(Below mentioned interview was dated 12th May 2011. But it is still relevant. Hence, read on to understand the Indian stock market from Fund Manager's point of view.)
Prashant Jain is known to be a voice of calm reason - a trait that is even more appreciated in stormy weather like what the stock market is witnessing right now. In a conversation with Wealth Forum, Prashant shared his simple and clear insights on the key aspects that markets are worried about : inflation, interest rates and oil. As regards the fear that markets are entering a bear phase, he poses a pointed question : has the bull market started - for us to worry about its end? Here are the excerpts of that chat ……
Inflation and stock markets From an equity market perspective, we must appreciate that in an economy like India, inflation is more often than not a pass through. Good companies have pricing power - they should be able to pass through the impact of inflation by means of marginally higher prices. So, the direct impact of inflation on earnings is expected to be rather muted.
What would be a concern is if we see demand destruction as a result of consumers' inability to absorb this inflation.
We are not seeing significant evidence of demand destruction as of now. We must look at this fear of demand destruction in context. First, the proportion of middle class household income that is spent on food has come down substantially in the last decade as incomes have risen quite rapidly. Food inflation - which has been the biggest concern - does impact the poor very severely. But, the consuming class - the middle class - has been able to absorb this impact to a large extent, thanks to rising income levels.
Then, if you look at the discretionary spends of the middle class, the story on inflation is entirely different. Consumer electronics prices today are lower in absolute terms than where they were 5 years ago, same is the case with cable TV costs, with airfares, with hotel room tariffs. Consumers have not really felt any inflationary impact on all of these items, which are increasingly becoming a big portion of their spending patterns.
Yes, power and fuel prices have gone through the roof and consumers' pockets are getting pinched by this. Is that enough to destroy demand? Will petrol and electricity bills bite so much that people start cutting down on entertainment, travel and other discretionary spends? Again, the proportion of household income spent on power and fuel has gone down over the last decade to levels where the middle class is perhaps able to absorb price hikes. But obviously, this cannot go on - if oil prices continue to rise, we will see some impact on overall consumption.
What RBI is trying to do is to postpone consumption by pushing up financing costs. If demand for consumer durables, automobiles, homes etc gets postponed and thus inflation can be cooled down, it is for the good of the economy. That consumption is most likely going to get postponed - not destroyed.
High interest rates and stock markets
High interest rates will have a negative impact on earnings. Growth can also slow down as investments get curtailed or postponed. It's possible that GDP growth rate can be knocked down by 1% - if we were projecting an 8% GDP growth, perhaps it is sensible to look at 7% now.
The Indian economy has lived through many periods of high interest rates, without it doing too much damage to the economy. Yes, some impact will be felt - but I don't think the underlying bull case for Indian equities is to be questioned by higher interest rates.
Sectoral impact of high interest rates
Auto and banking stocks have come under pressure as a result of the recent interest rate movements.
Regarding automobile companies, I suppose some of these concerns are warranted, at least in the cars segment. Footfalls in car showrooms have decreased. 7 out of 10 cars in India are sold on the back of car loans. As car loans become expensive, some consumers have sought to postpone their purchases - which can impact near term earnings of these companies.
As regards banks, I am not so sure that a high interest rate environment is so bad for banks. Well managed banks have close to 40% of their deposit base in the form of low interest bearing savings and current accounts. A stable base of low cost deposits should help manage a rising interest rate environment. Banks who depend on wholesale deposits are the ones who may be impacted adversely.
Banks have corrected to fairly attractive levels. Some of the large well run PSU banks are available at close to 1 time book value on a FY 13 valuation basis. That's not really expensive.
Oil and stock markets
This is the one factor that we ought to be worried about. Last year, a robust export growth helped camouflage the impact of rising oil prices on our current account balances. If oil prices continue to rise to say $ 140, it will have a material impact on our fiscal deficit, on inflation, on aggregate consumption and therefore on growth.
If on the other hand, oil prices cool off to under $90, that will be a big positive for India and therefore for our markets.
Outlook for markets
I don't see why people should become bearish on the Indian market from a long term perspective. Let's remember that this market is where it was three years ago. And in these three years, earnings have grown and therefore valuations have become reasonable. So, when people talk about the bull market ending, my only question is: has the bull market started yet? We are only where we were three years ago! One can describe this as a flat market - not a bull market.
Markets are fairly valued - while we can't see huge room for near term appreciation, we don't see a case for a drastic fall as well. The structural case for Indian equities continues to be strong - it will play out over the next several years. One should expect markets to deliver returns in line with earnings growth, over time. But, for that, one needs patience and conviction to stay invested through volatile conditions.
DISCLAIMER: The views expressed by Mr. Prashant Jain, Executive Director & CIO of HDFC Asset Management Company Limited, constitute the author's views as of this date. It should not be construed as investment advice to any party. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on the author's views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. The recipient(s) before acting on any information herein should make his/their own investigation and seek appropriate professional advice and shall be fully responsible for the decisions taken. Mutual fund investments are subject to market risks, read the Offer Document carefully before investing.
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