Only when the strong macro-economic platform we are on gets converted into earnings growth will the domestic equity markets gain strength, says Vetri Subramaniam, Chief Investment Officer, Religare Invesco MF. Excerpts from an interview:

What is your outlook for the equity markets? How long do you expect volatility to last?

The macro-economic platform for India is stable at this point in time. But the challenge is that the growth outcome is perhaps not at the level at which we would like it to be. A lot of the numbers that we are seeing are consistent with the GDP numbers based on the new series, which is at around 6.5-7 per cent, whereas the expectation was that the economy could hopefully recover much faster and get into a higher growth trajectory. But one should be realistic. A growth outcome of 6.5 or 7 per cent is not bad when the rest of the world is struggling to keep its head above water.

The real challenge for the equity markets is that valuations have run up. At the beginning of the year, valuations were at 20-25 per cent premium to the long-term average. In that sense, it had already discounted a strong recovery in growth. What we have seen in the last few months is that we have gone from trading at around 25 per cent premium to may be 11-12 per cent premium. We are getting a bit closer to the comfort zone in terms of valuations relative to growth prospects. But we are still not really in the cheap zone.

So if markets correct a bit more, are Indian stocks a good buy?

The macro-economic platform is strong. But for equity markets, this needs to convert into earnings growth. If you have a long-term perspective of, say, five years, then the risk-reward is starting to get more attractive now than what it was in the beginning of the year. But it still calls for patience. Growth acceleration still remains a question mark, not only because of global factors but also because of domestic factors. We have a corporate sector which has still not completed its de-leveraging process; a banking system which is still to absorb the non-performing loans in the system. This is constraining our ability to accelerate the growth rate.

With prospects for India looking better vis-à-vis globally, does betting on domestic themes make sense?

At this point in time, it is more about getting the stock selection right rather than getting the sector selection right. Corporate profitability has been suppressed in India with reasons related significantly to the domestic economic cycle as well.

But at some point, we do expect that it will bounce back, which means that expansion in corporate profitability will come more from domestically driven areas, such as financials, consumer discretionary and industrials. But based on valuations, within those three areas, our preference is more for financials and consumer discretionary. Not that it is really cheap but the potential for profit recovery in an upturn looks reasonable here.

With the rupee depreciating, are export-oriented sectors expected to do well?

That’s a short-term outlook. We can take comfort from the fact that the consumer price inflation (CPI) has dropped to 4-5 per cent levels. But the inflation differential with the rest of the world is still stuck at 3-4 per cent. Given this gap, over a period of time, the currency should have 4-5 per cent depreciation per annum.

It need not come like clockwork but if you take a medium range forecast, then that kind of currency depreciation can be expected. A year ago, when people were panicking that the new government would orchestrate a strong rupee approach, we did not see that as being based on fundamentals, because of the inflation differential. Being invested in some of those exporters who are competitive companies has paid off.

If they are competitive, then currency helps them. But over a four-five year period, I don’t think that it’s an exceptional benefit.

What is your strategy for the Religare Contra fund?

The contra fund has a strong value-oriented approach. We have an internal target that about 40 plus per cent of the portfolio should be such stocks which are in the value territory. If you look at the portfolio in aggregate terms, it trades at a PE which is at a significant discount to the benchmark and almost 25 per cent discount to our in-house growth-oriented funds.

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