'India best poised among emerging markets'

Despite good fundamentals, capital flows to India can dry up if investor sentiment towards emerging markets (EM) turns adverse, believes Nischal Maheshwari, head, institutional equities, Edelweiss Securities. 

In an interview with Ashley Coutinho, he says EM asset classes could rally if the pace of US Federal Reserve rate increases moderates.

Edited excerpts:

Equity markets have seen a sustained fall since March last year. What is your outlook for the year ahead?

Emerging markets (EMs) have fallen at least 25 per cent since March in dollar terms.

This is one of the steepest corrections after the Lehman crises (starting 2008).

While the China slowdown did have a role in this sell-off, I think the role of the US Fed lift-off is understated.

Last year, while the US was gearing for a lift-off, the growth of EMs was slowing, with a lot of central banks (including China's) trying to ease monetary policy.

This divergence accentuated the outflows from EMs. 

If the pace moderates of Fed rate hikes, the trend of outflows from EMs would subside and asset classes there could rally, given the sharp corrections in most of their prices.

However, the yuan devaluation poses a risk to the outlook.

How is India placed among EMs?

Given, the sharp correction in commodities and oil prices, and a lower inflation and current account deficit, India is best poised among the EMs.

However, if the Fed goes aggressive on rate hikes, it is likely to dampen the overall EM investor sentiment.

And, as we observed in 2015, despite having good fundamentals, capital flows dry up if investor sentiment towards EMs turns adverse.

What risks does a slowing China pose?

China saw unprecedented growth for the past 20 years. This has resulted in a large number of people being lifted out of poverty.

It is now a middle income economy and its demographics are deteriorating.

Hence, it is due for a structural slowdown. This could be actually good for global growth, as it reduces imbalances and keeps commodity prices in check. However, a sharp slowing does pose a risk, as it will make deleveraging difficult and cause a further slide in commodities.

What is your assessment of the December quarter results?

We expect this to be another soft quarter. In our coverage universe (excluding oil marketing companies), the (growth in) top line and profit after tax are forecast to be flat, year-on-year.

Domestic consumer discretionary and private sector banks are expected to post decent growth.

However, defensives such as consumer staples and information technology might see a fresh down-leg, with decadal low profit growth, owing to the impact of rural stress on the former and the one-off impact of the Chennai floods on the latter.

Commodities, automobile exports (Tata Motors) and public sector banks are likely to clock a soft quarter, with profits continuing to contract in teens.

It's largely the domestic institutional players that supported the market last year. Will this continue in 2016?

Domestic inflows were indeed very buoyant last year. This is perhaps due to the improvement in urban real incomes.

The subdued prospects of property markets and gold also seem to have played a part in the equity inflows.

Going into 2016, we expect these trends to continue and domestic institutional investors to continue to support the markets.

However, if the Nifty corrects by another 10 per cent from here, there could be redemptions and domestic flows could moderate.

Could last year's rally in mid-caps and small-caps sustain?

Last year, mid-caps and small-caps outperformed the Nifty (benchmark index), despite negative returns in the latter.

This is a historical anomaly. A possible reason is that mid-cap and small-cap companies are less globalised than the Nifty.

Two-thirds of Nifty revenues and half of profits come from either commodities or exports.

The poor external backdrop, accompanied by a collapse in commodity prices, resulted in a Nifty correction.

Mid-cap and small-cap companies are more domestic focused and had better earnings and performance.

This trend of small-caps outperforming large-caps is also observed in Europe, where the former have outperformed the latter by about 15 per cent.

Which sectors are you bullish on? 

For 2016, we expect urban consumption to deliver good returns.

This is because the 7th pay commission recommendations are likely to ensure demand remains intact and most of these companies also benefit from a commodity correction in the form of lower oil prices.

Companies leveraged to government capital expenditure should also deliver good returns in 2016. One should avoid commodity companies.