Tailwinds are strong and India directionally is looking very strong and upwards, so chances of an upswing are more than potential downswing in the equity market, but it will remain volatile, Ajay Garg, Managing Director at Equirus says in an interview to Moneycontrol.
Equirus is cautiously optimistic about the IT space as it still believes that the sector is amidst the journey of enterprise clients towards cloud and digital adoption, which will continue for another 2-3 years before the growth plateaus through this initiative.
Also, the firm believes that the worst related to margin challenges is also getting behind. Hence, for the long-term investment horizon of 2-3 years, risk-reward is turning favourable for the sector, says a veteran investment banker, with over 22 years of experience in investment banking.
Will the expected US recession be positive for India?
Besides being the acknowledged leader in software and business services support, India is also emerging as a global manufacturing hub across sectors and any recession will increase pressure on cost management and moving to locations like India and will be positive. Also given the India growth forecast, we expect the allocation to India to increase – although if the recession is mainly on the back of high inflation and hardening of interest rates then overall allocation to equities may need to be closely evaluated.
Do you think the June lows are unlikely to be met by the market again in the rest of the financial year?
The mid-June low of 15,300 is at 12.5 percent from the current level. Given that there are so many variables and uncertainties around them 5-15 percent correction is always possible and markets might be volatile therefore trying to predict the same for this financial year is unrealistic. Tailwinds are strong and India directionally is looking very strong and upwards so chances of an upswing are more than potential downswing but as we have seen equities market will remain volatile.
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Do you expect the higher interest rate scenario to remain till the end of 2023 or will it be reversed in the second half of 2023 ahead of general elections?
Let us first understand the status of the interest rate scenario in India and then define whether it is “high, low or optimum”. First of all, RBI is hiking primarily on the note of “withdrawal of accommodation” provided during the pandemic. While the pandemic support rate cut of 115 bps has been more than reversed, we have to come to the second point of the inflation mandate of RBI. Guided by its 4 percent (+/-2 percent) target, the RBI is hiking to counter inflation to ensure real returns are positive. Thirdly, the global interest rate scenario is in an aggressive hiking mode and capital flows dependent emerging markets like India have to increase to counter the hikes and offset the currency pressures to some extent.
However, it is important to note that India’s hiking cycle is not as aggressive as other countries as a) our inflation is not way above the tolerance limit like developed economies and b) we have a visibility that inflation into next year will fall into the tolerance limit.
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Furthermore, RBI is supportive of growth and we are already noticing that some of the members of the monetary policy are calling for a pause. Therefore, in the balance of the growth inflation cycle, one can rather put that the current rates are rather optimum to support growth and at the same time encourage savings, which will support investment.
Note that positive real returns are key to encouraging savings, which is the key to pushing the investment cycle and growth. So for growth, an optimum level of interest rates is much needed. The current level of repo rate at 5.90 percent or close to 6 percent is not the level we have not seen in the past (January-June 2019 6-6.25 percent). The average repo rate in the growth era of 2003-2008 was 7.25 percent. Therefore, we would not necessarily call the current era a high interest rate era but rather a reversal of the ultra-accommodative policy era.
We do not think that elections are a criterion for a central bank to decide on the direction of rates. Central banks and especially RBI are guided by growth inflation mandate and will stick to the dynamics of the economy rather than political considerations. The clear commentary that real rates to be at 1 percent will be the guiding principle and we have seen macro policy decisions not being influenced by immediate political compulsions of elections.
What are your expectations from this festive season in the stock market?
We are looking at record sales in the discretionary segment in Navratri and Puja. We expect sales growth to continue this Diwali as well. Growth coupled with gross margin expectation improvement should provide support to the market in the volatile global environment.
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Do you see gold prices falling more from here given the strong US dollar and rising fears of aggressive policy tightening in upcoming meetings?
Domestic gold prices have been more a function of global prices and currency. With a depreciating rupee, there is a bias for the rise in gold prices (adjusted for global prices). International gold prices are, however. being rangebound now and gold is usually a hedge against recession, inflation and oil shocks.
With oil prices remaining rangebound we would expect gold to also remain rangebound rather than expect any strong one-way moves. Again if there is visibility on the peak of the global interest rate cycle, and the geopolitical environment turns positive, there could be drivers for gold to remain sideways rather than have a strong one-way move.
Do you think the value is emerging rapidly in the IT space and also what are your thoughts on the IT earnings announced so far?
The CY22E-YTD underperformance of the Nifty IT Index versus the Nifty index to the extent of 28 percent has now resulted in sector valuation approaching the 5-year mean making the valuation reasonable versus earlier it was trading at above +2 standard deviation of its 5-year mean and now factors to some extent the expected slowdown in sales growth/demand starting CY23E/FY24E in our view unless recessionary pressure in the US, which is the key market for the Indian IT, is more severe than expected. We are cautiously optimistic as we still believe that the sector is amidst the journey of enterprise clients towards cloud and digital adoption, which will continue for another 2-3 years before the growth plateaus through this initiative. This will result in the start of pent-up demand from 2HFY24E/FY25E post likely demand slowdown in 2HFY23E/1HFY24E. Also, we believe that the worst related to margin challenges is also getting behind. Hence, for the long-term investment horizon of 2-3 years, risk-reward is turning favourable for the sector in our view.
Do you think the fall in global tech budgets and further fall in margins are two major worries for the IT sector?
We do foresee tightness in CY23E IT budgets as clients across developed markets will be prioritising to conserve FCF (free cash flow) given rising interest rates, deteriorating macro outlook given ongoing supply chain management issues, shortage of gas (especially relevant for clients in Europe) and hence CC (constant currency) growth outlook for the sector in FY24E is likely to be soft and lower than FY23E. However on EBIT margin we expect year-on-year improvement in FY24E for most stocks considering tailwinds including i) reducing supply side / attrition-led challenges and resulting lower cost pressure to retain talent, ii) with easing travel restrictions we expect a reduction in sub-contractor cost as the strong number of fresh graduate engineers recruited across most companies in last 3-5 quarters will turn billable and, in turn, replace some semi-lateral employees in India, who, in turn, will replace high-cost sub-contractors in onsite locations, iii) COLA (cost of living adjustment) led price hikes which are coming with a lag in FY23E can have full year benefit in FY24E and iv) lastly if currency (INR/US$ ) remain weak it will have some margin-led tailwinds, even after factoring increasing cross currency headwinds (due to appreciation of US$ versus most of the foreign currencies). So actually margin management will not be a big worry for the sector going forward.
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