He tells Ashley Coutinho, in an interview, that a quicker-than-expected reversal in easy monetary conditions could sap the liquidity that has elevated asset price valuations.
Downgrades to EPS growth forecasts and hyper-inflation are the biggest risks for Indian equities, says Rajesh Cheruvu, chief investment officer, Validus Wealth. He tells Ashley Coutinho, in an interview, that a quicker-than-expected reversal in easy monetary conditions could sap the liquidity that has elevated asset price valuations. Edited excerpts:
What are the biggest risks for the Indian equity market right now?
Equity markets are always forward looking and tend to move on from transient economic disruptions quickly. But when valuations are as stretched as at present, corporates have no space for mistakes in business performance and earnings delivery. Though the two-year forward EPS (earnings per share) growth is still healthy, the possibility of a return of localised lockdowns and uncertainty over the government’s ability to quickly inoculate a large mass of the population have led to financial year 2021-22 (FY22) real gross domestic product (GDP) growth downgrades from 12-13 per cent year-on-year (YoY) to 8-10 per cent.
So, the biggest risk is downgrades to EPS growth forecasts due to weaker-than-expected macro. The second risk is from hyper-inflation. The third is from a quicker-than-expected reversal in easy monetary conditions both locally and globally as it would sap the liquidity that has led to elevated asset price valuations.
What is your take on valuations?
There is no doubt that on an absolute basis valuations are higher than long-term averages across all metrics, be it PE, PB, and market cap to GDP. But when looked at from a relative lens, even debt valuations are reaching for the sky, given the low yields on offer and likely continuation of low interest rate policy by central banks globally. With inflation risks on the horizon, equities offer the best risk-reward to generate reasonable real returns over the medium to long term.
How do you assess the impact of the second wave on economic activity?
The first quarter (Q1) had the benefit of a low base (nationwide lockdown in April-May 2020) and was expected to report a strong 25 per cent YoY growth, leading to a real GDP growth of 12-13 per cent for FY22. The resurgence in cases led to curfews and localised lockdowns across states in April, which
continued in May. High frequency macroeconomic indicators like auto sales, fuel demand, rail freight and property registrations have fallen month-on-month versus March. Even mobility indicators, which had shown good recovery till February, have weakened and unemployment has risen. As a result, Q1 is going to bear the brunt of the second wave, exposing full-year GDP forecasts to downward revisions, unless phase-3 of vaccination is executed quickly, helping the coming quarters offset this impact.
What is your view on mid- and small-caps?
Given that mid-caps are trading at relatively better valuations and are witnessing higher EPS upgrades, we continue to support our tactical overweight view on mid-caps vis a vis large-caps. Also, mid- and small-cap companies tend to benefit from broadening flows as more foreign investors participate in local markets. Rising retail participation has also led to increased interest in domestic companies that largely belong to this space.
Which sectors are you betting on?
We believe top quality sector-leading companies are inherently Covid-proof, but if someone wants to invest in specific sectors, then it would be prudent to follow a core-satellite approach. The core (70-75 per cent) would constitute allocations to secular sustainable growth businesses and satellite (25-30 per cent)
would focus on short-term thematic ideas with a 6-12-month view like pharma (API, CRAMS, Vaccine, Diagnostics), IT services (Cloud, digital), new tech (EV, platform plays), PLI (Atmanirbhar Bharat), and infra (capex-loaded Budget). But investors should be cognizant of the fact that the non-core allocations are not buy-and-hold and must be exited immediately after expected thesis has played out and absolute returns have been made.
What is your take on banking and NBFC stocks?
Indian lenders faced several obstacles in the last five years, which led to higher credit cost and lower growth. But they have used Covid-19 to strengthen capital, provision buffers, hasten digital adoption, deepen predictive analytics, granularise liabilities, cleanse lingering asset quality stress, and focus on cost
rationalisation. We think financials are unlikely to repeat the mistakes of the past. In addition, tailwinds of strong macro recovery led by government fiscal expansion, likely return of private capex, excess liquidity, a low interest rate regime, excess SLR and lower credit costs brighten the outlook for FY22 and beyond. Key focus should be on top quality private banks, NBFCs, HFCs, and MFIs.