DAILY VOICE | Inflation, delay in vaccination, tapering by US Fed key risks for Indian market: Janakiraman R of Franklin Templeton

Market Outlook

Janakiraman R – VP & Portfolio Manager, Emerging Markets Equity – India, Franklin Templeton, said that risks to the market sentiment could arise from the unexpected resurgence of inflation with no commensurate economic recovery. Inflationary pressure resulting in the hardening of interest rates could impact market valuations.

With an experience of 24 years in the investment management industry in his pocket, Janakiraman now manages assets worth about Rs 29,000 crore. Prior to joining Franklin Templeton, he was managing the investment corpus of Indian Syntans Group, a Chennai-based privately held group of companies. He has also worked for UTI Securities, Mumbai.

Janakiraman admires legendary fund managers like Charlie Munger, Peter Lynch and Terry Smith.

In an interview with Moneycontrol’s Kshitij Anand, he said that smart money is moving towards cyclicals, financials, IT, and housing-related sectors. Edited Excerpts:

Q) What are the key risk to the current bull market?

A) Risks to the market sentiments could arise from the unexpected resurgence of inflation with no commensurate economic recovery. Inflationary pressure resulting in the hardening of interest rates could impact market valuations.

Other key risks include an extended period of time taken for recovery from the second wave along with further delay in the resumption of vaccination drive in the country and any tapering of stimulus measures by the Federal Reserve following an acceleration in the US economic growth, which could potentially affect risk sentiments and impact flows to emerging markets like India.

With structural improvement in the economic growth and improving quality of earnings growth, market should hopefully mirror the same going forward.

Q) The second wave is not yet over for India, and the third wave is expected to hit in October. Do you think the market has factored in third-wave impact? What is the kind of impact you see on markets and earnings?

A) The second wave in India has turned out to be more intense in terms of transmission and fatality rates. The health situation looks grim on account of shortfall in healthcare facilities and vaccine shortage.

While the vaccination drive has slowed down considerably over the last couple of months, supplies are expected to improve on account of (i) capacity expansion, (ii) approvals for more global vaccines, (iii) imports, and local manufacturing of global vaccines.

These factors could contribute to a significant acceleration in the vaccination drive over the coming quarter. Vaccines along with COVID-appropriate behavior will be crucial to determine the extent and severity of third wave that is being predicted.

If the expectation of a meaningful coverage of the population in the vaccination drive over the next few months materializes, it will be a positive for both the economy and markets.

The economy has not gone into a stringent lockdown in the second wave as was the case during the 2020 lockdown. The lockdowns remain regional/local; to a large extent, manufacturing activity continues to operate.

While the second wave has delayed recovery, positive effects of policy measures taken in 2020, low-interest rates, and accommodative fiscal policy are expected to support medium-term growth and could likely offset any short-term impact of lockdown on the economy.

Expectations of large-scale vaccination, less disruptive lockdowns, and better-prepared corporates are the reasons the market has taken well in its stride the economic impact of the ongoing second wave.

Janakiraman Quotes_001

Q) Small & midcaps have remained resilient in the past few months but with most businesses remain shut on account of lockdown that could well continue for some more time – do you think the outperformance will continue?

A) The small and midcap segments require a bigger thrust of economic growth for performing well. Structurally supporting factors that are unfolding in the economy augur well for the sustainability of domestic growth.

(a) Household spending has bounced back well as and when lockdowns were relaxed. A rise in household savings seen in FY21 due to lockdown could boost discretionary demand in FY22
(b) Government spending to accelerate in FY22 supported by accelerated tax revenue collection.
(c) Potential continuation in the real estate sector recovery that started in H2FY21, could be an additional booster to economic growth.

(d) Export growth – reflationary conditions are seen in developed economies post the massive stimulus programs could bode well for Indian export growth.

These factors should provide a better GDP growth rate, which in turn will offer an impetus to the small and midcap segments.

Q) The Warren Buffett indicator is above Long Term Averages at 92%, according to a report. It has come down from a high of 105 in FY21. Do you see this as a sign of caution?

A) Market cap-to-GDP is one of the many ratios used to assess the valuation levels of equities. One evident shortcoming of this tool is that progressively an increasing part of the economy gets listed in the markets and ceteris paribus pushes up this metric.

Compared to the earlier peak of 2008, sectors like insurance, mutual funds, etc have been added to the listed space. Besides, this tool, like the PE ratio, ignores the effect of interest rate on valuation.

The structural interest rate in India is lower than in the past decade and should lead to higher equity values. One can infer from this statistic that equities are fairly valued now.

Valuations also build in expectations of reasonably strong growth in FY22, as is visible from the consensus estimates. Incremental returns are likely to be driven by earnings growth and little push will be available from better valuations.

Q) Where do you see smart money moving in various sectors and why?

A) With a broader recovery in the economy, there is a meaningful re-rating in cyclical sectors. From a sustainable growth perspective, cyclical sectors could well participate in the economic growth resumption.

The financial sector remains attractive from the prospective growth point of view. Growth potential in the Auto sector could also emerge from the electric vehicles segment going forward.

All the value chains for the housing-related sector including mortgage, finance, cement, local steel manufacturers, consumer housing construction materials, consumer durables, real estate could perform well. IT stocks are not into a structural overvalued zone and remain attractive.

Q) Lot of IPO have hit the market so far in FY21 and many MFs have taken a big bite out of it. What are the factors which fund managers look at while investing in an IPO?

A) There is no difference in evaluating an investment opportunity, be it an IPO or a secondary market idea. At FT, the investment team follows a standard screening process that focuses on quality, growth, sustainability of growth, and valuation when identifying businesses for an investment opportunity.

The belief is that value is created by effective management that is focused on the right businesses, is agile, and adapt/position themselves well for the future.

An in-depth analysis of the environment, business model & strategy, and competitive advantages of the business is conducted when evaluating an investment opportunity.

Q) From an FII perspective, how is India placed in terms of valuations when compared to global peers. Are we still attractive?

A) A simple comparison of EMs based on their PE ratios will be a rather incomplete evaluation of the risk/reward characteristics of these markets.

Long-term economic factors like household savings rate, ICOR, demographics of the population, structural rate of deficits, sustainability of government debt, CAD, etc are some key aspects for global investors to consider when evaluating EM opportunities.

Additionally, political factor like the presence of an effective legal system is important. Countries advantageously placed on these factors are likely to command higher valuations.

This explains why India, in the last two decades, has almost always traded at a premium to many EM peers and has continued to deliver attractive returns.

A senior asset allocation analyst at a global bank retired recently and in his swansong note had listed the USD returns of 48 different asset classes/factors over the period 1997-2020.

MSCI India has delivered an aggregate return of 619% and ranks eighth in the pack. In contrast, the MSCI EM lags far behind with an aggregate return of 229%.

Perhaps the more appropriate question could be whether India is trading at a premium higher than its trend level relative to its EM peers. This does not seem to be the case at present.

Q) According to CMIE report, 11 lakh jobs have gone amid rise in COVID. This will hit economy and earnings of India Inc. Do you think this will put banking and financial sector including NBFCs at a risk in the near term?

A) The pandemic has resulted in the loss of income for many and dented demand to some extent. This loss is expected to be less reversible especially for the economically weaker sections of the society.

However, for the microfinance lenders which cater to these small borrowers, things have been improving.

Compared to 2020, the stress in the financial sector has been more manageable in 2021. Banks and financial institutions are better positioned in terms of bad loan provisioning and management of credit quality.

Strong policy measures are undertaken to clean up asset quality of banks, recapitalization, and credit guarantee schemes for lending to SME/ MSMEs are jointly yielding positive results and adding to the fundamental strength of the banks.

Most players have been able to accommodate higher credit costs that came through FY21 without significant damage to their balance sheets. This in turn should help to maintain credit flow to small borrowers going forward.

In effect, with the re-opening of the economy post lockdown, a lending activity could resume and support economic growth.

Revival in the commodity cycle is a positive for the recovery of bad loans, demand for working capital loans, and new capex cycle, which is further supported by the government’s infrastructure push.

Furthermore, the move towards digitization, formalization of the broader economy, potentially pick up in corporate credit growth offer additional opportunities for the financial sector.

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