ETMarkets Smart Talk: Constructive on India story but equity markets have to deal with these 3 headwinds in 2023: Niraj Kumar
In an interview with ETMarkets, Kumar said: “While we remain constructive from the medium-to-long-term perspective, we believe the markets will have to navigate a few headwinds in the near-term,” Edited excerpts:
While the Indian market has remained resilient amid global volatility and the Adani story. Where do you see markets headed? Any near-term headwinds that investors should watch out for?
Over the past 12 months, Indian equity markets have weathered numerous adverse events like the Russia-Ukraine conflict, surging energy costs (Crude oil & Natural gas), unprecedented inflation in the developed world and consequent aggressive global monetary tightening etc.
The markets have remained reasonably resilient especially amid the onslaught of FII selling of more than Rs3 lakh crores over the past 12 months.
Even though the markets are barely 5% away from their all-time highs, they have had a reasonable time correction of over 18 months now.
The earnings during these 18 months have caught up which have ensured valuations revert to more reasonable levels providing a lot of comfort.
Going forward, while we remain constructive from the medium-to-long-term perspective, we believe the markets will have to navigate a few headwinds in the near-term.
1)The foremost headwind is going to emerge from the asset allocation decision of the global money managers. With fixed income offering lucrative yields we anticipate movement of funds from Equities to Fixed Income.
2)Second headwind is likely to come from the lagged impact of the aggressive monetary tightening on the economic activity. The growth slowdown is likely to have an impact on the earnings outlook which will in turn impact equity markets.
3)Another headwind would be waning attractiveness of India versus relatively cheaper markets like China. With China reopening fully after long, the re-opening trade is playing out which has led to flow of funds from India to China.
We believe these are near term tactical headwinds and the medium- and long-term structural growth potential of India will keep attracting fund flows.
Some of the banks have already started raising rates – do you see the realty, auto, and capital goods sectors taking a hit?
Interest rates indeed have a salutary impact on economic activity. The interest rate transmission in this cycle has been very swift owing to external benchmarking (Repo linked, MCLR) of the lending rates and hence effective interest rates have risen by ~200-250 bps in line with the rise in Repo rates by the Reserve Bank of India.
This is likely to have some impact on demand especially from the discretionary sectors like Autos, real estate etc. However, we must bear in mind that interest rates are not the only factor determining the demand in these sectors.
For instance, in real estate while the investor-led demand is likely to slow down, the demand for end-use may remain strong.
With the markets strongly tilting towards demand for end-use over past 2-3 years, the overall impact of the interest rate hikes is likely to be manageable.
Having said that, we do anticipate some slowdown in demand in the discretionary & the asset heavy sectors which are mostly loan funded.
In a rising interest rate environment how should investors play the market? Does it make sense to reshuffle asset allocation?
Asset allocation is the most important decision from an investor’s perspective. The asset allocation should be periodically reviewed, and the portfolio rebalanced if not aligned with market perspective and investor’s needs.
From the perspective of the current market set up, we believe that investors have a lucrative opportunity to skew their portfolio towards Fixed Income space and benefit from higher interest rates and potential capital appreciation as the interest rate cycle turns.
However, while Fixed Income appears to offer better risk-adjusted returns in the near-term, we believe there are multiple caveats to it in the long term and the investors should keep faith in Equities for long term compounding and wealth creation.
Where is the smart money moving? What is the data telling you?
We believe that the definition of smart money is gradually changing. With domestic investors becoming more relevant for determining the fund flows and direction of the market, the erstwhile smart money (FII money) will see its dependence come down over a period.
Having said that, the data reveals that FII’s have been reducing their equity exposure in the Indian market for many months now having sold more than Rs3 Lakh crore since October 2021.
In fact, FIIs have also been continuously selling in the derivative markets remaining net short at the index level. The entire selling has been absorbed by the domestic investors with the liquidity remaining extremely strong aided by a strong monthly SIP book of Rs13,000 cr+.
What is interesting to note is that despite the massive selling, markets are barely 5% away from their all-time highs.
We believe that the FII selling is tactical in nature and flows would eventually come back to India owing to strong long term structural growth potential which would bode well for future returns.
Priority of the Budget is to ensure that Rs 10 lakh crore earmarked for capital expenditure is spent within the fiscal 2023-24 for keeping up the growth momentum – FM said in an event. Which sectors could be impacted by the government CAPEX?
Aggressive CAPEX increase has been the hallmark of the budget over the past 2-3 years. In line with the trend, budget 2023 has also increased the CAPEX outlay to Rs10 lakh crores.
We believe that such large increase in CAPEX outlay bodes well for the infrastructure & related sectors. CAPEX in the infrastructure sector has a very large multiplier impact and has backward as well as forward linkages.
Accordingly, we expect sectors ranging from Cement, metals, EPC contractors working in Roads & Railways to benefit the most.
We also see a lot of work happening on the water and the housing front and hence companies working in sectors like Pipes, wires & cables, consumer durables etc. are also likely to benefit out of this.
What is the ideal methodology for picking the bottom up picking? What is the checklist one should follow?
Bottom-up stock picking must be done through holistic evaluation of the company and the business environment that the company operates in.
The typical checklist that one should follow must include the evaluation of the business model & the growth potential of the company, a detailed study of the financial statements of the company with special emphasis on the execution, cash flow statement, leverage profile & return ratios (ROE & ROCE).
Sufficient emphasis should also be laid on the corporate governance & historical track record of the promoters & management teams. Last but not the least, investors must pay due regards to valuations.
Since the evaluation of most of these parameters and the consequent judgement will be subjective in nature, the investors have to ensure that they have adequate margin of safety and hence valuations become extremely important when doing bottom-up stock picking.
What are the changes you made in your portfolio? Any additions or exclusions you made?
We have been consistent with our approach and have been incrementally adding to our existing positions.
We remain extremely constructive on the Banking sector as the sector benefits from strong growth & margin expansion with best in a decade asset quality.
The balance sheets are fortified with strong capital adequacy ratios and yet the sector is trading at below median valuations providing comfort.
We are also positive on Telecom as we believe that we are at the cusp of strong growth in profitability & cash flow aided by regular tariff hikes.
We also have a contrarian positive view on the Metals sector where we believe that markets have not rewarded the companies for balance sheet repair adequately.
We remain underweight on the IT sector owing to our concern on margins & growth outlook. We also remain negative on FMCG owing to weak rural consumption led by high inflation.
What should investors do when they face a situation when the portfolio stock falls say 40%? How should one evaluate buy or sell strategy?
Equity markets typically oscillate between two extreme ends of the pendulum. When an investor sees the pendulum swinging towards the negative end the investor should revisit the investment thesis in the stock.
If the investment thesis remains intact and the stock price has fallen purely based on external factors, the investor can remain invested and can perhaps look to add as well.
However, if the investment thesis has changed adversely, it is not a bad idea to book some losses and scout for newer investment opportunities.
We suggest that before taking a decision to buy or sell any security, the investor should holistically evaluate the company including business model, growth potential, financial statements, corporate governance, and valuations.
What is your call on IT stocks for 2023? The voice is growing louder, and the sector could turn out to be an outperformer.
The IT sector towards the end of 2022 had massively underperformed the market and we used the sharp fall to build our exposure. Now, we maintain our cautious stance on the sector with underweight positioning.
The IT sector got tremendously re-rated during COVID and valuations went up to +2 Standard deviation above their historical averages as companies had to undertake digital transformation at an accelerated pace to remain relevant to their consumers.
This resulted in compressed spending cycles which was reflected in strong double digit growth rates for most of the IT companies. This coupled with the strong cost controls resulted in margin expansion & valuation rerating for the sector.
Going forward, we believe that the structural growth drivers for the Indian IT remains in place and the companies would continue to grow at steady pace which along with other positive factors like strong cash flow generation, capital allocation & corporate governance makes them a core long-term holding in our portfolio.
However, we remain wary of the valuations in the near term and hence our cautious view on the sector.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
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