition of some projects and easing of approvals. Clearly, there is a lot riding on this front

How is the market reaction to the divestment process

Hindustan Copper was not a representative issue because of its small size. However, if an asset is offered at the right price to the market, the Street has enough amount of liquidity to take it. NTPC, Oil India and NMDC are good companies to look at depending on what price they are offered. The government may end up raising something around the budgeted amount.

Which sectors are you buying

There are some consumption-related themes that are turning little bit expensive. It is time to play cyclicals given our expectations of an improving scenario where they tend to outdo defensives. Even, cheap valuations of some of the cyclicals make them attractive. This includes the banking sector, cement companies and select capital goods names. We remain underweight on the FMCG, IT and metals and neutral on Pharma.

What is your outlook on the interest rate cycle

We expect the RBI to start cutting rates by January. However, a lot would depend on how it reads into the recent GDP numbers along with the latest inflation number. In the current fiscal we expect 25 basis points of interest rate cut to come through and, for the next fiscal, we expect about 50 to 100 bps of cut being delivered.

Can FII flows get stronger

FII flows may see some volatility, but it is likely to be reasonably good going ahead as well. We are likely to stand out in terms of GDP growth, valuations, bottoming out of earnings growth and stable commodity prices in the recent past. Even global liquidity is expected to support the flows.