What is your assessment of the recent stock market rebound?
Indian markets performed well due to fewer Emerging Markets (EM) options, weak positioning from overseas investors and falling commodity prices – mainly crude. Some of these factors are long-lasting, while many other global geopolitical and macroeconomic concerns are still there. This could lead to continued earnings downgrades. Current consensus expectations – of around 23% earnings growth for this fiscal year – are extremely unlikely to be met. As earnings emerge, valuation multiples will also need to adjust downward to the actual price.
So, do you expect a reversal of the market rise?
In the short term, the markets could get carried away too soon. There are immediate risks and this would lead to a contraction in profits. I expect a short-term correction before moving into the long-term bullish story.
How much can the Nifty decline?
We believe that faced with 23% earnings growth, the most likely growth could be 17-18%. Thus, there could be a 4-5% correction due to the loss of earnings and another 4-5% correction as valuations are outside the comfortable zone. So on a fair value basis, the market (Nifty) could be 9-10% lower than where we are today.
Optimism reigns as to the resumption of the flow of foreign funds. Is it sustainable?
Unless there is clarity on many ongoing debates such as the US recession, inflation under control, geopolitical tensions and rural economic recovery, it is difficult to conclude. For example, there are fears that parts of India, particularly the rice belt, have experienced reduced rainfall. This could lead to rice shortage and food inflation, not only in India but in the rest of the world, as India is a big exporter of rice. Until there is a conclusion to many of these debates, I would not be in the camp of believing that FPI flows will be sustainable.
What are foreign fund managers telling you about India?
Basically, most of them are conservative or cautious. The problem is that there aren’t too many options available for an EM fund to park their money. Indian equity ownership by REITs has fallen from a high of 23% to 19%. From a valuation perspective, India’s valuations are 83% higher than other emerging markets. The long-term average is around 46%. That’s too high a premium on a relative basis. Even if you compare Nifty’s valuation to its history, it’s just over 20 times forward earnings over one year assuming earnings expectations materialize. First of all, the profits themselves will emerge. Assuming earnings will emerge, India’s valuations are very close to 1 standard deviation plus from the Nifty average. Considering a lot of uncertainties, I think 1 SD plus is too expensive. It’s a view that REITs generally agree with, but in the absence of alternatives, valuations alone aren’t something they want to focus on.
Where is the money to be made in India?
We believe valuations in financials, capital goods and some autos are still reasonable. They are still not expensive. If the markets correct, the defensives will outperform relatively.
How to bet on financials?
We are generally positive on all things Financials, but investors could decide based on the risk profile. If anyone is considering a low-risk portfolio, the big private banks cut a fine figure. If you’re looking to generate higher returns and are okay with more risk, then mid-cap banks and PSUs look good. We think this will be a long-term story of at least five years because India has just come out of a weaker credit cycle.
Which pockets of the automotive sector are you bullish on?
The increase in utility vehicles is relatively limited. Four-wheelers are the area where we are most optimistic about two-wheelers in terms of earnings and volumes. Even from the point of view of disturbances linked to electric vehicles, this is an immediate risk for two-wheelers. For four-wheelers, the disruption of electric vehicles is still a long way off.
Are you comfortable watching IT stocks after the nearly 25% drop?
No. We believe that the risk to FY23 volume growth is unlikely, but from FY24 volume growth will begin to decline. We think the world will slow down significantly, especially in the US and Europe. We say with near certainty that the United States will enter a mild recession beginning in the fourth quarter of this calendar year itself. If that’s the case, we think tech spending will come off, which will be reflected in FY24. Pre-Covid, these companies were trading at 17-18 times the PE multiple and going up to 25 times. Now they are at 21-22 and we think the chance of the PE falling to 18x is higher than against a return to 25x.