V Srivatsa, Executive Vice President & Fund Manager at UTI AMC
“Given the fact that global growth is slowing down and supply is being ramped up, we see signs of inflation easing in the second half of the year. This is already visible in base metals which have seen a decline in the last month,” V Srivatsa, Executive VP and Fund Manager – Equity, UTI Asset Management Company, said in an interview to Moneycontrol.
If one needs to build inflation proof and recession proof sectors, FMCG and utilities offer the best scope for outperforming, he believes. UTI AMC believes that demand trends are strong in sectors such as banking, automobiles and capital goods, and the impact of inflation would be temporary there.
What is your reading on the Fed meet conclusion? Can the consistent and sharp hike in interest rate bring recession in US markets?
The hike by US Federal Reserve is in line with market expectations and this would have implications as RBI may also need more rate hikes to combat inflation and maintain differentials between the US and Indian rates.
The equity markets are expected to post higher volatility in returns and flow as global investors pull out money from riskier assets. The performance of the markets will depend on the trajectory of the inflation as price rise that is higher than RBI expectations would put pressure on the central bank for higher rate hikes and will have impact overall demand which is not the base case for markets.
The markets are expected to post recovery in demand which should offset some of the negative impact of rate hikes on the economy.
The market has corrected more than 11 percent so far in 2022 especially after 24 percent run-up in previous calendar year. So what is your view on the market for the second half of 2022?
As part of our process, we do not forecast market returns either in the short term or long term. Our focus is on overall valuations of the market and identifying long term winners. In terms of valuation, the markets are currently trading at 18.5x on 12 months forward and at slight discount to the long-term averages.
While there is scope of earnings cut given the high inflation and pressure on margins, however, there are opportunities in both stocks and sectors which are trading at valuations below long-term valuations. The markets are also influenced by global macro factors such as growth, interest rates and valuations which have largely been negative for the Indian markets year-to-date.
Inflation grabbed headlines in the first half of this year and made equity markets nervous. Do you think this risk is going to persist for the rest of the year too? Also is geopolitical tension the only reason for inflation?
Inflation has been impacting earnings for the last couple of quarters and is expected to do more damage in the next couple of quarters given the current trends. Inflation has largely been supply led as there were supply bottlenecks in both global production and transportation and the Russian war has only exacerbated inflation given Russia is a significant producer of crude, base metals and foods.
However, given the fact that global growth is slowing down and supply is being ramped up, we see signs of inflation easing in the second half of the year. This is already visible in the base metals which have seen a decline in the last month. The trajectory of inflation depends on the war as commodities such as crude can fall drastically if there is any resolution on the war.
Apart from inflation, what are the other risks that can be seen in rest of the year?
Most of the risks are after-effects of inflation as we see interest rates rising in India which has the potential to impact discretionary consumption in automobile, durables and real estate which is probably not factored in market valuations.
We also see government finances constrained which would impact infrastructure spending which is needed for growth in the next few years and we are also seeing potential for companies to delay their growth capex given the uncertain environment. Continuation of the global risk off environment will also lead to valuations further moderating for the Indian markets.
What is yet to be discounted by the market (in terms of positives as well as negatives)?
Impact of inflation for the next couple of quarters is discounted by the markets and any high inflation beyond that would impact earnings. Also, the second order impact of demand slowing down is not factored in by the markets in most of the consumption-oriented sectors which would lead to further earnings downgrades.
In case of commodity stocks, the commodity assumptions implied by the market cap are quite conservative and factors in decent decline in the prices.
Do you think the earnings downgrade risk is rising?
Given the current trends of inflation, markets have factored in similar trends in the next couple of quarters and some normalcy is assumed beyond that.
We need to be watchful of any demand trends in the core sectors of automobile, credit growth, residential property sales in the coming months to see any impact of high inflation and rates.
Reserve Bank of India has delivered two repo rate hikes this year and the Street is counting more by the end of this year. What are your thoughts and is there any possibility of a pause in rate hikes from RBI?
The action of RBI is in line with global central banks as they continue to fight inflation by increasing rates. RBI has retained its growth target.
We believe that while further rate hikes cannot be ruled out as India needs to align with the rest of world, however, at some point RBI needs to pause.
How can one make the portfolio inflation- and recession-proof?
Our base case of portfolio building is not assuming recession and inflation lasting for two to three quarters. Our key active weights are domestic recovery sectors such as banking, automobiles and capital goods where we believe that demand trends are strong, and impact of inflation would be temporary. However, if one needs to build inflation- and recession-proof sectors, FMCG and utilities offer the best scope for outperforming.
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