The Sensex and Nifty are nearing their all-time highs. Is it a new bull market or another of those bear market rallies?
The bull market started during the Covid panic in April 2020. We continue to be in a bull market and a new high is around the corner. The market went into consolidation post-October 2021 as multiples were at levels which discounted immediate growth. Earnings growth itself began to slow due to rising raw material costs. That phase of consolidation concluded in March and the market has gained confidence that growth prospects have not been hurt by rising interest rates and that rates have peaked.
How are foreign fund managers evaluating India keeping in mind its rich share valuations?
A lot of the tourist money uses these headline valuations to make their investment case. However, more serious investors dig deeper, and I see some of that money is coming back to India. India is one of the few countries in the world that is making new multi-month highs on PMIs (purchasing manager indices), earnings as well as RoE (return on equity). The challenge for a lot of emerging market (EM) economies is to grow earnings at the pace at which India is likely to grow its earnings. In part, the headline valuations reflect some of these fundamentals that are coming through. Some of them are being anticipated by the market, but not all of them.
How will a US slowdown or recession impact Indian equities?
Ever since India opened its doors to foreign capital, every single US recession has produced a bear market in Indian equities. When the US goes into a recession, there is a contraction of outward flows from the US into EMs because the dollar tends to appreciate given the risk-averse behaviour. Now a lot of things have changed in the last few years. India has migrated to inflation targeting and there’s a law in place which mandates the Reserve Bank of India to focus on inflation as its primary and sole target. This has brought about amazing macro stability to the country. This wasn’t the case prior to 2015. When you’re targeting inflation and maintaining price stability, you are not subservient to the US Fed cycle to maintain stability in your own currency. In fact, the Indian rupee has been the better-performing currency globally.
Another change we saw was that the government allowed retirement funds in India to invest in the equity markets. This created a massive boom in equity flows. If you look at the last five years of FDI, it is nearly half of the cumulative FDI over the last 25 years. All these factors have helped break the strong linkage between India’s stock market performance and the US growth cycle. That said, if the world and the US go into recession, there will be some slowdown in India, but its impact on India’s growth and stock markets will be far less than it has been in the past three decades.
Have IT stocks fallen enough for you to reconsider them?
The market is partly expecting that the Western hemisphere might go into a recession. That’s why IT stocks have been struggling and some of that is in the price. But all of this will be determined by the extent of the slowdown in the Western hemisphere. If our base case is right and we don’t see a recession, we have seen the trough for IT stocks. Even though the earnings may be weak in the next two quarters, share prices may not fall further because the market has already baked that into the price. That said, IT stocks are not our most preferred pick. Our top sectoral picks are financials and within that the wholesale lenders followed by industrials and consumer discretionary; and if one has more appetite, then IT stocks.
Large banks have not performed as much as the market expected. Why is that?
We expect banks’ NIMs (net interest margins) to come off over the next 12 months. Even though loan growth will remain strong, there will be some NIM compression and therefore some slowdown in earnings growth. However, the opposite of this holds true for wholesale lenders. For them, they have a much shorter duration of liabilities, and their asset-liability durations are more evenly matched in that sense. So when the interest rates peak, their liability costs rapidly decline and they enter a cycle where interest margins can actually be either stable or slightly higher. With a 12-month view, we prefer wholesale lenders over banks. Of course, banks have a long positive cycle before them. In fact, we are at the beginning of a loan boom cycle and eventually the banks will come back because the market will recognise that even though the margins may contract, the top-line growth will still be very strong.
What is the upside potential for stocks in infrastructure, capital goods and related spaces?
We have to separate the fundamental prospects from what the market is pricing in. The forward-looking fundamentals for the industrial space look very strong because we are at the beginning of a new capex cycle. At the trough of 2003, corporate capex-to-GDP in the private sector was 4% and that peaked at around 17% in 2010 before we went into a long descent which ended last year around that 4% mark-to-GDP. We are inching back up and there is a lot of headroom for this number to rise and probably go into double digits over the next four or five years. When that happens, you get a lot of nominal capex growth and therefore industrials have a very strong fundamental environment. The market is not oblivious to this and some of it is in the price and therefore looks expensive, especially because earnings are very depressed versus history. While if you look at the trailing or one-year forecasted earnings, industrials look expensive but if you take a five-year view, the sector looks cheap.