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24 November, 2017 22:24 IST
Fund Manager

Earnings recovery, policy reforms to drive markets in 2016: Harsha Upadhyaya

Source: IRIS (30 December 2015)

Earnings recovery, policy reforms to drive markets in 2016: Harsha Upadhyaya
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Harsha Upadhyaya, CIO Equity, Kotak Mahindra AMC expects 2016 to be a better year for the stock markets. He expects recovery in corporate earnings growth trajectory and gains due to policy reforms will likely to drive market performance in calendar year 2016.

In an interview with Sourabh Pandhare, Harsha Upadhyaya said, 'After muted first half, the earnings outlook for second half of FY15-16 is incrementally better. We expect a gradual pickup in earnings momentum going forward on the back of better demand outlook, improvement in margins and lower interest burden. We may see 6-8% earnings growth in FY16 and a growth in the region of mid-teens the year after.'

Excerpts from an interview:

1. Stock market is expected close 2015 year on a negative note. Sensex has lost over 5 percent since December 2014. Do you think 2016 will be better for markets than 2015?

After a forgettable CY15, we expect CY16 to be a better year. The benefits of ongoing reforms will translate into a slow but steady economic recovery. Earnings expectations for FY16 have been significantly cut. However, it now does appear that the pace of earnings downgrades for the market is close to its peak and FY17E earnings growth should settle at around 15-16% levels.

From here on in FY16, we expect a modest recovery driven by two factors:
i. A favorable base effect in H2FY16
ii. A recovery in margins as the complete pass through of lower input prices and interest rates is effected

2. Foreign investors have invested close to $2.80 billion so far this year, which is lower by 82.70% from net investment of $16.12 billion in 2014. Is the market overly dependent on foreign inflows? Will foreign inflows pick up in 2016?

While the foreign flows dipped during 2015, the domestic investors continued to make significant investments into equity mutual funds. The strong flows into domestic funds and equity investments made by long term domestic institutions such as EPFO, pension funds made up for reduction in foreign flows. With expected recovery in earnings growth scenario, we expect foreign flows to improve next year.

3. What are the key triggers that will drive market performance in calendar year 2016?

Market performance in 2016 is likely to be driven by expected recovery in corporate earnings growth trajectory and gains due to policy reforms.

4. According to you which sectors likely to outperform and underperform in calendar year 2016 and why?

Urban consumption is likely to be strong going forward given declining interest rates, positive impact of seventh pay commission and improving corporate wage growth. Auto sector could be a major beneficiary of this trend. Even enablers such as banks focusing on retail business are likely to see better prospects. On the back of renewed government focus on building infrastructure we expect cement sector and select stocks from engineering/ capital goods to do well.

We expect the downturn in global commodities to continue even next year, and hence believe that it is likely to underperform the market.

5. Which sectors are you avoiding at this point of time?

Metals, global commodities and telecom are the sectors to avoid.

6. Mid-cap and small-cap stocks recorded a marginal gain in 2015. Do you think, mid-cap and small-cap stocks will continue to perform better than their larger counterparts in 2016?

With continued outperformance of midcaps, midcap valuations are now at a premium to the large-cap valuations. Historically midcap valuations were mostly at a discount to large-cap peers. However, the earnings have also been steadier in case of midcaps in 2015. Given this scenario, we believe that the stock-specific approach in midcaps in a diversified equity portfolio will yield better results in 2016.

7. Favourable inflation has provided RBI room to lower interest rates by 125 basis points in 2015. Meanwhile, industrial production growth was positive with volatile movement in this year. In this light, how do you see outlook on growth, inflation and monetary policy in 2016?

In our view, Indian economy is on the mend. While there has been significant improvement on the macro side over the last year or so, the corporate and business fundamentals do not inspire the same level of confidence yet. With interest rates easing, we may some gradual pick up in consumption levels, which could lead to better utilization of existing capacities and eventually for further investment plans. The renewed focus on building infrastructure by the government will also start yielding results in the coming years.

The recent rise in CPI inflation in India as per the latest data should be viewed in light of the fading base effect and we expect that CPI inflation for FY16 would average about 5% and remain within RBI's targeted rate of 5.8% in January 2016. For FY17, our expectation is for average CPI inflation to range between 5-5.5%.

We believe that even after the 50bps cut in policy rates in September 2015 (125 bps cut in policy rates cumulatively in CY15), RBI has the head room to cut rates by another 25-50bps in CY16, given our expectations of modest inflationary scenario.

8. Earnings performance remained lackluster for September quarter. Do you think India Inc. earnings will pick up in the next year?

The overall corporate results for the quarter ending Sep 2015 were quite muted, broadly in line with expectations. For Sensex companies at aggregate level, while the topline de-growth was 6% y-o-y, decline in bottom line was about 2% y-o-y. With declining sales growth this quarter, the trend of y-o-y decline in sales has continued for fourth quarter in succession. This was primarily driven by sluggish demand scenario and negative wholesale inflation. While the gross margins improved for many companies due to fall in raw material costs, the positive impact of this trend did not flow into bottom line as companies could not hold on to pricing in a sluggish demand scenario.

After muted first half, the outlook for second half of FY15-16 is incrementally better. We expect a gradual pickup in earnings momentum going forward on the back of better demand outlook, improvement in margins and lower interest burden. Lower base of previous year should also have a favorable impact. We may see 6-8% earnings growth in FY16 and a growth in the region of mid-teens the year after.

9. What is your advice to investors at this point in time?

SIP is always preferred way for retail investors as it allows building long term portfolio in a regular and disciplined manner. However, given the current equity valuations which are at fair levels, the risk-reward profile even for a lump sum investment is not bad.

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