India best prepared for Fed taper, though fund flow can take a hit in short term, says Vinit Sambre of DSP Investment

Market Outlook

Vinit Sambre, Head- Equities, DSP Investment Managers, says emerging markets (EM) will be vulnerable to the tapering of bond purchases by the Federal Reserve. India, which sees a  sizable inflow of FII money, will be hit as well but is best prepared for the much-talked-about taper, he says.

In an interview to Sunil Shankar Matkar, he says India has been able to handle FPI outflows on the back of strong interest from domestic institutions and retail investors. Edited excerpts:

A lot of companies lined up to raise funds through IPOs. Do you expect a record IPO fundraise in 2021? Any possibility of LIC and NSE IPOs this year?

As of July 2021, a total of Rs 37,336 crore has been raised from the primary market. With a robust pipeline ahead, there is certainly a possibility of a record amount being raised through IPOs this year. Liquidity is awash, sentiment is positive and most firms are able to raise money in this easy liquidity environment. This does indicate that activity will continue until these conditions prevail.

Most IPOs are getting fully subscribed either in the initial hour of the opening of the bids or on the first day? Which are the factors driving optimism and why are retail investors so excited about every issue?

There are three specific factors that are supportive. First, there are a large number of new investors in this cycle. New investors tend to gravitate towards IPOs. Secondly, there have been a number of large issuances with which investors have been able to connect from their own experiences which created a lot of buzz. But the most important factor is the performance of newly listed IPOs companies that have delivered handsome returns, especially for people who have used leverage to apply for such IPOs. This mix is the most probable reason and is mostly market-led. We have seen these trends in the past and they repeat in an easy liquidity environment.

Have you spotted any wealth-creating ideas among the IPOs that have been launched or are in the pipeline?

In terms of our IPO selection, we seek visibility of business growth, decent cash flows and reasonable valuation. Till now, we have been a bit low in terms of participating in most IPOs as either of these criteria have not been met.

FIIs are consistently selling in the Indian equities but at the same time, the market is not seeing major selling pressure. What does it indicate and who is supporting the market?

We have seen some outflows recently. In CY21, so far, FPIs have pumped in Rs 45,000 crore. In the month of July, we saw outflows of 11,000 crore after an inflow of nearly Rs 17,000 crore in June. Part of these outflows is due to heavy selling pressure across emerging markets led by China. Emerging market indices recently touched seven-month lows. India has been able to handle FPI outflows on the back of strong interest from domestic institutions and retail investors. The domestic flows to equities remain supportive with ultra-low rates making equities attractive.

Do we need to worry if the Federal Reserve starts tapering bond purchases sooner than expected? Do you expect a sharply rally in US bond yields this time?

Emerging markets (EM) will be vulnerable to the tapering of bond purchases by the Federal Reserve. India, being a big beneficiary of massive inflows of FII money, will also be impacted. India, with a weight of about 9 percent in the EM basket, a large outflow from EM spread over months, can cause a corresponding outflow from India as well. That said, India has some reinforcements in place.

Our domestic institutions have become larger than before and can act as a buffer to FII outflows. India can also manage currency volatility with the fourth-largest forex reserves, a benign current account, a supportive central bank and balanced inflation. In short, India is best prepared for a taper from Federal Reserve but would be impacted through the fund flows in the short term.

The US 10-year yields are negative when adjusted for inflation. In fact with tight labour markets, high headline inflation, soaring government debt and equity markets flirting with all-time highs, this is a surprisingly low level of US yields.

Once the taper ends, it is expected that yield would move up. However, in our study of the past trends, bond markets have been more right than wrong in anticipating growth and inflation, which means US bond markets expect the current round of inflationary pressure to be transitory and growth would also mean revert to lower levels.

We do not foresee a secular uptick in US bond yields but are prepared for yields to head back to the recent 2021 high of 165 to 175 bps when taper-led volatility hits the market. We are more concerned with falling yields which reflect poor growth outcomes.

A majority of experts talk about the risk of a third Covid wave. Do you agree and what are other risks that one has to consider before investing in equity?

There has been a spurt in the number of cases across many countries. I am not an expert in pandemics but we are watching the fatality rates closely this time. As per specialists, it is important to see how quickly we reach the zone of herd immunity across the world with the use of vaccines which is likely to bring down the fatality rates and making COVID manageable. We remain cautious and attentive to any such risk but we can’t predict third or multiple waves.

The most important risk to investing is firstly the knowns. We see there is some valuation discomfort building in pockets. We are focussed to remain invested in opportunities that are structural and also provide growth for the valuations we are paying. The biggest risk in the current environment is to overpay for growth.

The market has continued its record-high journey in the second half of 2021. What are is driving the market–FOMO (fear of missing out) , TINA (there is no alternative), or plain liquidity?

It’s a mix of earnings revival, consolidation in the number of industries, favourable conditions for cyclicals and of course, easy liquidity. There are no bull markets without easy liquidity. Easy liquidity is a necessary condition but not sufficient. There are sectors that have seen the large, listed players gain market share and that is reflected in a strong uptick in their earnings. Cyclicals like metals, energy and select building materials are also witnessing strong earnings revival and record cash flow generations. These are coinciding with post-pandemic reversion to mean for other parts of the market. In combination, this is the base on which the market is standing with liquidity as its foundation.

Do you think it is time to be cautious, considering the outperformance of midcap and smallcaps over largecaps? What should investors do now?

There is certainly some discomfort in a number of small and midcaps in terms of valuations and expectations being built. We are optimistic about growth on a medium to long-term basis, so excessive valuations may be a matter of concern in the short term but the long-term journey is intact for us.

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