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EXCLUSIVE: Sensex, Nifty overvalued 15-20%, but the rally may be sustained; Saurabh Mukherjea tells how

While rupee tumbles to record lows, benchmark share market indices Sensex and Nifty have scaled record highs. Indian stock market is currently overvalued by up to 20%, says renowned investment manager Saurabh Mukherjea.

According to Saurabh Mukherjea, while the current P/E of Nifty isn’t worrisome, financial services stocks trading at 5-7x P/B or even higher is indeed alarming.

While rupee tumbles to record lows, benchmark share market indices Sensex and Nifty have scaled record highs. Indian stock market is currently overvalued by up to 20%, says renowned investment manager Saurabh Mukherjea. However, if liquidity doesn’t tighten, the market could sustain these levels, he adds.

According to Saurabh Mukherjea, while the current P/E of Nifty isn’t worrisome, financial services stocks trading at 5-7x P/B or even higher is indeed alarming. While rupee has assumed heightened focus, most fast growing developing economies tend to have inflation rates which are between 4-10%, and a gradual depreciation is actually beneficial for the economy, he says.

Sushruth Sunder of FE Online recently interviewed Saurabh Mukherjea, Founder and CIO, Marcellus Investment Managers. Saurabh Mukherjea, who recently stepped down as the CEO of Ambit Capital, shares his insights on rupee depreciation, the recent small and midcap correction, the capex cycle and how retail investors can create their own coffee can portfolio. Here are the edited excerpts:

What is your near-to-medium term view on the stock market outlook?

I don’t have an outlook as such on the market. However, I do believe that Indian stock market is overvalued by 15-20%. That being said, provided liquidity doesn’t tighten, such an overvaluation could continue for while.

We seem to have come out of a small and mid-cap mayhem, and the space is showing signs of a rebound. Is the worst behind us, or is there further correction in the offing?

If CPI inflation continues to be 5%+ then small and midcaps will remain under pressure as such companies do not have the bargaining power to deal with inflation. When the prices of raw materials rise, when the cost of money rises, smaller companies tend to see operating margin compression.

What is your view about the NPA resolution process?

It is a partial success insofar as that for regular NPAs there is now a semblance of a process. Where it is less than ideal is that powerful promoters are still able to manipulate the process and drag things out in a manner which suits them. That’s where the slowness of the Indian legal system when it comes to dispensing justice becomes a binding bottleneck.

How can retail investors create their own coffee can portfolio?

As explained in my books, the template is simple – look for companies which over the last ten years have delivered at least 10% revenue growth every year alongside 15% Return on Capital Employed. There are only a dozen or so firms in India which pass these tests. Buy them and hold them for a decade. You should end up multiplying your money tenfold.

What do you make of the current valuation of Nifty? Reports suggest that the Nifty is trading at a trailing PE of 28. Is this unprecedented? What is your view.

The Nifty has been more expensive before, eg, at the height of the dotcom boom. So it is not the P/E multiple of the Nifty which worries me. What keeps me awake at night is the valuation being attributed by the market to Financial Services stocks. Such stocks make up nearly 40% of the Nifty. No sector in the history of the Nifty has ever accounted for such a high share of the Nifty’s market cap. Several second tier banks and NBFCs are trading at 5-7x P/B or even higher. Such valuations don’t make sense to me.

The rupee has hit record low, and the financial turmoil in Turkey seems to have no end. What is your view on the direction of rupee? Should RBI intervene?

I have never understood why everyone obsesses about the level of the rupee. Most fast growing developing economies tend to have inflation rates which are between 4-10%. As a result their currencies depreciate as the economy goes from being third world to second world to first world. Such a depreciation is not only par for the course, it is actually necessary to keep the developing economy competitive in the global economy.

What impact is election 2019 likely to have on the stock market? What would you advise investors?

I don’t think there is any specific pattern which correlates election patterns to stock market returns. Neither is it obvious at this juncture what will happen in the 2019 elections. So I don’t think there is any point in speculating on this issue.

Where are you finding value in the current stock market?

The rupee is long overdue a major slide. Hence export centric sectors should do well. Pharma looks like an appealing sector to me.

There seems to be an earnings bounce back in the latest quarter. Which sectors have done well in your assessment, which sectors must investors look at?

It is great to see EPS growth finally hit double digits after 5 years. FY19 should be the first year of double digit EPS growth after 5 years. However, this EPS recovery is more than adequately discounted in stock prices.

Except the recent HDFC AMC IPO, the primary markets seem to have taken a breather. What are the upcoming IPOs which investors can look to invest?

I have never understood the fascination for investing in IPOs. 80% of Indian IPOs give returns lower than inflation. The novelty of the occasion seems to delude people into believing that there is money to be made in betting on IPOs.

The mutual fund inflows have seen some kind of tapering in the last two months, receding from highs last year. Is this trend likely to continue?

Mutual fund inflows are running at Rs 10,000 crores per month. That is remarkably healthy by any benchmark. While there might be temporary reversals in this trend if markets weaken, the structural pattern is clear – Indians have finally broken free of the obsession with buying flats and buying gold.

What would the impact of RBI rate hike on the stock markets?

The market is already discounting 1-2 rate hikes by the RBI before the General Elections. So I am not sure that this will be a source of negative shocks.

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