MUTUAL FUNDS

Expecting a sharp upside to certain beaten down sectors in engineering and capital goods<
05-Jan-13   10:51 Hrs IST

Mr. Tushar Pradhan
International capital flows have been very strong this past year and a continuation of the same is based more on hope than a real possibility at this time. This is due to the fact that apart from being the best performing emerging market of significant size this last year, other economies are expected to improve on the back of renewed hope of a global uplift in GDP growth rates driven by the US. Thus on a valuation basis the India story does not look that attractive. India continues to remain one of the most expensive markets on a P/E basis across the emerging markets. says Tushar Pradhan, Chief Investment Officer at HSBC Global Asset Management, India

We at Capital Market interacted with Tushar Pradhan to now the outlook on equity markets for the year 2013.

Excerpts:

1) Year 2012 has been good for the markets, including India. How long into 2013 can we carry this optimism, given the way the global economic and political landscape is shaping?

The past year surprised on the upside as an earnings growth of around 12-13% translated into a market return of close to 30%. This was on the back of strong foreign flows and a late rally in stocks led by some positive noises coming on the reforms front. Thus the re-rating appears to have already happened. We believe that in the New Year the markets may provide returns based on earnings growth, which for now yet looks suspect, but may turn strong towards the latter half of the year. Globally the unresolved issues in Europe still dominate and no clear solution looks imminent. However China manufacturing is showing an uptick and so is US housing. These may provide some relief.

2) India received good inflow from FIIs in 2012. Do you think India will continue to receive such inflows?

International capital flows have been very strong this past year and a continuation of the same is based more on hope than a real possibility at this time. This is due to the fact that apart from being the best performing emerging market of significant size this last year, other economies are expected to improve on the back of renewed hope of a global uplift in GDP growth rates driven by the US. Thus on a valuation basis the India story does not look that attractive. India continues to remain one of the most expensive markets on a P/E basis across the emerging markets.

3) What is your outlook for 2013? Which sectors do you expect to benefit in 2013?

With the current economic climate, it appears unlikely that the markets may provide more than low teens returns for the new calendar year. The opportunity beckons from a valuation perspective. While we do expect the broad market to produce tepid returns in New Year, we do not think that all stocks will remain in this range. There is big gap in valuation between cyclicals and defensives. While 2012 narrowed this gap a little, some companies continue to show deep undervaluation. We expect the natural phenomena of mean reversion, seen in most markets, to be strong this year. While we do not expect a sharp de-rating in expensive stocks such as FMCG and private sector banks, for example, we do see a sharp upside to certain beaten down sectors in engineering and capital goods.

4) Where do you see Sensex by the end of 2013?

We expect low teens returns for the new calendar year. This will mean a new high for the equity market, but the momentum may not be there to support this performance from creating an upward move from there. The last peak of the BSE Sensex was seen in early 2010 at a level of 21004 on 5th November of that year and the market had seen a peak level prior to that in the year 2008 at 20873 on 8th January. We expect that these levels will possibly be broken upward in 2013.

5) Banking sector has sprung back sharply in 2012, compared to negative returns in 2011? Moreover, MF industry's exposure to bank shares has been over 20% of the industry's total equity AUM? What's your outlook on banking sector moving into 2013?

The BANKEX which represents the banking sector in India returned an astonishing 56% for the calendar year. However the largest component of the index, ICICI bank which provided around 63% returns during the year, drove the index to this level. Several public sector banks remained under pressure due to asset quality woes, so it would not be correct to paint the entire sector in one color. The industry exposure is a function of the weight of the sector in any index which is upward of 22%. We believe there is selective value that can be seen in the sector while some private sector banks are clearly overvalued at this time.

6) In India, consumption theme has done well over the past couple of years. Will the trend continue in 2013?

The sector today trades at a significant premium to both, the index as well as its own historical valuation. This indicates that an outsized return may not accrue this year. However irrational valuation on the back of a sustained momentum of FII inflow can yet keep the returns high.

7) Do you subscribe to the view that a change in the business cycle will improve the performance of infrastructure funds? What would you advise investors viz their holdings in infrastructure funds?

Pure infrastructure plays still face significant headwinds on issues such as high debt, structural bottlenecks and delays in land acquisitions, etc. We do not foresee a quick redressal to these problems. However the sector may move up in response to a general positive sentiment if it emerges and corrects the deep undervaluation as the current prices seem to price the worst case scenario. We are strong believers of mean reversion and this may yet prove the case this year.

8) Going by the mutual fund folio closures seen in the recent past, do you think retail investors are still doubtful of how the markets may pan out? Do you expect active retail participation in 2013 or will it be another year of fence sitters?

In the history of stock markets globally, retail investors have seldom been convinced of the longer term nature of the markets and they have persisted in timing the market. Strong momentum driven retail interest usually comes at the end of a bull run when most of the gains have already been made. I expect a similar approach from the Indian retail investors this time around as well.

9) What reforms you expect for curtailing fiscal deficit?

The largest measure to be taken to reduce the structural nature of our fiscal deficit is reduction in subsidies on power, fuel and fertilizer. It is anybody's guess if this will change in a material manner ahead of a general election. However we are optimistic of some changes likely to occur and may yet take the bite off the fiscal deficit. A strong currency driven by FII inflows will itself lower the fiscal deficit since most of the deficit stems from our dollar purchases of crude oil.

10) What would be your advice to investors for the forthcoming year?

Investors should be best served by allocating their assets next year in a judicious mix of assets across equities, fixed income and others rather than rely solely on any one asset class to deliver the best returns, their risk appetites notwithstanding.

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