DAILY VOICE | A sustained rally in crude prices could hurt capital flows and macrostability of India: R Venkataraman of IIFL Securities

Market Outlook

R Venkataraman, Chairman, IIFL Securities is of the view that apart from the US Fed policy, the capital flows to India are also vulnerable to high crude prices.

Venkataraman has over 28 years of experience in the financial services sector. Prior to this, he was associated with ICICI, including ICICI Securities, their investment banking joint venture with JP Morgan of US and Barclays – BZW, and G E Capital Services India.

In an interview with Moneycontrol’s Kshitij Anand, Venkataraman said the second Covid wave could adversely affect 1QFY22 corporate earnings, but the market is likely to overlook the same as a temporary disruption

Edited Excerpts –

Q) As we step into the second half of 2021 what are your views on markets? The Nifty50 rallied 13% in the first half; do you think the momentum will continue?

A) The equity market momentum is likely to persist aided by healthy capital flows and earnings growth. Although the second Covid wave could adversely affect 1QFY22 corporate earnings, the market is likely to overlook the same as temporary disruption.

Having said that, we could continue to see sector rotations based on earnings visibility and risk sentiment.

Q) In terms of IPOs we saw an exciting first half, and now as we enter the second half the biggest attraction would be the Zomato IPO. What are your views on the primary markets for 2H2021?

A) Since the equity market momentum is expected to sustain, we could see a busy IPO market in 2H as well. Retail/HNI participation in some of the issuances has jumped to multi-year highs in anticipation of listing gains.

However, investors need to be cautious with this approach and valuations/growth outlook should be carefully evaluated for investment.

Q) One trend which picked up last year was the new army of retail investors which joined D-Street in 2020. What is the kind of response you are getting for your firm, and what does the trend suggest?

A) Overall 60% of our customers invest through IIFL Markets mobile app, however, the new user, especially the millenials and zillenials are almost 100% mobile, app-based users.

Many active traders (millenials and zillenials included) use our desktop application due to advanced algo platforms.  We are constantly improving our platforms both app and desktop and using advanced technologies like AI and machine learning for decision making.

Currently, our chatbot and news section is backed by AI, while we are further upgrading the platforms with AI and ML technologies.

Q) Do you think the recent announcement made by the FM to support the economy are enough? Or, more should be done to achieve a double-digit growth rate?

A) The recent FM announcements are useful but may not be sufficient to support growth. Economic disruptions due to Covid waves have hurt lower-income households and could drag demand recovery.

However, the elevated levels of fiscal deficit and public debt seem to be weighing on the government decisions of fiscal support. Given these constraints, we believe, the government should focus on policy reforms that encourage private investments.

Q) What are the cues that you are getting – any signs of topping out? The dollar is getting strong, and the impact is visible on the rupee as well? What are your views?

A) Apart from the US Fed policy, the capital flows to India also remain vulnerable to high crude prices. High crude prices hurt India’s external account and the expectations of currency depreciation adversely impact the foreign portfolio flows.

Hence, a sustained rally in crude prices could hurt both – capital flows and macrostability of India.

Q) W H O has warned of a third wave in in Europe and other parts of the world. There are few cases which signals that a possible third wave is here. Do you see more lockdown that could come into play and disrupt the business cycle which would mean that earnings estimates would have to be revised again?

A) Our interaction with medical experts suggests that the intense second Covid wave has provided natural immunity which should last for 6-8 months or more.

Further, while the vaccination pace should have been faster, even at the current pace ~350mn people have received at least one dose of vaccination. These factors should help prevent an intense third wave.

While the second Covid wave was stronger than the first, learning from the first wave helped implement localised restrictions to minimize damage to the economy.

We believe, if India experiences third Covid wave, it could be milder and short-lived with minimal impact on economy.

Q) The year 2021 also marks 30 years of reforms for India. What is your take on that? For the market, it never looked back – do you feel that the current reform process are equally strong and will take the economy to new highs?

A) The reform momentum has been fairly strong even in the last decade. However, execution errors, aggressive interpretation of tax and corruption laws has vitiated the business environment. If the government continues with the reforms and fixes the execution errors, growth should rebound sharply.

Q) What is your call on the small & midcaps. This space has been resilient in the recent past and has outperformed the benchmark indices so far in 2021. Will the momentum continue in the second half as well?

A) The mid and small-cap stocks have continued to outperform large caps in CY21 so far (CY21YTD NSE Small Cap index is up ~37%, MidCap index is up ~28% and Nifty is up ~13%).

However, outperformance of this magnitude may be difficult to sustain. NSE Small Cap trailing P/B (2.9x) is trading at 0.9x Nifty trailing P/B (3.2x) compared with longer term average of 0.5x and NSE Mid Cap trailing P/B (2.6x) is trading at 0.8x Nifty trailing P/B (3.2x) compared with longer term average of 0.7x.

The mid and small cap stocks are relatively more exposed to domestic demand compared to large cap stocks and hence if the economy recovers, as we expect it to, by FY23, the outperformance may resume, though less spectacularly.

Q) Someone said that don’t chase what has done well in the last six months. Do see the underperformers of 2021 making a comeback in the second half?

A) The defensive sectors like FMCG and Pharma have underperformed cyclical sectors in 1HCY2021. The favourable commodity prices and optimistic outlook on capex revival also favour the cyclical sectors.

However, this could change if the US Fed, worried about inflation, starts tapering its monetary stimulus.

Q) Which are the next big themes emerging on D-Street?

A) Sectors like Insurance, Chemicals have a long runway of growth, in our view. The supply chain disruptions due to Covid pandemic has provided an impetus to China + 1 strategy and favours the Chemicals sector. Structural factors like favourable demographics, rising financial savings along regulatory changes for motor insurance favour long term growth.

Q) Any sector that could emerge as a Dark Horse towards the close of 2021?

A) The private banks have underperformed the broader market in CY21, so far (~6% returns in CY21YTD). The government has raised the limits of the credit guarantee scheme to Rs4.5tn from Rs3tn earlier. It has also widened the scope to include sectors adversely affected by Covid.

The credit guarantee scheme, like during the first wave, should help avoid a sharp surge in bad loans. Hence private banks could catch up with the broader markets by end of CY21.

The auto sector has underperformed the Nifty Index in the last three months (NSE Auto is up ~3.5% vs. ~6.5% returns of Nifty Index in last three months) due to demand hit during second Covid wave and margin pressures due to rising commodity prices.

However, companies are gradually taking price hikes and demand should also improve with easing lockdown restrictions.

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