2 sectors to bet on for an inflation-proof portfolio

“IT and the banking sector have one thing in common. Both of them got hammered by FII selling and it is a good time to look at them,” says Gautam Trivedi, Co-founder & Managing Partner, Napean Capital






Markets have not done well and markets eventually will do well. How should one prepare for the next run? What are your observations globally and in India and how should one prepare their portfolio strategy going ahead?

I wanted to see what would be the impact of the rate hike by the Federal Reserve. The next question is by how much will the RBI increase rates because the Fed move will clearly have an impact on the currency and the Indian rupee is already down over 7% year to date.

We cannot afford the Indian rupee to keep depreciating because it ends up importing inflation. I do not feel that the FII selling which we saw over the past nine months had been extremely aggressive and will continue to be as aggressive unless the US goes into a very serious recession. The probability of that right now seems 30-40% versus it being high. Also this talk of a shallow recession will be actually a very positive event for India if that is going to happen. Right now, it is still a cautious wait and watch. Let us see what the RBI does to help the rupee consolidate at these levels because if it falls much further, then we have got a real problem in this country with respect to inflation.

Smart Talk

Are you expecting banking, financials to be the biggest pack for relief because they are the ones that really faced the brunt of the FII selloff?

Yes, IT and banks took the most hit because they were the most liquid largecaps and we have not seen that much selling coming in the other sectors. But having said that, given the quantum of fall that has happened in both these sectors, we are very bullish on financials and we are starting to find value in IT as well. One should very much stick to these two sectors.

For IT in particular, the valuations have corrected 20-30%. So if

or

is now trading at roughly about 23.5 to 24 times FY24 PE, I think it is a good enough correction that has already happened. The commentary from these companies and especially on result season so far has been that the top client will not be impacted.

« Back to recommendation stories

I don’t want to see these stories because

SUBMIT

If that is indeed the case going forward, and I assume that they have a pretty good handle on what the customers are going to be up to between now and the next 12 months, that is an area we should be adding to the IT sector. As far as the banking sector is concerned, a lot of the bad news is now over and behind us. We have had literally five years of NPL cleanups. The banks have been much stronger. It is not just the

number which was fantastic, all of the four major private sector banks have also surprised on the upside. Even a

for that matter did pretty well.

So the good news is that the banking sector is looking a lot better than what it was five years ago. Having said that, the one area of concern in the banking sector is that bulk of the demand for credit is still coming from retail. That has to change and at some point, we hope to see private sector capex coming back into the economy. As a result, growth in industrial credit should follow.

If you have got , and and then you have got the , , PolicyBazaar which one will make more money? Earlier, you had said the new age companies. Are you sticking to that?

I was hoping you had forgotten that but it looks like you have a pretty good memory. But having said that, what has indeed happened is the disconnect between the VC and private equity world and the public market world where the tolerance for losses is just not there.

The question now the people will ask is if you have got A company which has been, forget about EBITDA being EBITDA positive but net profit positive for the last 30 years and you have got a new age tech company which refuses to meet investors and refuses to give any visibility as to when they will turn positive and then says that we are now more like a private equity fund and we will be using the proceeds of our IPO to make investments in other tech companies, you will end up un-nerving any public market investor.

That is the reality check, not to mention the fact that in the past three months or so, we have seen huge down ground starting to happen in the new tech space. We also run a private equity fund and I see a lot of that starting to happen where we had a certain number in the month of January in terms of valuation for some of these companies and now these are 30-50% lower than what they were back in January.

For the first time ever, McDonald’s globally has increased the prices of the cheese burger by 20%. Inflation is a reality not just in the US but here in India as well. At a time like this, what is your anticipation of what the RBI is going to do next?

As I said earlier in the interview, I do not think the RBI has a choice. They have spent $50-60 billion trying to defend the rupee. It is not working and we are at 80 and below. My view is that the RBI will have to hike rates; whether it is 35 or 45 bps is a question which is more academic but it has to do with whatever it can do to save the rupee from falling further. Anybody out there who thinks that a weaker rupee is positive for exports is completely wrong because there are multiple other factors which help exports and not just the depreciation of currency.

So I still think that the RBI will have to take a tough call maybe this week or early next week. They were meeting on August 6 but they might have to pre-empt that and take a quick call. Otherwise, inflation will come to haunt us pretty soon. There has been a relief in commodity prices globally.

Let us understand the very cause of that and the cause is the fear of a recession in the United States and Western Europe. That is really what has caused it and if the recession does not happen, it is not a steep or maybe a shallow recession. Some of those commodity prices could indeed be back so let us be practical about where this commodity cycle is today.

How do you inflation-proof your portfolio? What sectors do you need to have a larger exposure to as opposed to lesser in the others to mitigate the inflation impact?

There are companies in India that have mostly overseas businesses. Some of that could be interesting like IT. That sector has had a great correction and now is the good time to start looking at them. The hiring for the IT sector for FY23 seems to be very much on track, based on the commentary that I have heard so far from the IT companies. So, I think that is one. I would have said pharma but the whole sector has been dead for the past about 24 to 36 months. I remain very bullish on the banking space and would stick to IT and banking for the time being.

IT and banking two different sectors they usually have a negative correlation. If IT does well, banks do not do well in terms of floor or otherwise. Why do you like IT considering the stocks are reacting on the downside after numbers? Also banking has been a consensus buy call for the last one and a half-two years?

Banking to start with is clearly number one in the last five years. We have seen a huge correction in the NPL cycle. That has cleaned up the banking system for the most part. Of course, there might be a couple of more Nirav Modis lurking in the shadows which we have not heard about and they may come back to haunt us leaving that aside for a minute. The balance sheets have been significantly cleaned up.

The retail credit growth is still significant and that has not changed. I was on a call with one of India’s largest loan originators last week. In FY22, they did loan originations of about Rs 38,000 crore; their target for FY23 is Rs 60,000 crore. It is a significant jump, more than 50% from the previous year.

I asked them the question with respect to rising interest rates and how that is impacting their business. They said almost two-thirds of their origination business is home loans and they said that while home loan rates have gone up a 100 bps from 6.5 to 7.5%, they do not see interest rates impacting demand until it gets to 7.5-8.5%. It is not demand destruction but it will slow down some of the demand. Even now we are still at pre-Covid levels in a lot of these verticals in terms of interest rates, I do not think that such a bad thing if the RBI were to hike rates by another 35 bps.

I am not so sure about what you said about the negative correlation between IT and banking sector. I think IT has been punished a fair bit and frankly valuations are very much attractive at 23 to 24 times FY24 PE. That is the reason I like both these sectors.

You think valuations for a lot of sectors whether in midcap, large cap space in a lot of sectors and companies have become quite attractive because the earnings cut in some of these largecap IT, large cap banking names have not been largely to the tune of price fall?

Yes, they have become attractive. Where would you see a convergence or would you even think there would be a convergence in valuations between an

and an

? So that has been great.

is very well valued by the way we own all of these three banks and so from a disclosure standpoint, that is something to keep in mind from a IT sector perspective.

A lot of these stocks are now pretty much in the ballpark of where they were about four years ago in terms of valuations. Some of the valuations had gotten stretched to about 28 times-29 times one-year forward but we have seen a correction in them. So, IT and the banking sector have one thing in common. Both of them got hammered by FII selling and it is a good time to look at them.

Harry Byrne

Related post