Shyamsunder Bhat is the CIO of Exide Life Insurance
The Indian equity market has gone into a tailspin in the last few sessions amid mounting inflationary pressure and intensifying fears of recession in the US economy. But the Indian economy looks seated to witness an increasing weightage in emerging market portfolios over the next few years, since the country is favourably placed from the perspective of political stability, relative GDP growth, forex reserves and currency.
“While we have witnessed relentless selling by FIIs in this calendar year due to higher valuations as well as possibly redemption pressures, we could witness substantial purchases in India next year, with potential portfolio re-allocations,” says Shyamsunder Bhat, Chief Investment Officer at Exide Life Insurance, in an interview with Moneycontrol.
Excerpts from the interview:
Do you expect the second half of the year 2022 to be same like first half?
The 24 percent gain in the Nifty50 index in calendar 2021 has to be viewed in the context of the sharp earnings growth which was expected in FY21-22 (and which materialized: a 38 percent earnings growth on a low base of the previous year), coupled with the overall liquidity and interest rate conditions prevailing for the larger part of calendar 2021.
Earnings growth in the next two years could be modest, and the outlook for the indices for calendar 2022 would need to be seen from this perspective. We do not have specific targets for indices, as our investment strategy is stock-specific.
Further, as insurers, our investment outlook is longer-term. We have a positive long-term outlook on our equity market while being cautious in our outlook for the current calendar year, though the correction thus far (particularly in individual stocks) appears to be largely pricing in the concerns that have arisen this year.
What are your thoughts on the commentary by the Federal Reserve?
Earlier this week, the US Federal Reserve increased policy rates by a sharp 75 bps. This is the third (and largest) hike in 3 months, and a series of hikes is projected over the next year, to curb inflation. Along with the hikes, there is a projected shrinking of the balance sheet as well. There would be an impact on sentiment, disposable incomes, the US GDP growth, FII actions and the currency.
The gap between inflation and interest rates is much larger in the US than in India, which is likely to result in a much larger hike in interest rates in the former (the interest rate hikes in India are likely to be to a lower extent).
Inflation has been a headline in the first half of this year and made equity markets nervous. Do you think this risk is going to persist in rest of the year too? And, do you think the geopolitical crisis the only reason for inflation?
Inflation has been stubbornly high globally, and has emerged as a big concern for markets globally. While inflation is high in India too, a bigger concern is the inflation level in the US economy, which has set the tone for aggressive action by Central Bankers.
Higher inflation reduces customers’ purchasing power, thereby impacting demand, sales and eventually earnings of corporates. RBI has amended its stance and shifted focus from fostering growth to targeting inflation at a potential expense of growth, in terms of the hikes in policy rates.
There is a concerted effort from the Government’s end as well, with large excise duty cuts in petrol and diesel, imposition of a high export duty on steel, and a curb in wheat exports. Therefore, while inflation could remain at a high level of 6 percent+, we may have witnessed a peaking at the 7.79 percent level reported in April (we have seen some easing already in May, at 7.04 percent).
Geopolitical issues are the reason for the spurt in inflation in the past few months, but we also had supply-chain issues and excess liquidity in the system, coupled with prolonged low interest rates, which all contributed to the build-up in inflation. Most of these issues are being addressed, however the ongoing Russia-Ukraine conflict is one which is difficult to assess in terms of the duration, and longer-term supply-chain effects which we may see even after there is a cessation in the conflict.
What other risks do you see for the rest of the year?
Apart from inflation which has an impact on consumer demand as well as on the extent of interest rate hikes by Central Bankers, the other risks are the impending earnings downgrades, a potential fatigue in Indian retail investor purchases after having held up very strongly thus far, and the continuing effects (and after-effects) of the Russia-Ukraine conflict on various commodities and supply-chains.
What is yet to be discounted by the market (in terms of positives as well as negatives)? And views on the current market situation?
If the US economy does tip into a recession in calendar 2023 as economists have been increasingly predicting in recent months, the market may not have fully discounted the same, as earnings expectations may not have been adjusted for the same by analysts. If this does materialise, it would have an impact on global trade as well as markets, including India.
Another factor to be considered in India, is the fiscal implication of the reduction in central excise duties on petrol and diesel, along with a potential shortfall in disinvestment/privatisation receipts, as this could either result in a further increase in borrowings, or a cut in spending on capex (as higher tax receipts may not be able to compensate for the shortfall). The former will not bode well for bonds, while the latter will not bode well for equity prices.
In terms of positives, we could witness an increasing weightage of Indian equities in emerging market portfolios over the next few years, since India is very favourably placed from the perspective of political stability, relative GDP growth, forex reserves and currency : most of the other large emerging markets have concerns on one or more of the following fronts: geopolitical/economic sanctions/currency/growth.
Therefore, while we have witnessed relentless selling by FIIs in the current calendar year due to higher valuations as well as possibly redemption pressures, we could witness substantial purchases in India next year, with potential portfolio re-allocations.
A lesser concern in India on the pandemic front going forward, post the high level of vaccination in India and the relatively limited impact from the Omicron variant witnessed as compared to the earlier waves; and a strong trend in GST collections are two other positives.
Finally, in terms of valuations, some individual blue-chip companies are now available at reasonable valuations, and at the present 15,400 levels, the Nifty50 itself too is at 16-17 times the 2 years forward earnings multiple, and has almost retraced to its long-term average multiple. Therefore, our view on the current market situation is that while there could be still some downside for the Nifty50, we are seeing opportunities in select stocks.
Our market is better placed in terms of growth as well as the difference between inflation and interest rates, we could see an earlier recovery in the Indian market as compared to the US market; however it is important for the US market to stabilise first as this is one cue which would be keenly watched out for.
Do you think the earnings downgrade risk is rising?
Yes, while the consensus estimates for the Nifty50 earnings for the next 2 years are presently higher (in mid-teens), the earnings growth in FY22-23 and FY23-24 could moderate to a range of 12 percent CAGR due to various reasons such as the higher base of FY21-22, a likely difficulty in the ability of corporates to pass on their higher costs (as retail demand could be impacted by the impact on disposable income with rising EMIs, and industrial demand could be impacted by slowing global growth), and finally the impact of higher interest costs for companies with debt on their balance sheets.
Do you expect the RBI to take a pause after the next rate hike?
Despite the steep 90 bps hike in the repo rate over the past month, the repo rate is still below the pre-pandemic level of 5.15 percent. The Monetary Policy Committee is likely to remain focused on withdrawal of accommodation to ensure that inflation remains within the targeted range going forward, and we could therefore see further rate hikes during the course of the year.
However, as the rate-hikes have been front-loaded in line with global central banks, we may see the pace of the hikes becoming slower after the repo rate is increased beyond the pre-pandemic level of 5.15 percent, which is another 25 bps away. The trend in inflation domestically, and the impact on growth, are both factors which would be closely monitored for further hikes by the MPC beyond this level and we could see a temporary pause thereafter, depending upon the data.
How can one make his portfolio inflation and recession proof?
Sectors such as banking and IT should do better in the inflationary environment. In a rising interest rate scenario, the repricing of loans would happen faster than the repricing of deposits, and margins are likely to expand for banks. With credit costs under control, this should reflect well in terms of profitability and balance-sheets.
Most companies from the IT sector have strong balance sheets with zero-debt; and inflationary impact would largely be from the salary-hikes to address attrition. IT-sector stocks have fallen very sharply in calendar 2022, partly due to some earnings downgrades on the margin front, and partly due to fears on the demand environment if US/Europe were to slip into recession (therefore this is one sector where this risk appears to have been already factored in by now). Some of the impact on margins could be offset by a weaker Indian rupee, and the impact on IT spends may actually not be as adverse even in a recessionary environment. Therefore there is reasonable comfort in some of the good IT names at current valuations.
The pharma sector and the FMCG (consumer staples) sector would fare better in a recessionary environment, to an extent. However valuations in most of the FMCG companies, and in some of the pharma companies, may not offer much upside from present levels.
Presently, since there are headwinds for equities as well as bonds, asset-allocation would be a key factor in portfolio construction and would vary depending upon the age, risk appetite, time-horizon and income /liquidity requirements of an individual. Most importantly, investors should be looking at a much longer horizon, beyond the next couple of years at the very minimum.
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