If the inflation trajectory does cool off, then India will be amongst the best markets in the world to invest in, says Rajesh Bhatia, MD & CIO at ITI Long Short Equity Fund. In an interview with Nishant Kumar of Mint Genie, Bhatia explains the challenges for the market and his favourite sectors to bet on.
Edited excerpts:
There is a lot of uncertainty owing to the Ukraine war and soaring commodity prices. Do you think inflation is the biggest threat to the market at this juncture?
Yes, rising global inflation certainly is the biggest threat to the equity markets. To step back, the primary reason why equity as an asset class rose sharply post April 2020, is the unprecedented amount of money supply issued by the G-10 central banks, as an aggressive supportive response to the covid pandemic.
The result was a decline in interest rates globally and an increase in asset prices, including equities. However, the consequence of this money printing is getting reflected in rising inflation.
Now this problem is getting exacerbated by the Russian-Ukraine conflict. The threat of persistence of disruption to the supply of these commodities, therefore, is further fuelling the inflation challenge.
To combat this rising inflation, central bankers would have to raise rates, which is a reversal of the trend of rising asset prices that we have seen so far since April 2020. It is however difficult to forecast the depth and duration of the inflation dilemma.
We believe the challenges to the markets are front-ended. If the inflation trajectory does cool off, then we believe India will be amongst the best markets in the world to invest in. And earnings growth in the double-digit will lead to double-digit rises in stocks as well.
A pessimistic view would be that inflation charges ahead and as a response central bankers globally have to increase interest rates very aggressively, triggering a global recession.
We witness a contrasting trend between FIIs and DIIs. For how long will it continue? Is it the new normal?
Basically, there have been two views on the markets over the last few months. One is the FII's views as they have been large sellers in the Indian equity markets.
Their view has been that India, while at the cusp of an earnings and credit cycle upturn, has incorporated this upcycle in the 16-18 percent CAGR earnings estimate for FY23 and FY24. And post incorporating the growth in earnings, the Indian markets were trading at 17-18 times FY24 earnings, which has been at the highest band of its historic PE ratio.
So, while earnings were adequately discounted, these valuations did not account for the potential rise in interest rates globally (particularly in the US to which Indian cost of capital is also linked) - note, as interest rates go up, PE ratios tend to decline.
Further, the Indian market also did not account for the sharp increases in inflation which had the potential to hurt the earnings estimates as well. In effect, this led to their negative view on Indian markets and hence the record amounts of selling from FII.
On the other hand, the Indian investor has a more positive outlook on India. India this year will be a US$3-3.5 trillion economy and will register the fastest growth in the world. It is at the cusp of the earnings and credit cycle and therefore if inflation scares prove to be transient, then FIIs will have to come back to India.
It is difficult to call the trajectory of inflation and especially since the outlook is clouded by the Russian invasion of Ukraine (Russia is a large exporter of oil, wheat, coal, etc.
A long-duration war or high sanctions would acerbate inflationary pressures and vice-versa) and the spike in covid cases in China (production stoppages in China could worsen supply chain issues). We expect the volatility in equity markets to continue in the short term as it navigates this inflation direction.
To what extent crude oil prices can spoil the mood of the market? What sectors may be the worst affected?
We expect the IT sector particularly to do well in this environment. We have been bullish on this sector for the last four years. This was a sector, while India's most competitive sector, was thought of as a slow grower and hence valuations also sagged.
The sector has been energised post covid since the top 2000 companies globally feel a dire need to digitise their entire operation at a fast pace or face an existential crisis. This has led to a sharp demand bounce back and we expect this trend to continue for several years.
At the moment, cost inflation is leading to the biggest deterioration in potential earnings for sectors such as autos, cement, consumer staples and consumer discretionary.
At the current levels of costs, the earnings downgrades would have to be substantial in these sectors and hence we are witnessing sharp declines in stock prices of the companies in these sectors. Not surprising then, if inflation does soften, there would be significant potential for stock price rises in these sectors as well.
When do you expect the RBI to begin the process of rate hikes and policy normalisation? What are your expectations from the RBI MPC's April meet?
The RBI has been quite explicit in its stance of supporting growth. Hence, it is quite likely that it will delay rate hikes and prevent liquidity withdrawals as far out as it can. However, if inflation continues to inch up over the next few months, they may have to raise policy rates eventually. Accordingly, we expect no rate hikes in April.
What sectors would you recommend to bet in this market?
We like the IT, Telecom, Insurance, private banks and select consumer stocks from here on. We are also likely to increase cyclical bets as we either get a better handle on inflation trajectory or if valuations decline for these stocks to make them attractive. Regardless, cyclicals are a part of our tactical portfolio which we increase or decrease depending on our short term views also.