‘We are neutral on equities for next six months’

Indian equities might not see much gain in 2018, given various headwinds and the coming state and general elections. RAJESH SALUJA, managing director and chief executive officer, ASK Wealth Advisors, in conversation with Vishal Chhabria, says from a three- to five-year horizon, he would advise clients to use volatility as a friend and increase allocation to equities. He believes as earnings catch up, stocks will get re-rated and that's what investors should look at. Edited excerpts: The markets recently saw a sharp swing. The macros have deteriorated. How much worse could it get?

Two aspects need to be considered. One is at the micro level, where earnings are improving. Disruptions related to the goods and services tax (GST) are settling and overall demand is picking up. Globally, both the US and Europe are improving. This is getting reflected in better earnings. However, there are challenges at the macro level. Increase in yields and introduction of the

long-term capital gains (LTCG) tax have increased the cost of equity by 1-2 per cent. This affects valuation and, hence, we have seen a correction of 10-12 per cent in the Sensex and a much larger one in the midand small-cap space. There is also a fear of slippage on the fiscal deficit front given it is a pre-election year.

Against this backdrop, the market is expected to remain volatile. Also, the US Fed is likely to lift rates three or four times this year (one already done). While it shows confidence related to growth of the economy, it does create a temporary movement of money from equities into fixed income. This will also keep global markets volatile. And, not to forget trade wars.

We are neutral on equities this year, as micro improvement will cancel out macro challenges. We will have to monitor how the government maintains its fiscal deficit or takes further populist measures, the liquidity situation, both domestic and global, and its effect on yields and equity valuations. But, from a three to five years horizon, our advice to clients is to use volatility as a friend and increase allocation to equities with higher allocation to quality large-caps. This year will be one of a bottomup approach investing in equities.

Indian and US government bond yields have moved up. So, won’t debt become more attractive than equities, which are at record high valuations?

Debt will throw up opportunities but nothing exciting. Indian 10-year government bond yields are 7.6-7.7 per cent. Debt funds and other fixed income options are likely to deliver 8-8.5 per cent after tax if held for three-four years. Hence, money that has an investment horizon of two-three years will be parked in such investments. However, for five-year-plus money, we believe equities will deliver 18-20 per cent return on the back of gross domestic product (GDP) growth of 7.5-8 per cent. Yes, equity valuations could be a concern but only with specific stocks in the mid- and small-cap space. We have to be disciplined and careful in selecting businesses.

Which are these pockets of opportunity?

There are many in the agriculture, technology, non-banking finance companies (NBFC) and banking spaces (mainly private sector). After the correction, most automobiles, tractors and two-wheelers are reasonably priced, given the earnings growth expected. So, on a trailing earnings perspective, it looks expensive because there had hardly been any earnings in the past two years and prices have gone up, mainly on hope. But, as earnings catch up, stocks will get re-rated, and that is what equity investors should look at.

The consensus is estimating earnings to grow 18-20 per cent. Given the past record and current headwinds, don't you think FY19 will be another year of disappointment?

In the past two-three years, against a consensus prediction of 15-18 per cent annual growth, the actual number was smaller. In 2016-17, we were on track but demonetisation and GST threw businesses off-track. However, Q3 and Q4 of FY18 have been pretty good. So, unless there is some major disruption, earnings are on an upward trajectory. There is a much better chance of FY19 hitting the number.

Your take on overall asset allocation?

We remain neutral on equities for the next three to six months. On fixed income, our focus is on FMPs, accrual and credit funds. We have increased our allocation towards alternative investment strategies like real estate funds, pre-IPO funds and long-short strategies (portfolio of equities and simultaneously short on the Nifty), among others. We recently allocated a small portion to global equities under our first-of-its-kind US Opportunities Fund. The objective is to get geographical allocation for our clients and also get them to invest in businesses you don't find in India, such as Apple, Alphabet, Netflix, Nike, Starbucks, Visa and Adobe. We expect the rupee to weaken and that will add 3-5 per cent return, over and above the 11-12 per cent return on the dollar from such investments.

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