Everybody is talking about how markets will go down because bond yields have gone higher. What is the correlation and can we ignore it? Or is this something which will have serious implications in the long term?
There is some correlation between bond yields and the market but that is over a longer term. Initially what happens is that when you come from a downturn and growth starts to pick up, there is bound to be a rise in bond yields because bond markets will believe that inflation will catch up over a period of time. The central banks would raise policy rates and that would start impacting the valuations of the companies because we have seen that in a period of very low bond yields — almost zero levels — the PE multiples tend to be on the higher side because your discounting rate is lower.
But as growth picks up, earnings growth also starts to pick up and we have seen surprising earnings growth across the board in the last quarter. Growth predominates in the initial part of the recovery than the increase in bond yields which tend to have impact on the valuations. But after a sharp rally, some of the near-term concerns like the increase in bond yields is a reason for the markets to make some corrections. Also some amount of money which had moved into the market on the basis of low interest rates, could get pulled back a bit. But this is a short-term impact on the market. Overall from a medium to long-term perspective, the growth recovery is strong. It will continue to drive the market higher after a brief adjustment to the current bond yields.
While what is happening in terms of both incremental and transformational changes in the economy is good, are markets pricing that in? What is needed for markets to go higher now?
It is true there is reflation in the market because of the easy financial conditions and the liquidity has slightly gone ahead and tried to factor in some of these factors. But again after the initial rise, the market is bound to take some pause. There is bound to be some correction based on some of the risk and negative news coming in in terms of increase in the number of the total Covid cases. I think that is the part of the market rally.
We think that the growth improvement is going to sustain and if it is going to sustain beyond the next one year, then the growth trajectory for corporate earnings over the next three to five years can be much higher. That is what the market is still not discounting. Market is probably discounting what the growth will be over the next say one or one-and-a-half or two years at best and as that unfolds, the market will continue to scale higher. Even in the best of bull markets, we have seen corrections of up to 15-20% and the market is probably taking some pause and reacting to some of the news globally. Also, we are in a correction phase. But from here, it is going to be purely an earnings trigger.
More and more sectors are coming out from under the pandemic cloud and starting to recover. For the first time, we are seeing it is across sectors. It is not only the so called defensives, IT, pharma or consumer, but even some of these domestic cyclical sectors. The capital goods sector also is showing some promise with investments likely to pick up on the back of the government initiative taken on the PLI Schemes. It will take some time, but when there are more drivers and more sectors participating, the recovery in the earnings growth and the sustainability of that becomes much stronger. That will take the market higher in the medium and long term.
How exactly do you see the redemption picture moving for domestic investors because it has been six months now?
The good news is that the redemption pressure which was there in the last four-five months, is easing off a bit. We saw that in February and even in March. Clearly the initial reaction of the investors was to take out money. That is now slowing down and investors would hopefully take a slightly longer term view on the market. If you see some correction in the market, that would nudge investors to put in money and buy into that correction. So next year and the next fiscal year, the whole redemption pressure should ease off and we could possibly see some net inflows coming into the mutual fund industry. I am pretty hopeful of that.
Given the current global environment, you have been fairly bullish or active on some of the steel majors as a fund house. What is your outlook on that front going forward and what gives you the confidence that we will see these trends sustain?
The commodity trade is driven by two factors; one is obviously the demand and supply side equation which is currently favouring because supply has not been able to catch up with the sharp increase in demand or the recovery in China where the economic growth has now come back to the earlier levels and demand has increased. Supply had to catch up with that. A lot of capacity in China has been shut down because of environmental issues and that is not going to come back to the market. Even from a medium term perspective we have not seen any large investments in the commodity sector, especially the metal sector in the last four-five years and that will keep the pressure on the supply side.
The second factor is the dollar. Dollar weakening was driving the commodity prices higher and some amount of speculative interest was coming into play with low interest rates. Some of the money moves into the commodity markets and tries to be over there. All these factors continues to hold on and given that scenario, I would say the outlook over the next six to nine months looks fairly strong over here.
While the stocks have rallied, the price to book value shows they are not that expensive and there is also a deleveraging story which is playing out because this year the cash flows for lot of the commodity plays will be very strong. It will be used to pay down the debt and that would also benefit the overall balance sheet for some of these commodity companies.
Back home, given the substantial push in the infra story, expectations are that we will begin to see a much more resounding growth story on that front with the cyclical uptrend. Would some of that rationale also flow in and apply to some of those infrastructure, capital goods names, materials or would you still be a little cautious on that front?
There was a clear push to the infrastructure sector in the Budget, especially the road sector. We are seeing a renewed interest in terms of new ordering coming over there. The challenge for the government has been in terms of the funding. If they ramp up the new infrastructure development fund which has been formed, that should provide some of the needed capital for the government. Also the government is looking at various other options like the InvITs to monetise some of the assets and plough back that into new projects.
So if that gets traction, we could see more money coming in the infrastructure sector and some of the companies especially in the road, urban infrastructure should see decent growth in terms of their order book. The capital goods sector is also looking still early days but I think the government push on Make In India the PLI scheme which is now being rolled out across sectors and is covering more number of sectors. That should drive some investment in the private sector but large investments in the power sector for example or in metals and mining will take some time. There would be some improvement in the capital goods sector selectively but a very big ticket private sector capex I think is still some time away.
