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Slowdown Won't Be Severe

In an interview with Value Research, Sandip Sabharwal, CIO Equity, JM Mutual Fund talks about the market scenario

What's the reason for five of your funds featuring in the 'Most Hit' list in the fall between January 8 and July 15, 2008?
The main reason would be that we did not have a cash strategy. None of the funds mentioned had any significant cash in their portfolios. We were more or less fully invested during this entire period. If you look at the mutual fund industry as a whole, the cash levels in equity funds were at around 20-odd per cent. So if the market falls by around 40 per cent from its peak, the fund that is fully invested will get more badly hit than those which have 20 per cent of their portfolio in cash.

So did this crash catch you by surprise?
On the contrary, we very proactively anticipated this correction. In November and December 2007, when the market was heavily overbought, we were sitting on 20 per cent cash. But the market did not fall despite most of the Asian markets correcting. By January, it looked like most of the Asian markets were bottoming out and India had not fallen. So we figured that the rally would probably go on for some more time before the correction takes place. That's why in January we began investing and deployed our cash. Unfortunately, that's when the market began to fall.

You don't believe it was the mid-cap tilt that hit your funds?
We did have a mid-cap tilt but that's not the main reason. Stocks have fallen across the board, not just mid- and small-caps. Large-cap stocks in sectors like realty, capital goods and banking have fallen by about 60-70 per cent from their peak.

What about exposure to particular sectors?
If you look at actual portfolios, it's not that ours have fallen more than others. It is more to do with cash levels. We were underweight on capital goods but we did have a number of stocks in the construction space. And, yes, that sector was very badly hit. Our view was that the momentum would continue as valuations were not that high. But all stocks fell.

Are you getting rid of any of these stocks after this crash?
There is no need unless the companies which I hold are showing a deteriorating performance, more than its peers in the same space. I am not unduly worried about my portfolio. Company fundamentals do not change that much, market sentiment does. No one wants to take a bet on any stock right now because the sentiment is so low. No one is interested in making fresh commitments to the market too. Those with cash will continue to hold.

Does that mean you will be moving into cash?
No. Uncertainty in the global markets and the entire inflation scenario is what mainly led to this fall. The former still holds. And looking at the monetary tightening, there will be a slowdown in the economy. The market has already factored this in. The question is: When will inflation peak and when will there be a change in policy to support growth? That will happen sometime over the next six months. So now is not the time to change strategy. Now is the time to be patient.

Patient for how long?
The market is pro-active in nature. So it will sense what is going to happen months down the line. At the start of the year, if you had asked people, most would not have expected the kind of carnage we saw in the markets. But the market has been falling since January. Going forward, once the market senses that inflationary pressures are being reduced, it will react prior to that actually taking place. So in a few months we should have some stability before a boom. In my view, looking at the structure of the economy, I don't think we are going to have a structured long-term bear market in India anytime soon.

Does the fiscal deficit not worry you?
Over the last 15 years, the deficit was always a concern on the macro side. The government always had a weak fiscal situation. There are three balance sheets to look at: Government, Corporate India and households. The latter two are still very strong. The balance sheet of the government has taken a hit but whether it will continue to deteriorate over the next few years is unlikely. The main reason for this deficit is the fertiliser and oil subsidy. Given the kind of oil and gas production, which is going to start in India over the next two years, even if oil prices stabilise and do not fall, things will change for the better. The subsidies will not grow, even if they do not fall. But the GDP will keep growing.

Do you see inflation easing?
When oil moved from $10 to $100 in around five years, inflation in India was just 4-5 per cent. The inflationary pressures right now have come from rising crude, oil seeds, food grains, edible oil — everything moved at the same time. We have already seen huge corrections in agricultural commodities. Monsoons are well spread out so the agricultural production will put less pressure on prices. With the global slowdown, there will also be correction in metal prices. Today things look bleak, but will improve.

What are you buying now?
Right now there is value across sectors. When the market falls, all sectors fall. But when it rises, all may not rise. I am increasing my exposure to capital goods. That sector has a lot of visibility of earnings and valuations are now reasonable. Most stocks are down 50-60 per cent from their peaks. Where power sector is concerned, on the utilities side we do not see too much of value creation, but on the equipment side we are more bullish. We still have a reasonable exposure to construction because we believe it is a space that will continue to grow. We are not buying more, but neither are we cutting down. I believe that this is the time to buy companies that generate strong cash flows and do not need much capital raising to sustain their growth. As such, companies in the technology sector also look extremely promising.

What is your advice to your investors who are panicking at the steep decline in your funds?
On an average, if you look at equity funds, they have fallen by around 40 per cent. Our equity funds have now fallen by 10 per cent more. But look at last year when all our funds beat the market by a huge margin. So the key is to look at the portfolio and see how the companies are doing individually relative to the market. The PE ratio of most of our funds are between 9 and 11 times. The portfolio earnings growth is around 40-50 per cent. That amounts to buying a stock at a low PE, which is growing at a strong earnings rate. Such a stock may go down in the short term, but should do well in the long run.

Do you see any more pain in the market?
We may have one more knee-jerk crash. The RBI has said that from Q4 this year, inflation will start falling. Looking at the speed at which the monetary tightening took place, it will hinder growth. So it is unlikely that the markets would rise in the near term.

There have been bear phases which have been short and long. Ultimately it comes down to earnings, fundamentals and valuations. Liquidity is cyclical in nature — it will come and go, it will tighten and loosen. But as long as fundamentals remain strong, the bearish phase will be shorter than the bullish phase. If the fundamentals deteriorate significantly, the reverse will take place. Given the structure of the economy, the strong corporate balance sheet, increasing household income with too much debt on their books — will ensure that the slowdown in India is not severe.

The quarterly results have been much better than expectations. Our expectation was that earnings growth would be 15-20 per cent this quarter while the consensus was 5-10 per cent. Companies have done well but sentiments are so low that nobody wants to look at the positives anymore. However this is a phase that will pass.