The market had been ignoring and not paying much heed to the rising Covid count across many states. But now it seems to be scared of the impact on people as well as the economy. Do you see this as an opportunity for long-term investors?
First of all, the second wave is different from the first wave. In the first wave, we did not have the vaccine and fear was very high. This time around, people are more relaxed. The vaccination drive is also taking place. So, I do not think the impact would be very severe on earnings and overall sentiments in the second wave. Obviously, in the near term, profit booking was warranted given the way valuations have run up. We think that by the end of this month the cases might peak. . We also believe that this will pressurise the government to accelerate vaccination drive because we are not hearing anything in terms of vaccine shortages in India. So we think that the earnings and valuation impact would be contained. This correction could be a buying opportunity from a six to nine months’ perspective.
The earning season is about to start. Do you expect the momentum to continue? Could this quarter justify the valuations?
In the past 10 years, we have started with certain assumptions and then have been disappointed at the end of the year. But this time around, we have been positive. If you had asked me three, four, five years ago, every time we were below consensus expectations in terms of earnings expectations for the market; but this time around I am pretty convinced that the macro recovery is going to be slightly better than what consensus is expecting. So, I am looking at FY23 in my valuations and numbers. I feel that is the number that one should be looking at and currently Nifty earning is expected to be somewhere around 820 for FY23.
I feel we might see some surprises there. There are a few reasons why I believe the market may see some kind of earning upgrade as we move forward. First of all, there is the vaccination drive. I think India has done a phenomenal job in terms of coming out with two vaccines as of now. We are also exporting vaccines and our track record in vaccine administration over the past has been great. I think we will be able to vaccinate our population pretty rapidly over the next couple of months or so.
Secondly, there would be the impact of the huge US stimulus. And there is talk of further stimulus in the US. The impact of the US stimulus is yet to be felt.
The third aspect of the market buoyancy and in terms of the earnings, we have not seen such strength in currency for the past many years. This time around, despite the rise in number of Covid cases, the rupee has been pretty stable. This along with the government’s reforms and the kind of developments we are seeing on the geopolitical side, will lead to a pretty decent couple of years from here onwards. I am more optimistic on earnings outlook as of now compared to the valuations. While valuations may see some kind of correction because the yields have started going up globally, the dollar outlook was very weak earlier. Now it is not as weak as envisaged earlier. So, there could be a minor correction in terms of valuations but that will be compensated by better than expected earnings recovery in FY22-FY23 in my view.
Where do you stand on rate cycle?
So should one expect earnings and macro recovery to be solid going ahead? Our house view is that the macro recovery will take place very sharply in the second quarter of this fiscal year, not just in India but globally as well, especially in the US. So rates are going to go higher naturally. How fast these rates rise we have to observe. Obviously, the rates have moved from below 1% to around 1.7% in the US over the past few months. We feel that rates will be capped at around 1.8% in the next three months and from a 12-month perspective, we expect the US 10-year bond yields to go to around 2% levels.
We are not saying the yields will spike very sharply to around 3% odd as some of the analysts are expecting. So, a), we remain slightly bearish in terms of US yield outlook. b) Coming to India, there are many moving parts — currency, government’s borrowing targets and inflation. But net-net what we feel is that with the kind of reforms the government is announcing, the FPI appetite might go higher. There are also some talks that our G-sec might get added to the global indices. If that happens, that will be a big boom for our 10-year yield and the government securities yield.
So there are a lot of moving parts but net-net we feel that the government’s tax collection is going to be slightly better this year. We have already seen some surprise in this March 21 numbers around almost exceeding our revised budget estimates by almost Rs 20,000 crore. The tax collection is going to be a surprise and it is going to be a positive sign. Second, the GST collection has shown good buoyancy so far, We are also expecting the tax compliance to go higher. So, I feel there are some surprises on the way. However, we should not neglect inflation. The commodity prices have started moving up sharply. We are also seeing some of the cement companies talking about price hikes again.
Steel companies, iron ore prices are at 10-year highs. So, inflation is going to be a key challenge but if you look at RBI’s comments in H1, they are expecting 6-6.25% inflation in the first half which is reasonable. We think that yields will remain in a range-bound fashion in India and with slightly downward bias. If our investment case plays out, then the recovery will be much faster than what the market is anticipating.
So 6- 6.25% is the range that we are looking at in the near term. Plus the currency is stable. We hope not to see any major outflows on the FPI front in the debt market.
What is the complexion of your portfolio looking like right now?
We have been slightly more optimistic in terms of recovery. We have higher exposure to the cyclical sector. We have been buyers of banks, private banks but over the past couple of months, we have trimmed down our exposure to private banks. We are buying more metals as we feel that the steel cycle is turning in India. The outlook for other commodities such as aluminium are also improving.
We feel that some of the metal stocks despite this recent rally are attractive in terms of valuations and growth outlook. We are adding more cyclicals in our portfolios. We have trimmed our exposure to banks in the very near term. We are saying that one should look at the IT sector. We have been underweight on IT and we have recently added weights in IT over the past six to seven weeks ago. So we have a mix of cyclicals and defensives with a higher tilt towards cyclical from a longer term perspective.
The other aspect of our portfolio is that we expect the recovery to be broad-based. The value versus growth argument is going around the world and in India too we might see a broad-based recovery. Hence we have been adding some of the midcaps which are into structural themes such as businesses which are in contract hiring. There is a lot of headroom for these companies to do well over the next three to five years.
So, we are adding cyclicals, we are overweight on midcaps and we also think that the recovery will be broad-based. We are underweight on some of the very highly valued consumption oriented companies.
