From a medium-term perspective, one can consider banks, autos, industrials, and manufacturing sectors, says Ajit Banerjee, Chief Investment Officer at Shriram Life Insurance. In an interview with MintGenie, Banerjee explained the positives of the Indian market and how new retail investors should invest in this market.
How do you see the global macroeconomic environment evolving in 2023 amid risks of a recession in the West?
We have observed that most of the macro concerns of 2022 like high raw material inflation, global supply chain bottlenecks, Covid-19-related demand weakness, and rising interest rates are peaking out.
Lowering commodity prices (crude oil is down 29 percent in the last six months) is certainly a big relief to most governments and the respective central banks.
Having said that, predicting the macroeconomic environment in 2023 is quite tough due to various reasons, viz., challenges on account of changing dynamics in geopolitics, the limited policy response flexibility, liquidity tightening environment and commodity price movement.
Even though it is widely assumed that peak inflation is behind us and may not be a determining factor in preparing the policy fabric for 2023, the fear of inflation resurfacing may keep the policy restrictive in nature for a slightly longer period.
The consequences of adopting tighter policies in 2022 pertaining to growth are likely to crop up in 2023. We can expect deceleration as the base case for the global economy for this year and below the trend growth for years to come in the global growth scenario.
To summarise, we can expect economic growth tapering, tightened liquidity and higher volatility to dominate the global macro economy and hence policymaking will be formulated against the backdrop of these themes.
What positives do you see about the Indian economy compared to its Asian peers?
The following pointers are clear outliers for India when compared to its Asian peers.
India driving growth globally
India continues to be a global economic powerhouse despite testing times riddled with volatility and uncertainty.
What stands apart for India is when global markets and indices tumbled, India stood resilient and is already the fastest-growing economy in the world, clocking 5.5 percent average gross domestic product growth over the past decade.
While the IMF predicts global growth to slow from 6 percent in 2021 to 3.2 percent in 2022 and 2.7 percent in 2023, the World Bank forecasts India to grow at 6.9 percent in FY23 and 6.6 percent in FY24.
Three megatrends - global off-shoring, digitalisation and energy transition are setting the scene for unprecedented economic growth in the country.
Indian equity market standing tall amidst volatility
While global equity markets have faced four consecutive shocks in the last two years in the form of Covid-19, high inflation, geopolitical strife and a sharp rise in interest rates, the Indian economy has been able to withstand these shocks relatively better than other economies, thanks to the cyclical upturn, Capex recovery, and manufacturing tailwinds.
The Indian equity market is one of the very few markets in the world that generated an absolute performance of 4 percent in 2022.
Supportive government policies
We expect that over the medium term, the Indian economy would be aided by a favourable policy environment, the impact of PLI schemes crystallising, opportunities arising from the shift of the global supply chain, government thrust on infrastructure spending, etc.
The rupee and almost all currencies witnessed huge volatility this year. However, on a real adjusted basis or REER (real effective exchange rate) terms, the Indian rupee has appreciated against a wide basket of currencies, signifying that depreciation in the rupee has been less than the relative inflation differential.
The Capex cycle in the country has picked up substantially. Initially, the Capex was limited to government expenditures but now we are witnessing Capex being undertaken by the state governments and private corporates which would certainly propel economic growth.
Ample availability of financial resources (internal cash accruals, tax buoyancy and bank credit) and relatively affordable interest rates and rising capacity utilization (72.4 percent in Q1FY23) and credit growth (18.4 percent in Oct’22) are facilitating factors for improvement in capex volumes.
India may be on the cusp of a strong Capex cycle but do you think we have enough financial strength for this? There are also speculations that the Budget 2023 may be slightly populist due to the general elections in 2024.
While it’s a fact that the general elections in the country are due in 2024, the coming financial budget will be the last full-fledged budget this government will place before the Parliament.
However, we have been seeing that the present government has continued with the economic reforms agenda over the last decade despite key state elections taking place.
Moreover, at present many key government schemes and initiatives get announced throughout the year and are not restricted only to budget proposals.
The existing social welfare measures targeted the rural sector and for an economically less endowed segment may get extended and new schemes may get added as that will add balance to the rural economy and aid rural demand to pick up.
But still, we believe that the Capex cycle which has picked momentum off late to continue in future for the following reasons:
(a) Ebullience in capital-intensive sectors such as energy, power, mining, infrastructure, construction materials, real estate, digital infrastructure, PLI-incentivised sectors, etc.
(b) Sufficient availability of financial resources (internal cash accruals, tax buoyancy and bank credit) and relatively affordable interest rates.
(c) Rising capacity utilisation (72.4 percent in Q1FY23) and credit growth (18.4 percent in Oct’22).
There is so much noise about the current valuations of the Indian market. Are we staring at the risk of a deep correction?
While the structural story of India is strong, valuations of the Indian equity market remain high compared to its emerging market peers as well as from its own long-term averages.
Nifty is trading at 18 times - one year forward earnings as of the end of December 2022, this is 5 percent premium to the last 10 years' median valuation, nearly 15 percent below historic highs touched in October 2021.
Valuations being higher than historical averages is also a risk that may lead to lower tolerance in case of earnings misses.
While we don’t see markets come off a cliff due to increased domestic investor participation by both domestic institutional investors (DIIs) and retail, we feel the risk is to the downside and there can be intermittent choppy sessions which we think should be used as a buying opportunity for long-term investors.
Rate hikes are expected to continue at least until the first half of 2023. What should be the investment strategy for the debt market? On the other hand, is an investment in the equity market a wise decision at this juncture?
The RBI Governor as well as Fed Chair has indicated that the war over inflation control isn’t over yet and some more actions may be required to be taken by the respective central banks.
Hence, we can perhaps assume that a few more rate hikes may happen at moderated levels before the pause button is pressed.
The investment strategy to be adopted by investors for the debt market and the equity market would certainly depend on the investor’s profile, investment horizon, investment objective and risk appetite.
We should not certainly try to time the market but can take investment decisions to optimise our risk-adjusted returns.
Investors buying into target maturity funds when the interest rates are high tend to benefit from roll-down maturity portfolios offered.
These schemes can give higher returns along with the additional benefit of indexation if held for more than three years.
Institutional investors like life insurance companies will have to continue investing depending upon the ALM requirement and investment objectives of different funds under which they received the money but retail investors can perhaps invest for a shorter duration up to two years where interest rates have risen significantly over the last one year and there will be limited upside from here.
The yield curves have flattened in the mid to long-term segment hence there’s no point in investing long at this point in time unless there are ALM compulsions like banks and insurance companies have.
Investing significant money into equities for a short duration isn’t prudent at this juncture.
Some selective investing on a bottom-up basis where there is some upside potential left still may make sense for a longer period.
Investment in a staggered manner would cap the risk in case if any correction happens post-investment.
A mix of debt and equity with a slightly higher allocation to short-term debt instruments may be preferred for a retail investor.
How should new retail investors invest in this market? Which sectors should they bet on for the medium term?
We have always maintained that investors must look at equities from a long-term perspective and invest keeping their time horizons as well as asset allocation in mind.
From a medium-term perspective, we can consider banks, autos, industrials, and manufacturing sectors.
Banks: The banking sector’s balance sheet is amongst the strongest in the last 10 years, especially in terms of credit cost potential.
Further, the system credit growth has surprised all with a 10-year high number of 17.2 percent year-on-year (YoY) till November 2022, indicating continued improvement in economic activity.
The risk-reward looks attractive, with the potential for upgrades and rerating. Banks with strong liability franchises and large branch networks would benefit more from maintaining deposit growth in a rising rate environment.
Auto: Volumes improved across segments on a weak base. Realizations have improved across most companies because of price hikes taken to offset higher commodity prices.
Demand remains healthier for passenger vehicles (PVs), commercial vehicles (CVs) and premium 2Ws (2-wheelers) versus entry 2Ws.
Margins are expected to improve sequentially as commodity prices are cooling and volumes are improving.
Industrials: While public Capex led by the government is already on, the private Capex has started to pick up off late.
Increasing capacity utilization (exceeded 75 percent), deleveraged corporate balance sheets, substantial revenue collection by the government and softening commodity prices are aiding Capex activity.
Manufacturing: With renewed government focus on manufacturing and self-reliance, we have already seen action in areas like defence and PLI schemes. We remain positive about the manufacturing theme in India for the coming years.
We observe nascent signs of Capex cycle recovery, with recovery in the real estate cycle, government policy initiatives (especially the PLI schemes), continued FDI inflows and China+1 related export opportunities.
The geopolitical tensions have increased the urgency to become self-sufficient in terms of energy and defence requirements, which are large opportunities for manufacturing in India.
For the short, to medium-term period, investors can choose to invest within the manufacturing sector in those companies whose products form consumables to the large production cycle and would gain market share from an increase in production levels.
For long-term investments, one can consider investments in capital goods manufacturing companies.
What is the outlook for the IT sector? Should we pick only the largecap IT players and avoid the midcaps?
The Indian IT industry's exposure to the US and European markets makes it susceptible to any downturns that it might face.
Needless to say, the likelihood of a near-term recession looms over key western economies, which would cause Indian IT stocks to remain subdued over the first half of CY23.
IT stocks have corrected by 40-45 percent across the board and we believe that value has started emerging.
Some of the names though are not still very cheap but they have come to reasonable valuations.
The third quarter management commentary needs to be seen carefully on the forward guidance note issued by the management.
From mid-2023 as we gain visibility around global demand and therefore the order book stickiness of Indian IT companies it may become relatively easier to pick up stocks.
As a matter of safety, bottom-up stock picking will be prudent at this point of time.
What could be an ideal asset allocation strategy in the current economic scenario?
Unfortunately, there is no ideal asset allocation strategy or a "one size fits all" type strategy in any economic scenario.
The asset allocation strategy will depend upon many underlying factors like investors' age, risk appetite, free cash flows available for investment, existing liabilities, investment horizon, investment objectives, etc.
If the investor is nearing his superannuation period, then he should have a higher allocation to fixed-income securities or annuities as rates are higher for annuity products at this point in time and a limited portion of his corpus can be allotted to equity which he can part with for a longer period of time to get a higher inflation-adjusted return or for future capital appreciation.
On the contrary, if an investor is a relatively young professional having free cash flows with a reasonably good investment horizon and a high-risk appetite then he can possibly have a higher allocation to equities in a staggered pattern after setting aside a corpus to meet any emergency fund requirements and risk covers in place.
Disclaimer: The views and recommendations given in this article are those of the analyst. These do not represent the views of MintGenie.