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December 05, 2001

Tata TD Waterhouse MF : Shyam Bhat, GM

 The Indian equity markets appear very attractive on valuation, fundamentals and improving corporate governance standards, which is also evidenced from the FII Investment in the last six months. When do you think this is likely to get reflected in the Sensex movements?

The Indian equity markets definitely look very attractive from a long term point of view ie from a time horizon of about two to three years. However, in the short term we do not expect a big rally in the indices. This is because we have already seen a recovery in the Sensex from 2600 levels to 3300 level, which is a rally of more than 25%. This rally has more than nullified the sharp fall in the Sensex seen subsequent to post September 11 events. However, from a long term point of view, markets are definitely attractive because in terms of valuation markets are currently trading at historic lows while the economic indicators are not so bad that one can overlook equities all together. We expect a compounded annualized growth of 20% in the broad equity markets over the next 2 to 3 years.

Do you think the markets will be volatile in the short to medium term? If yes, what could be the reasons?

Until the Afghanistan issue was resolved, we had expected the Sensex to remain in a trading zone between 2700 and 3500 levels in the current year. Now that this issue is almost past us, we believe that the probability of a fall below 3100 is low, as there are no major negative triggers. Over the next one year, we expect volatility in the Sensex movements because of uncertainties ahead. This is on account of the following reasons:

• The way the international oil prices movements will move is also not clear, though it appears that the prices would be on the lower end of the price-band. First, there was a spike in oil prices on the expectations of the involvement of the gulf countries in the Afghan conflict. Then there was a sharp retracement in the oil prices on concerns about a global recession. OPEC has proposed to cut oil production, but the success in ensuring an increase in oil prices depends upon Russia’s cooperation. India being large importers is very sensitive to any increase in oil prices.

• Secondly this time, though the monsoon has been good and well distributed it has been not been spectacular. This is because certain states have received lower than usual rainfall. The only comforting factor has however been that states, which were deficit last year, have seen good rainfall. Thus the expectation of a good monsoon leading to spurt in rural incomes and economic recovery may not take place.

Thus in the short term the markets are expected to be volatile but in the medium to long term the situation is expected to improve.

Do you think the recent lows reported by the Sensex was more of an aberration or do you feel the market is likely to touch new lows in the remaining periods?

One can never be certain about the equity markets, but the probability of the Sensex touching a new low is very less. This is because the scenario under which it touched previous low seems to be much under control. Earlier there were fears of a full-fledged war and India getting directly involved in the war. Bur the war was restricted to a region and is over for all practical purposes. Thus the scenario under which the Sensex experienced the earlier lows does not seem to exist and hence the probability of the Sensex touching new low is very low.

What are your views on the current capital market reforms undertaken by SEBI? Will it reduce the volatility in the markets in the long run?

We believe the introduction of stock futures could actually increase volatility in the markets. In one way, stock futures could actually be compared to badla. This is because one is allowed to speculate on certain stocks by paying a margin. We feel stock futures will bring back trading interest in the market and improve liquidity in the stocks. It will take some time to understand but in the long run it will definitely help to increase the depth of the markets. Though not very successful in many countries, we expect stock futures to be a success in India given the nature of the Indian stock market (as compared to index futures), where the indices have not really given returns of any significance. We expect the success of stock futures to lead to more and more players participation in stock futures and result in greater flow of money into stock markets.

Do you think fund managers should increase allocation to defensive sectors or hold cash and wait for opportunities?

Any equity portfolio should definitely comprise of all the three components - growth sectors, defensive sectors and cash. The actual proportion can vary depending on circumstances and valuations. Under the current situation if one has low exposure to defensive sector, then one can increase. But if one has reasonable level of investment in defensive sectors, say between 20% to 25% then one should not increase beyond that level. One should also have 5-10% allocation to cash. This is because markets are expected to remain in a trading zone for a better part of the year and hence one would get opportunities and therefore one should not be short of cash at that point of time. Further cash can be deployed in government securities, which has given much higher returns than equities in the last one year.

What are your preferred sectors and top investment picks?

We expect the automobile sector to do really well in the current year as we have seen definite improvement in the volumes like commercial vehicles segment. Within 2 wheelers we expect the motor cycle segment to continue showing improvement in numbers on month over month basis. We are confident that automobile companies will show good performance as many of them have undertaken several cost reduction measures which has led to an improvement in their margins despite lower sales growth.

We expect Indian pharmaceutical companies focusing on generic exports to do really well. We are also bullish on companies showing high growth in the domestic market and operating in niche areas like Wockhardt and Sun Pharmaceuticals. We are currently underweight on the FMCG sector as we expect the FMCG sector to take quite some time before showing any significant top line growth. Further most of the FMCG companies are currently trading at very high Price Earnings to Growth multiples and appear to be fairly valued.

The Indian economy has reported poor numbers in the first half of the current year? Do you expect any revival in the Indian economy going forward and what could provide the trigger?

Today the problem is not of an agricultural production but more about the demotivation of the farmers. This is on account of granaries overflowing due to record agricultural production in the last few years. This has meant farmers are not really getting their money’s worth of what they have produced in the last few years. In such a situation farmers do not have motivation to really produce more. Unless the foodgrains stored in granaries are consumed or exported will the farmers situation improve. It will take time for this situation ie excess supply of foodgrains to ease. Thus even though one feels that a good monsoon with a lag effect would lead to spurt in rural demand, one has to be realistic about the overall implications.

Secondly, the industrial production numbers have been very disappointing so far. For example neither the volumes nor prices in the steel industry have shown any signs of improvement. Similar situation exists in the aluminum industry. Also, one has hardly seen any new industrial projects being undertaken by large corporates. Further, if one looks at the infrastructure industries numbers, even there no signs of definite recovery are visible. On the exports front the situation is also dismal. It is ironical that today one country is affecting the fortunes of two industries in exactly the opposite direction. On the one hand the Indian IT industry is reeling under the impact of the recession in the US while on the other hand generic exports of the Indian pharmaceuticals to the US are increasing in a big way. However the overall impact is unlikely to mean a higher export growth.

The only comforting factor could be the government spending on highways as planned. This could trigger demand for cement and commercial vehicles segment and lead to an economic recovery. It is widely believed that early signs of revival in auto industry could mean economic recovery

Is there a high level of correlation between the US and the Indian economy in view of the fact that both economies have seen significantly reduced interest rates?

Interest rate cuts carry a lot of significance in the US because a lot of consumers borrow significantly for consumption as well as investments. As the US economy is highly leveraged, any interest rate reduction would mean savings from the consumers’ point of view by way of lower borrowing costs. Thus as the disposable income of the consumer increases it should lead higher consumption and thereby a US economy recovery. In India lower interest rates is not expected to have any positive impact from consumers’ point of view, as traditionally Indians are savings oriented. A reduction in the interest rates in the economy means lower disposable income, which leads to a deferment of purchases. Unless the Indian mentality changes from savings oriented to spending oriented the lower interest rates could actually harm the Indian consumers.

Do you believe in buy and hold strategy or active churning strategy?

Our investment decisions are based purely on valuations. We make investment decisions with a buy and hold perspective by setting price targets based on the valuations, which we think the scrips deserve. In case the stock prices move sharply and reach our target price, we may book profits even if the time period that has elapsed is small, say 3 months. Here the strategy of portfolio churning is more on account of market conditions. On the other hand if the stock price moves down significantly, then we reevaluate the stock. We add more if we are convinced that the fall in price is more on account of technical factors and not any change in the fundamentals of the company. In case the fundamentals of the company have deteriorated or there are any adverse developments concerning the company then we do not hesitate to book losses and cut our exposure in the stock.

What according to you should an investor in an equity funds do in the current market situation - buy more units and reduce his average cost, do systematic investment for next few months or simply hold on to his investments?

An investor should not aim to time the entry into the mutual funds. If the equity fund has performed better than the market indices and the peer group then an investor should buy more units and average his cost. However if the fund is a laggard in performance vis a vis the peer group or has consistently delivered poor returns compared to benchmark indices he should switch to better performing funds. A new investor can definitely earn good returns from a good diversified fund over a three year horizon by opting for a systematic investment plan.