In your opinion, what are the most important monitorables at the moment? Part of the market believes that the CPI has flipped in both the US and India and is set to fall trend-setting. But the other section believes inflation will be long-lasting and won’t be easy to get over. They say the market may have run ahead of fundamentals. What is your opinion?
Two major macro variables are important to the future of the stock market. Locally and globally, particularly in the US, investors are focused on these two variables. First, it is the timing of the inflation spike and hence the timing of the Fed rate spike or the timing of the local repo rate spike. There is a little more comfort on that front given the data over the last few weeks. The risk aversion that is taking place in the market due to these variables appears to be easing somewhat.
But the second variable is the impact of the impending slowdown and how long and intense it will be in the West, and the impact on emerging markets like India. The debate on this is ongoing and it will take around three to six months for clarity to emerge.
From a market perspective, a little more clarity emerged on the first stage. In the second leg we will continue to pose uncertainties and from that perspective, in my opinion, the chances are high that we will likely remain in a mode of consolidation.
Where do you find the most robust earnings quality and then we get to whether or not valuations are pricing that in. What is the yield curve from your observations of this past earnings season and your comment?
It was a mixed season. Certain sectors have clearly surprised and delivered gains. Banking is number one over there. Then even IT surprised positively on the margin front. On the consumption front, we have seen high-end consumption with good earnings quality. However, mass consumption still appears to be in a lull, having been so for more than a year.
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So it’s a mixed bag. Banking is looking good, high-end consumption is looking good, there are parts of the auto sector like the CV cycle, the car cycle that is looking good, and there are areas in the domestic private sector investment cycle where the Yield quality looks good. So this is one area where earnings quality is looking good. On the other hand, there is some weakness in mass consumption, as we can see from the way two-wheelers and many FMCG companies report performance. Some softness continues over there. The soft phase is also continuing for the metals, which are more strongly linked to the global cycles. So it’s a mixed bag out there.
How do you see the broader end of the markets, the small-cap and mid-cap ends of the market versus the large-caps? That particular end of the market sometimes outperforms fundamentals and becomes too compressed. How do you currently view the valuation argument in broader markets versus the benchmarks?
In the case of equities, too, the valuation foam was largely subtracted across asset classes. If you look at the type of correction that we’re seeing in the global technology space and even locally, the type of correction that we’re seeing in technology names that were quoted last year or in IT services year-to-date.
Broader markets have been euphoric and given the last year of correction, much valuation foam appears to have been drained from many mid and small cap names. I’m in camp believing that much valuation foam has been cleared after a prolonged period of correction over the past year.
How concerned are you about the global slowdown given that around 40% of Nifty’s revenue is global in nature? The fact is that Europe is melting away on the economic front, Germany in particular. How will this affect the overall revenues of a large division in India doing business with this region?
That’s a very valid concern. I mentioned that the magnitude and intensity of the impending slowdown in the west is a key factor in the macro behavior of the markets. I think Europe probably has bigger problems than what’s happening in the US. The underlying strength of the US economy looks pretty good to me.
My feeling is that India has a higher correlation with US markets in terms of economic performance and even market performance. My feeling is that the US will likely emerge from this situation much more easily, but I agree with you that Europe is likely to be the bigger problem and many manufacturing companies that have export links to Europe will have a hard time in the upcoming slowdown. It’s clear that next year one has to be very careful when picking stocks on the export front.
You must have stress tested your portfolio over the past few weeks. 12-24 months away, what comfort do you get from the returns of a mixed return portion of your portfolio after discounting a portion of it?
We continue to regularly stress test one-year and two-year results. It was a mixed bag at the end of this earnings season. The overweight positions I hold on sector calls have clearly seen some reinforcement. Clearly, some underweight bets tend to have more negative reinforcement.
While this is an ongoing exercise, it is still a bit early in terms of two years in advance. As I said the focus in terms of deceleration is over the next six to 12 months and we have done some stress testing and the current portfolio construction in terms of overweight and underweight is building some kind of slowdown which we expect and the impact on the respective stocks and the sector positioning in the funds.