Valuations in the Indian context have become reasonably cheap but inflation is a concern.

With inflation not subsiding and policy paralysis continuing, Business Line caught up with Nitin Jain – Head of Retail Capital Market, Edelweiss Securities Ltd, to find out the growth prospects of the India equity. We also try getting more clarity on retail participation in the market and quant trading for investment purposes.

What is your outlook on the market from a one-year point of view?

We believe that the valuations in the Indian context have become reasonably cheap but inflation is a concern. The interest rate cycle seems to have peaked but the reversal in the rate cycle has not started. Additionally uncertainty surrounding the Euro crisis is also not helping the markets.

Apart from attractive valuations, corporate India is still showing resistance in terms of earnings growth. Companies’ earnings have grown at around 10-12 per cent in the June quarter despite domestic and global concerns.

We believe the Nifty should trade in the range of 5,000-5,600 while the BSE Sensex may range anywhere between 16,500 and 18,500 levels this year, with a positive bias. Whenever stock prices come down we are advising clients to go for high quality companies where business models are reasonably clear.

What has driven the market rally which began in December 2011?

In 2012, we got a huge inflow of more than Rs 60,000 crore from foreign institutional investors. Despite the fact that there was pessimism, valuations were so attractive that a lot of global ETF money came into the equity market. Inflows were also due to risk-on play because of the cool off in commodities. India attracts inflows when commodity prices especially crude oil prices decline.

Secondly, there was expectation that the interest rates will fall. In fact, the 10-year government securities which were trading at 8.8-8.9 per cent in February are now trading at 8.1-8.15 levels. There has been a large rally in Government securities which is basically a pre-emption to that fact that interest rates will cool off. Markets will always try to predict what may happen six months down the line and take positions before that. These expectations led to Indian markets outperforming. Markets also had become extremely cheap in December trading at 12.5 times forward earnings. At these valuations, there was a lot of buying interest from the value investors.

Even as the valuations are cheap, given the decline in profitability and growth in earnings, is the market really undervalued?

Valuations are at 12.5-13 times forward. I think it is also a good thing that the earnings are suppressed. Suppressed earnings is a great recipe for a significant up move as everybody has revised their targets and profitability numbers reasonably low. If there is a surprise on that front, the markets will dramatically go up. One, the earnings would have gone up and the PEM will definitely shoot up which would be a double benefit.

Which sectors is Edelweiss bullish on?

Private sector banks still look very good to us. There are a few retail NBFCs which we like a lot. For instance, Gruh Finance is a company which looks expensive but has done phenomenally well in terms of earnings. It has HDFC management with a reasonable market capitalisation. Bajaj Finserv is also looking attractive. We continue to like FMCG stocks such as ITC and Hindustan Unilever.

Does low retail participation have anything to do with very low returns from the equity markets in the last five years?

Equity is a mean reverting instrument. If you have seen during the 2002-2007 period one would have got 45 per cent compounded return. A lot of people got tempted to invest in equity during 2007-08 year. As advisors our job is to inform investors that if the valuations are attractive then this is a great time to go and invest irrespective of historic return. And you don’t have to invest 100 per cent of the savings in equities. Invest 30 per cent and do it systematically.

I think the message to clients is that one has to invest whenever the market corrects. Over a long-term, real wealth can be created if you are only in equity. Worse the returns in the last five years, the chances of making returns in the next five years will be higher.

Can you tell us briefly about quant trading which is unique to Edelweiss?

Quant trading takes emotions out of trading. The approach is simple. You build algorithm to pick a stock valued at price to book of less than 2, with ROE of 24 per cent and is trading above 200 day moving average, then you should buy the stock. The stock should be a good company at cheap valuation and when the technical indicator shows that it is looking strong we should buy. This rule we should follow across all stocks. This is what quant trading is. It ensures you are not violating the basic principles of trading and if the stock does not perform you will have a stop loss. You don’t have discretion and it just happens automatically.

(This article was published on August 18, 2012)
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