'Trading rally possible but storm still raging'

“The funding environment is going to get a lot more selective as we go ahead and so unless you are on a path to profitability and are making money, valuations will see a compression across the board and the richer you are on valuations, the harder it is going to be,” says Ashwini Agarwal, Co-founder & Portfolio Manager, Ashmore Investment.

Last two trading sessions were somewhat of a respite in the backdrop of what happened on Monday not just in the Indian market but across the globe. But all of it rests on tonight when the outcome of the FOMC meeting is announced. Do you think markets have priced in a 75 bps cut or hike?

The expected 75 bps Fed rate hike has been very widely spoken about and it is significantly in the price. The question in my mind is not what happens tonight. One might see a relief rally on Thursday or something along those lines. That is a very short term trend. What happens as an aftermath of the rate hike and whether this is the end are two questions which are worrying my mind because inflation is trending much higher than what we had anticipated.

The energy prices are not showing any signs of cooling off and in this kind of a narrative where fiscal incentives have been withdrawn and higher rates coming through, there is a significant slowdown up ahead. Compounded with this is the fact that investors across the world have lost a reasonable amount of money both in the markets as well as in crypto currencies and the negative wealth effect of that is still not fully understood or priced in. We might get a trading rally because of ‘sell the rumour buy the news’ but on a global market basis, we are not out of the storm yet.

We can endlessly argue how this is wrong and what should one do. The list of negatives is a long one. My question is what is the good news here?

The good news is that India is in a reasonably good space when one looks at the rest of the world and I say this because our macro imbalances are limited, leverage in households, leverage in consumers is relatively small. The lending infrastructure is in great health, the PLI schemes launched by the government of India do seem to be taking some effect if you look at the order books of various engineering companies.

Look at the investment plans that are being announced every day. Investment is going on in full swing. It is possible that after a 7% odd growth in real terms in fiscal FY23 most of which is going to be front loaded, we might see slower growth continue through in FY24, which is 5% or 5.5% or along those lines. It would still be a reasonable growth in context with the rest of the world, which is in a pretty bad shape.

What excites me is that we have gone through almost six or seven years in doldrums. We have had demonetisation, GST, the financial crisis and then Covid pandemic. Now, the deck seems to be clear for a reasonable pickup in growth. The headwind now is from the global markets and not from local issues. So, to that extent, we will lose some growth because as the external sector is weak, one will lose some growth on account of that but even then, for long-term investors, current storm is a great time to be doing long-term investing.

One has to find ideas and keep adding to them gradually as we go long. We do not know when markets will bottom, how deep they will go but the fundamentals of the Indian economy, relative to the rest of the world are in very good shape and that is the positive news.

How are you picking your spots?

Financials continue to be an area of great interest to us. Some of the stocks have done well, others have not done well but the financial system is in great health. Loan growth is picking up. If you look at the RBI data ended May 20, loan growth for the banking system is about 12%. Some of it is driven by inflation but the fact is that a rising rate environment in the short run for banks that do not have a lot of long dated government bonds are positive on spreads. We are seeing loan books grow as well. So there is both volume and price growth coming through. Credit cost continues to be under control and so the earnings narrative for financials remains quite strong.

Automobiles is another area that looks interesting to us. Again for the last five years, there was hardly any growth. It is negative in two-wheelers. It is flat to down in cars and trucks. Going back to my comment, investments in the economy are going to take place and some of the replacement demand that were deferred due to Covid is going to come back. Some of it will get deferred because inflation will start to bite the middle income household.

But still we should start to see growth in both volumes and the cost pressures should start to go away. We are also looking at investors selectively trying to figure out how to play the capex cycle. I was a little circumspect about this three-four months ago but now as more data is emerging, I am gaining more confidence in that theme and that is another area we are looking at. You will note that most of the sectors I am pointing out are India specific. I am looking less for businesses outside India or outward facing businesses, I am more looking at businesses which are inward facing, local economy oriented.

If you are looking at more India focussed businesses where would that leave the IT pack which has been an outperformer? We have seen a big correction as well and many think that maybe there is a decent entry point in at least the top tier companies?

IT is in a situation where growth outlook has been very robust but valuations have been very extended.Till very recently, one was not getting worried about growth but with the kind of storm that seems to be coming on the horizon in the United States, my view is give it some time and the growth outlook may start to look a little more difficult. Counter balancing the revenue aspect will lower pressure for costs as demand for talent also will abate a little bit, especially as the startup ecosystem gets starved of liquidity and the fact that the weaker rupee might provide some tailwind.

I still am not very sure how much earnings downgrades we will see. Earnings downgrades may not be there or maybe marginal but given how well the sector has done, how well owned it is and where the valuations are with respect to historical averages, I would tend to not be very excited about stocks in this area especially the midcap names and the smaller companies which I find very expensive. Largecaps still look okay, relatively speaking, but making money on them is going to be difficult.

You are overweight on financials but do not like small banks. What is the rationale behind that? Are you overweight on private sector lenders where it all seems to be about these days?Or are you preferring public sector banks where has remained an outperformer?

We like all the frontline names, some in the public sector and some in the private sector. Unfortunately, we cannot take names but the argument of big versus small is simply that the smaller banks will find it harder to compete on the liabilities front.

Having said that, I am not sure I had said that we are very against small banks. I do not think that is true. We do have one or two names which are in the smaller cap space which we like and which offer incredible value. Structurally of course, they have a disadvantage compared to the larger banks but if valuations are favourable, then why not?

A rising tide lifts all boats and therefore smaller banks that have a healthy balance sheet, are well provided and are available to you at a bargain price should be looked at is my view. Longer term, the smaller banks have a challenge, the NBFCs have a challenge because the business is getting consolidated. The cost of funding etc are challenges but I would not say that we are against all the small banks.

What do you recommend for a ‘sell’ or a complete avoid?

The metal space is one which we have historically stayed away from and to my mind destruction of demand globally and large capex plans going through can make the going a little bit difficult for them. They are deep cyclicals and we are going into a cyclical downturn as an economy but we have ignored them on the way up and we are ignoring them on the way down.

It is not a very exciting ‘sell’ for us. We did not own them and so how do we sell them? So that is one place that we have tended to keep out of. I am also concerned about very high valuation companies which are still expensive relative to the rest of the market despite the route that we have seen in the stock prices over the last six months.

We are value investors, we find it hard to pay 50-70x, 100x on earnings notwithstanding the growth. That is one area I will continue to stay away from. I also think that the funding environment is going to get a lot more selective as we go ahead and so unless you are on a path to profitability and are making money, valuations will see a compression across the board and the richer you are on valuations, the harder it is going to be. That is the broad outlook that I have on areas where we are not very gung-ho about.

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