DAILY VOICE | If US yields rise rapidly, there could be a knee-jerk reaction in Indian market: Mihir Vora of Max Life

Market Outlook

Mihir Vora, Director and Chief Investment Officer, Max Life Insurance believes higher oil prices have an unfavourable impact on all Indian macro variables. A $ 10 per barrel up move in oil price will move the CPI higher by 0.6 percent, WPI by 1.3 percent, GDP lower by 0.15 percent, current account deficit higher by 0.45 percent and fiscal deficit/GDP higher by 0.1 percent, and even impact the currency exchange rate, he said in an interview to Moneycontrol’s Sunil Shankar Matkar.

He feels the rising yields globally are a key monitorable for all asset classes and Indian equities are no exception. Rising US bond yields are negative for Indian fixed income primarily from the sentiment perspective, he said.

Vora has more than 25 years of experience working across various asset classes like equity, fixed income & hybrid funds.

Edited excerpts:-

Q: Do you think the rising US bond yield is a big risk for India and will it really reverse FII money? Also what does the rising bond yield mean for investors and traders?

Liquidity has been the fuel for all asset classes in the past 12 months and has driven valuations to all-time highs. Rising yields globally are a key monitorable for all asset classes globally and Indian equities are no exception. Any change in the perception that the current scenario of low yields and abundant liquidity will change rapidly, would result in a ‘risk-off’ situation which cannot support such lofty valuations. We could see outflows from India and other emerging markets.

However, the key is to differentiate between an ‘orderly’ rise in yields versus a sudden or panicky reaction. If the yields rise due to good growth and sustained revival of the global economy, then the reaction will not be negative. On the other hand, if yields rise rapidly due to quick rise in inflation or inflation expectations, then there could be a knee-jerk reaction.

In fixed income, FPI flows have been negative for the last 3 years and despite weaker dollar & lower US yields we did not see much revival in debt flows in 2020. We also do not see a risk of big outflows as FPI exposures are already low. Rising US bond yields are negative for Indian fixed income primarily from the sentiment perspective.

Q: There has been a gradual increase in oil prices for last few months given the vaccination and hope for rising demand in coming months. On the other side, the government has also been increasing petrol, diesel and gas prices. Do you think it will have major impact on the fiscal deficit when the government already announced growth-oriented budget at the cost of fiscal expansion?

With a rise in oil prices, Government’s subsidy burden inches up due to LPG and fertilizer subsidies. There will be a higher fiscal impact if taxes on petrol and diesel are cut to reduce burden on consumers. Every 1 Rupee reduction in excise duty on petrol and diesel reduces the excise tax collections by Rs 13,000 crore.

Higher oil prices have an unfavourable impact for all Indian macro variables. A $ 10 per barrel upmove in oil prices will move the CPI higher by 0.6 percent, WPI higher by 1.3 percent, GDP lower by 0.15 percent, Current Account Deficit higher by 0.45 percent and Fiscal Deficit/GDP higher by 0.1 percent and also impact the currency exchange rate.

So rising oil prices can adversely impact the Government’s efforts to stimulate the economy for higher growth.

Q: Will the broader markets outperform benchmarks in coming years and will it same like 2016-2017? What could be reasons behind it?

We have witnessed that the retail participation has increased significantly in Indian markets. In March 2020, retail share was 40 percent of total market turnover – it is now about 65 percent. Retail investors generally look at specific themes (midcap/smallcap stocks) while they ignore large liquid stocks with high floats, which tend to be expensive.

After a run of over 10 months in largecaps, a catch-up by the mid and small-caps is only to be expected. The smaller companies had massively underperformed since January 2018. While the last 10-month returns look good, the 1-year performance is barely in line with largecaps and the 3-year performance is considerably behind largecaps. In fact, even the 10-year returns are only just about in line with largecaps. Thus, if the growth revival trend continues, we expect smaller companies to outperform.

The latest correction in the Nifty has been due to global concerns and not local concerns and it has been quick and not yet at a point where there is widespread ‘pain’ to investors and traders, so it has not impacted the broader markets adversely. However, if the downtrend in the largecap indices continue, even the broader markets will react.

Q: Among midcaps, what are those sectors look attractive now for investment and why?

Availability of credit, lower interest costs and improved working-capital cycles will help midcaps. Many of the consumer and exporting companies are in the mid and small segments e.g. auto-ancillaries, chemicals, pharmaceuticals, mid-cap IT companies, multiplexes, hotels etc. which will likely benefit from the ‘opening-up’ and global growth themes.

Construction and capital goods also have a good number of quality midcap stocks which will benefit from the Government’s renewed focus on capex and the PLI also bodes well for revival of private capex. The theme of ‘Make-in-India’ will get good manufacturing capacities into the country, auguring well for these investments-linked segments.

Q: Do you expect around 10-15 percent correction in the Indian equities after more than 35 percent rally seen in last five months? If it happens, what should be those sectors for investment? What could be major risks for India in coming months?

The key driver for the markets over the past year or so has been cheap liquidity and fiscal stimulus. We don’t expect a significant correction till we see a reversal in these. Having said that, a 10 percent-15 percent correction cannot be ruled out as volatility is likely to remain.

Valuations are a bit frothy, not just in Indian equities but globally across various asset classes. We don’t shuffle the portfolio tactically for such 10-15 percent moves.

Key risks are: Inflation, oil prices, sluggish private sector & real estate investment sentiment, unknowns in the banking sector asset quality and the impact of lower employment & income loss on consumption.

Q: Have your made large reshuffle in your model portfolio after December quarter earnings? What is your view on December quarter earnings, and do you expect the better-than-expected earnings in coming quarters as well?

Overall December quarter saw earnings beat on back of cost efficiency measures and benign commodity input prices. Earnings beat was led by Materials, IT, Pharma, Large Banks and Industrials. Earnings was in-line for Auto, Real estate, Oil & Gas, Airline, Telecom and Utilities and there were earnings misses in Consumer Staples and Pharma.

Post December, we have reduced exposure to consumer staples and consumer discretionary sectors where earnings uptick may be muted by the twin pressures of higher raw-material prices and slower uptick in demand as the pent-up and festival spikes are behind us. The wedding season is also a bit later this time. In other sectors, e.g. Financials, Materials, Pharmaceuticals, Engineering & Construction we increased exposure to stocks where there were comparatively larger earnings surprises.

We expect March quarter earnings growth to be a tad weaker than the December quarter. We expect earnings to be impacted by higher commodity prices. Beyond March, we expect companies to take price hikes and return to normalcy, and benefit from a moderate inflationary environment.

The overall themes that we believe currently are a) global recovery will be faster than Indian recovery due to better fiscal support b) more domestic manufacturing via production-linked incentive schemes c) rural consumption being relatively stronger. We also believe that private sector banks will grow faster and hence will look to be overweight once we have a better handle on true stress in the books.

We believe the Government’s focus on fiscal expansion and PLI schemes augurs well for the revival of the long-anticipated private investment cycle. Further government’s focus on strategic divestments, rather than selling at a discount via OFS or ETFs augurs well for PSUs.

Q: What did the Q3 GDP indicate and has it really showed the impact of measures announced by the government so far? Also did it indicate that the government spending is slowing down?

A positive GDP growth number has led India out of the technical recession. We saw a revival in private consumption with pent-up and festive demand supporting positive manufacturing growth. There was also huge Central Government capital expenditure on roads etc. with October-January growth of 34 percent. Given limited fiscal resources, the expenditure was aptly timed to support demand after lockdowns were lifted. However, States spending during April-December spending remained contractionary at -2 percent for key 17 States (revenue spending grew 0.3 percent whereas capital spending was down by a steep -22 percent).

We expect the strength in Central Government spending to continue in the March quarter too, aiding the recovery. Private consumption remains robust and there are excess savings in the system, which should continue to support consumption as the economy reverts back to normal.

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