‘Demonetisation will lead to a big economic reset ’

With the long-term impact of demonetisation remaining unclear, there is a lot of volatility in the stock markets and uncertainty as regards the market trajectory from hereon. Against this backdrop, Business Line caught up with Harsha Upadhyaya, Chief Investment Officer– Equities, Kotak Mahindra AMC, to decipher the appropriate investment strategies for retail investors at this juncture. Excerpts from the interview :

What is the expected impact of demonetisation on economic growth?

While we are witnessing postponement of demand, cash flow issues and possibly some bad debts in some worst cases due to demonetisation, it is one of the biggest reforms to date in our country. Unproductive hoarding of cash and investments into physical assets will reduce due to this step. Economic growth will be more broad-based going forward. Tax compliance will increase and tax buoyancy will help government spend additional money on development.

What are market concerns at this juncture and when are we likely to see a recovery?

Market participants and corporates are still trying to assess the short-term impact of demonetisation. The short-term concerns on earnings visibility have increased. On the global front, the monetary easing cycle seems to coming to an end with yields hardening, which is creating volatility in emerging market currencies and markets. We are unlikely to see broad-based economic recovery for now.

Demonetisation will lead to a big reset in our economy, which will then be followed by GST rollout. Once these events are behind us, we are likely to see gradual recovery.

So, will corporate earnings take a hit due to this move ?

For the past two years, while the headline Sensex or Nifty earnings were quite sluggish, the broader market witnessed healthy earnings growth in select business segments. We began seeing some recovery in earnings during first half of FY17, and we were expecting this trend to gain momentum. However, with the demonetisation drive, the short-term outlook on corporate earnings has once again become hazy.

But we expect business activities to normalise gradually after a few months. Further, there could be a gradual shift in favour of organised businesses from the unorganised sector due to demonetisation and the expected GST rollout next year. Therefore, FY18 could well be a recovery year for corporate earnings. If this scenario pans out, we should see markets doing fairly well post-consolidation in the short term.

What kind of themes and sectors are you focusing on currently?

At the fund house level, we are focussing on domestic rather than export-oriented companies. Within domestic market, we are looking at companies with high operating leverage, especially those with excess capacity. As demand picks up, capacity utilisation would improve and they will start showing better profitability than others.

We are bullish on auto, cement, oil & gas and banking sectors. While we expect an adverse impact in the short term on auto and cement sectors due to demonetisation, we also believe the focus of the government will be on reviving rural economy, building infrastructure and improving consumption. Factors such as government initiatives on affordable housing should augur well for medium-term cement demand. So, capacity utilisation will continue to move up.

The competitive landscape of cement industry over the decade has turned for the better, with consolidation of the market in the hands of few players.

This has improved pricing power as well as pricing discipline in the industry. Higher capacity utilisation and pricing power will have a positve effect on profitability levels of cement companies.

We are positive on OMCs (Oil Marketing Companies) and gas utilities. OMCs have seen balance sheet and cash flow improvement due to diesel deregulation, which is sustainable. However, we are negative on oil producers. Banks are seeing cost of funds coming down very sharply. The banks that can manage asset books well are likely to gain further, going forward.

What returns can investors expect from equities over the next 2-3 years?

In my opinion, equities will most likely be the best asset class to invest over the next 2-3 years. We were already witnessing the trend of savings in financial assets having an edge over physical assets (real estate and gold).

Post-demonetisation, this trend is likely to gain further momentum. Even within financial assets, with already low interest rates and deposit rates, if one has to beat inflation consistently then equity investment is a must. We expect large pools of domestic savings to move into equities over the next few years.

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