With the rise in the government bond yields, the gap between risk-free rate and earnings yield is reaching a level from where it seems difficult for equity as an asset to re-rate further, according to Ihab Dalwai, Fund Manager at ICICI Prudential AMC.
In an interaction with Moneycontrol, he shares his insight into the financial market. Dalwai feels that domestic cyclical sectors like banking and autos look attractive. “Banking should potentially benefit from the expected pick-up in credit. Going ahead, higher profitability should be driven by lower credit costs,” he reasoned.
However, going ahead, the IT sector’s growth may taper on a year-on-year basis. Hence, one can be cautious towards the sector, the Chartered Accountant and a Chartered Financial Analyst advised.
How do you approach the markets that has been range-bound for a month now?
We expect markets to remain volatile. This is mainly driven by rising interest rates, Russia – Ukraine conflict, and fair valuation of equity markets. Triggers such as resolution to the conflict, correction in commodity prices and pick up in domestic credit growth can be sentimentally positive for Indian equities in the near term.
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Also do you think Indian markets valuations are still expensive, and will the expected change in stance by the RBI put pressure on valuations going ahead?
When compared to S&P500, the Indian markets are not expensive, especially when one factors in the long-term growth differential. However, in India, with the rise in the government bond yields, the gap between risk-free rate and earnings yield is reaching a level from where it seems difficult for equity as an asset to re-rate further.
What are your thoughts on quarterly and full year earnings announced by IT majors recently?
The IT sector has had a very good run over the last two years led by COVID-induced consumer behaviour shift to digital, which accelerated IT spends. This has resulted in both earnings growth and valuation multiple re-rating for the sector.
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However, going ahead, the sector’s growth may taper on a year-on-year basis. This will put pressure on the historical high multiples the sector is trading at. Hence, one can be cautious towards the sector. Moreover, S&P500 companies may postpone portion of their tech spends as these companies face margin pressure from both high material and labour cost.
FIIs remained net sellers for the seventh consecutive month now. Will the FII strongly comeback in second half of FY23?
Valuation has to be seen in context with long-term sustainable growth rates and return profile of the country. India scores high on these counts and hence trades at a higher multiple. The current FII outflow maybe a result of couple of things. First with rising US treasury yield there is a shift from Emerging markets to developed markets, and second global portfolio managers maybe reallocating within the emerging market basket from commodity importing countries to commodity producers given the high commodity prices.
Federal Reserve chair Jerome Powell hinted about 50 bps rate hike in May policy meeting. Do you think the Fed rate trajectory has already priced in by the market?
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Equities gradually reflect the change in a central bank’s stance. Similar to the fact that falling rates and easy liquidity had substantially re-rated some portion of the equity market over a period of time, the change in stance will have an impact on that segment.
Are you bullish on commodity-linked or commodity consumer sectors?
Since Russia is a large exporter of commodities, especially the ones related to energy, sanctions do have an inflationary impact on the commodity prices. While overall prices may cool off with any resolution to the conflict, commodity prices are expected to remain elevated when compared to their pre-COVID rates. This is primarily driven by under investment resulting in supply side constraints.
Given the high returns the sector has already seen, one can’t have a basket approach and will have to be selective in the commodity-linked sector which they want to invest in based on each commodity’s industry dynamics.
What are sectors to focus on and avoid in current market environment?
Domestic cyclical sectors like banking and autos look attractive. Banking should potentially benefit from the expected pick up in credit growth. Moreover, the entire asset side of the banking system has been stress tested, the corporate book pre-COVID and the unsecured retail and SME book during COVID. Hence, going ahead higher profitability should be driven by lower credit costs.
For the auto sector, volumes seem to have hit a nadir. Expect strong cyclical volume growth over the next 2-3 years. The average age of vehicles on road is at its highest and hence replacement demand should support volume recovery. Valuation of these sectors is comfortable both on absolute and relative basis.
One can be underweight sectors such as retailing, given its high valuation and increasing competitive intensity and IT as growth rates will be lower than what valuations are demanding.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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