WF: The recent correction is being attributed to news flow from China about measures to cool down their economy and newsflow from US where the Government has stated its intention to curb the prop books of large banks. What about the newsflow from overseas is likely in your view to have a material impact on our markets?

Prashant Jain: Globally, most economies are experiencing stability driven by easy money, low interest rates and high fiscal deficits. High fiscal deficits are not sustainable in medium to long term. The future of Global economy, interest rates, currencies, inflation etc is therefore not clear in my opinion.

The good news is that Indian economy is not materially correlated with the global economy. Our strongest linkage with the external world is OIL. As long as oil prices are moderate / low (which ironically is more likely to happen in a weak global environment) India should do fine.

The not so good news is that there has been a remarkable increase in short-term correlation of Indian markets with the global markets. Thus any correction in global markets is likely to result in a correction here as well. If and when these were to happen, this would be a good investment opportunity in India as was the case in 2008.

To conclude, Indian economy is not materially correlated with the global economy. The stock markets are however correlated over the short run. Long-term returns of the markets are however correlated only with the profit growth of Indian companies and not with markets / economies outside India.

WF: There is a view that the sharp rebound in markets across the globe is largely attributable to increased risk appetite due to an ultra loose monetary policy and near zero interest rates. To this extent, it is argued that as the excess liquidity gets sucked out of the system, markets can see heightened volatility. To what extent are these concerns valid and to what extent do you see them impacting our markets?

Prashant Jain: These are valid concerns, as the current high fiscal deficits and very low interest rates are not sustainable in the long run. The Global economy has attained some stability supported by large fiscal stimulus. As and when the same is reduced, the global economy should be adversely impacted. I am not clear whether this will lead to a double dip, or continued recovery or stagnant economy (L shaped). One thing however is clear - Indian economy is on a growth path and is all set to accelerate over the next few years. However, as pointed out above, our markets are experiencing increased short term correlation with global markets - hence if global markets correct driven by adverse developments on economic front, a correction here cannot be ruled out. I would however recommend such corrections to be used as opportunities to invest.

WF: How do you read the earnings that have come through in recent weeks? Do they reinforce the growth story or are there concerns on top-line growth in some sectors?

Prashant Jain: Earnings season has been decent overall. Volume growth is good in most sectors and even the margins are good. Consumer products, pharmaceuticals, media, banking, automobiles, engineering, IT etc. have reported good numbers. Results of refining, telecom and cement were subdued but along expected lines.

WF: Just prior to this correction, a Bloomberg report suggested that India was the second most expensive market (in terms of PE), next only to Japan. How do you see valuations at a broad market level now?

Prashant Jain: It is inappropriate to look at PE multiples in isolation. PE should be looked at in conjunction with the growth rates. If India offers higher growth, the PE's should be higher as well. The present PE multiples are just about fair in India.

WF: There are concerns that sizeable issuances of fresh equity and Government disinvestments can flood too much supply into the markets - with consequent adverse impacts on the secondary markets. To what extent do you share these concerns?

Prashant Jain: There is indeed a large issue pipeline. This is actually welcome for the long-term economic health and for the markets as well. A growing economy like India with large investment needs cannot grow without equity capital. Besides, supply of stocks also keeps secondary markets valuations in check and prevents excessive valuations, which invariably destroy wealth for a large number of investors. As mentioned above, any corrections because of IPO's or otherwise, in my opinion should be looked upon as opportunities to invest, as the economic growth prospects are good and valuations are reasonable.

BSE- 30 Index band & 1- year Rolling forward P/E

WF: Some economists and market analysts are calling for a double dip in US and other developed markets. To what extent can the risk of such events derail our market performance?

Prashant Jain: Covered earlier

WF: What is your view on Indian equity markets over the next 2-3 years?

Prashant Jain: While the markets have more than doubled since the lows of March 2009, we need to put things in perspective. Index levels of 20000 (Sensex) in Jan 2008 and 8000 in March 2009 were aberrations. The rally from 8000 has been sharp, but to be fair, that rally came after an equally sharp fall. This rally has merely corrected a severe under valuation.

We have a fairly balanced view of the markets right now. The markets are trading close to long term average valuations and returns are likely to be driven more by earnings growth than by a further expansion in multiples. Individual corporate performance rather than an overall market movement is likely to play a more important role. Thus, a stock specific approach based on fundamental analysis and focusing on high quality businesses is likely to prove rewarding.

Capturing long term earning growth of about 15% CAGR is attractive, particularly, in view of low interest rates. Investors with a long-term horizon and tolerance for volatility should continue to benefit from their exposure to equities as over time. Due to the compounding effect of returns, even moderate differences in returns get amplified and result in a large difference in wealth accumulated.

WF: What are your sector preferences now? Which are the sectors you are cautious on now?

Prashant Jain: I am very positive on India's economic growth prospects but not so clear about the prospects of global economy. Consequently by and large I prefer domestic oriented businesses like, consumer products, pharmaceuticals, media, banking, engineering, and construction over global cyclicals. The recent rally in industrial commodities is in my opinion more driven by investment demand due to very low interest rates and is hard to justify by demand supply / cost of production etc. Thus its sustainability is suspect.

WF: What are your concerns on the growth story - what are the things that we need to be watchful about, that can potentially go wrong?

Though not a major risk yet, but if fiscal deficit is not brought down quickly, it can do more harm to the long term prospects of the economy than benefits in the short run.

Disclaimer : The views expressed by Mr. Prashant Jain, Executive Director & Chief Investment Officer of HDFC Asset Management Company Limited (HDFC AMC), constitutes the author's views as of this date and is based upon information that is considered reliable, but does not represent that it is accurate or complete, and it should not be relied upon as such. Statements of future expectations are based on current 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. None of the information contained herein constitutes, or is intended to constitute a recommendation of any particular security or trading strategy or a determination that any security or trading strategy is suitable for any specific person. The recipient alone shall be fully responsible / liable for any decision taken on the basis of this Note. Neither HDFC Mutual Fund nor HDFC AMC nor any person connected with it accepts any liability arising from the use of this information/data. The recipient of this material should rely on their investigations and take their own professional advice.

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