Varun Lohchab, Head of Institutional Research, HDFC Securities, believes the market volatility attributable to the Adani saga is now negligible and the markets have priced in the potential risks surrounding the Hindenburg report. However, he expects interest-rate volatility to persist for the remainder of this calendar year, resulting in a range-bound market. In an interview with MintGenie, he said he prefers sectors and companies which are beneficiaries of capex amid the current market and GDP environment.
Edited Excerpts
The market is now back on a recovery path, do you think all that uncertainty and the negative overhang of the Adani saga is now behind us or is more yet to come?
Our belief is that the market volatility attributable to the Adani saga is now negligible; the market has priced in the potential risks and news flow surrounding the Hindenburg report. The potential impact on Indian banks is limited and well-contained, hence the sturdiness of well-capitalized banks is intact. The primary source of volatility currently plaguing the market is surrounding the terminal Fed funds rate. Just a week ago, the probability of a 50bps hike in the March meeting according to the Fed funds futures was 28 percent, which has skyrocketed to 68 percent as of March 9, 2023. The bond market currently suggests that the most probable terminal rate in this cycle as of today is 550-575 bps, which is expected to be reached as soon as the June FOMC meeting.
Expectations before Powell's recent speech were of a terminal Fed funds rate of 525-550 bps. Evidently, there is palpable uncertainty surrounding the peak of these interest rate hikes. The RBI is expected to follow suit and we are most likely looking at a higher terminal repo rate as well. We expect interest-rate volatility to persist for the remainder of this calendar year, resulting in a range-bound market.
Which part of the market is most preferred by you in the current scenario; where would you advise investors to increase exposure?
It is widely evident that the government has been preferring “investment” over “consumption” in the GDP equation as its strategy to drive the country’s growth. Given its clear focus on investment-led growth, we believe sectors and companies which are beneficiaries of capex should be preferred in the current market. In our view, early signs of capex pick-up observed in the private sector would be sustained aided by the confluence of enablers’ viz. healthy corporate balance sheet, well-capitalised banking system and mid-cycle capacity utilisation. Additionally, rising budgetary allocations towards capex and healthy execution by central government agencies bode well for the ongoing capex cycle.
Against this backdrop, beneficiary sectors such as capital goods, infrastructure, power, cement, chemicals and select financials should be preferred. Having mentioned this, it is an absolute necessity to be mindful of the valuation of stocks while doing a bottom-up stock selection from the above-mentioned sectors.
How is your model portfolio poised right now after the Q3 numbers?
On the model portfolio, we are maintaining our stance in favor of economy-facing and value sectors. This has been our view for the last several quarters that high PE-low growth stocks will face de-rating, which has played out so far. We continue to believe that in this rising interest rate scenario, the cost of equity will increase and hence one should stay away from expensive names with low growth. These stocks would face heat as the monetary environment tightens further. Our point of view is reflected in our model portfolio constitution wherein we are overweight on industrials, large banks, cement, power & pharma.
Further, post-wedding & festive period, we notice demand normalisation in various consumer sectors, hence we remain underweight there. We are slightly underweight in the IT sector due to a lack of clarity on FY24 deal pipelines. Additionally, we are underweight on the oil & gas sector due to the weak business economics of OMCs. To sum it up, we are positive on sectors in which stocks have a strong profit growth outlook and are available at reasonable valuations.
What kind of growth are you expecting in Q4? Will it be similar to Q2/Q3 earnings led by BFSI space or there are more winners emerging?
We expect Q4FY23 earnings to be largely on the same lines as witnessed in Q2 and Q3. The banking sector has been in an advantageous situation in the current scenario given the benefits of upward repricing of asset-book but liabilities getting repriced with a lag. The pristine asset quality of the banking system is an additional tailwind for the sector. As interest rate hikes are yet to peak out and so far, there are no meaningful indications of demand destruction due to high-interest rates, we believe healthy earnings of banks will sustain in Q4FY23 too. Given BFSI accounts for almost a third of the corporate earnings pool, it is expected to continue leading overall earnings in Q4. Additionally, driven by commodity softening and sustained demand momentum, cement and consumer staples may show improved earnings in the next quarter, in our view.
What trends will investors look at now?
Based upon our analysis, we are keeping a watch on the falling trends.
-Visibility of clients' IT budgets which will likely drive the performance of technology stocks in FY24
- Sustainability of capital goods companies' earnings which have shown strong earnings growth in recent quarters led by capex recovery
- Rural demand recovery which has the potential to drive growth for various consumer-facing sectors
Which sectors should investors stay away from for a while and which ones would be value investments?
Finding value today is a tall task; most stocks are fairly priced or slightly overpriced in our opinion. This is another reason why we're expecting a range-bound market this calendar year. We are currently negative on industries such as consumer discretionary, energy, IT, and e-retail/e-commerce. Additionally, it would be prudent to stay away from low growth high valuation stocks in this rising interest environment.
