After a big rally and the quality of earnings which have been pouring in, does it appear that a large part of the good news, which is earnings recovery, is now getting into the price?
There is both good news as well as bad news. The good news is that the macroeconomic picture is looking great, the economy is clearly bouncing back from the Covid lows, especially from the second Covid wave. Clearly, the vaccinations have picked up pace, offices are reopening, businesses are getting back on their feet and that is clearly getting into the expectations of earnings for companies. But coming to the bad news, the markets already seem to be discounting a lot of that and in fact much more than that.
Clearly the markets are running ahead of the fundamentals and trading at valuations which are higher than fair value. We have borrowed some of the returns from the future which means that the future returns from equities at least in the medium term are bound to be a little lower than what we have experienced.
We have indeed borrowed a little more than justified returns from future into present but money managers and practitioners of investing such as you, look for those nooks and corners where risk reward is still attractive, where structural stories are intact and there is perhaps a scope to juice out a little more alpha. What have you been reading lately in that quest of additional alpha?
There are always certain pockets which could have a superior potential than the general market and we are also trying to focus on some of them. For example, some of the reopening plays like the aviation business would be potentially interesting to look at from a near to medium term perspective. Infra plays like the cement sector could be interesting. Also sectors like telecom, IT could continue to remain attractive. These are the areas we are focussing on and are being overweight on.
Let us construct your framework a little more. What kind of earnings growth from these levels are you foreseeing in your broader market fund or your midcap tilted fund for the next two to three years. Do you see clear visibility of around 20% kind of earnings in the broader market or even 15% kind of CAGR earnings in the next two-three years in your large cap fund?
Most of the media look at Nifty or the Sensex earnings and try to form an opinion about the earnings growth per se for corporate India. We have recently released a research note which highlights that there is a fallacy in looking at it that way. What clearly drives the underlying earnings on a like for like basis is the overall nominal GDP growth and clearly that GDP growth is coming back on track.
Of course, listed corporate India is running slightly ahead of that and that means listed companies are going to see slightly better fair value growth than nominal GDP growth. But it cannot be completely disjointed from the nominal GDP growth. So yes, we are expecting slightly better than the nominal GDP growth in most of our largecap businesses.
Of course, the midcap and the smallcap businesses are chosen in such a manner that they are experiencing superior growth prospects in their businesses because they might be disruptors, they might be gaining market share and so on.
But once again, the anchor for all the growth is the overall economic growth and especially the nominal GDP growth. We are expecting some reasonably good growth especially because we are seeing the economy bouncing back from the Covid lows.
If the economy is bound to do well, what is your stand on capex? Do you see the capex cycle pick up meaningfully, if that is not happening already? Do you see it more durable beyond the 24, 36 months or for that kind of a horizon?
We are expecting a reasonably healthy pick up in capex in the next three to five years, driven by superior capacity utilisation which has happened in the last three to four years and also expectations of superior capacity utilisation in the next one to two years. Clearly companies have started planning for future capex and we see strong capex coming back. However, a very important point to note is that this capex is going to be very different from what we have been used to. What we are going to see is far more levels of capex being spent on digital factories, on technology, than just on plain vanilla plant and machineries which we have been accustomed to.
So yes, capex is coming but it is going to be spread out over different varieties of capital goods industries.
In the last two-three days, the companies which have been talking about capex are , Hitachi, ABB and the likes. So I understand where you are coming from when you say that traditional brick and mortar and large capex will not be happening perhaps but more focussed automation, digital that kind of a capex is happening in Indian factories. Where do you stand on the export theme?
It is one of the structural growth themes. There are lots of companies in the chemical space which are unique. These are world leading and during the Covid period, they have already started seeing the benefits of this China plus one strategy adopted by international customers. Clearly there is a shift in terms of supply chains and there are a lot of such companies in India which are getting benefits predominately in chemicals, pharmaceuticals or in IT.
For example in IT, digital IT is booming. I think there are lots of these white spaces which are going to get a big boost from exports and that is one area which interests us.
The roadmap for the next three to five years appears to be in place; it is an earnings led structural growth recovery led movement which is happening in the indices and returns are also moving in tandem, when returns move ahead and then stock prices follow. Does it look like we are in the middle of a durable cycle?
On the economic growth cycle or on the market cycle?
I meant economic growth cycle because after all stock prices mirror economic growth and earnings.
At least on the economic growth cycle, we have turned the corner and we are going to see superior growth in the economy and we are going to see better prospects for most of corporate India. Having said that, I would just be cautious on one aspect, which is inflation. If we are going to see significantly superior economic growth, we might see some slightly higher levels of inflation, which is what we should watch out for because at least over a medium term, it may lead to some tightening of policies which could have a debilitating impact on cost of equity and can pull down the valuation multiples. We need to be cognisant of some of the ill effects of growth and that is what we are focussing on. But economic growth seems to be back on track.
What are the risks from US tapering we should also be cognisant of? Do you think we are vulnerable and should we be mindful of that?
One advice which I would want to give is that this is a period when most of the investors are a lot more greedy than fearful. So the idea is that one should invest in the markets and not speculate in the market; understand what we are looking at and why we are buying. There are hidden risks which do not appear on the surface. Making money seems to be quite easy and that is the biggest risk in the market. I would say that rise in inflation and interest rates are the biggest risks, not just for Indian markets, but for the global equity markets or any other risk assets. We have experienced falling interest rates for the last 40 years in the US and even for India we have seen falling real rates for quite a long time.
If that changes, that could have a negative effect on equities. So make no mistake, even if there is earnings growth and if there is a rise in cost of equity, that could cause a fall in valuation. That is an important point which investors in the markets today should keep in mind.
