The economic growth momentum is definitely looking bright over the next 12 to 24 months at least and beyond that as well. That calls for some change in sector and stock allocations. What has worked in the last five or 10 years may not work in the next three years to five years because the growth outlook today is much better, says Mahesh Nandurkar, MD, Jefferies.

Just looking at India’s outperformance year to date or for that matter the last three months, the PE multiples are skirting close to highs. Is that any reason to worry or do you ride the wave now that the momentum is backing us?
It has been a positive surprise for us as well that India has ended up outperforming despite the Second Wave and the economic impact. But the economic recovery post unlocking is clearly surprising on the positive side. We track a whole host of indicators and many of these are daily and weekly data points which are pretty high frequency in nature and are actually showing that the pace of recovery post the second wave is a tad faster than what we saw after the first wave

This is a big surprise because the first wave economic impact was deeper. It was a national lockdown. This time, the economic impact was shallower with local lockdowns by different states. The momentum is back and we expect to see reasonable momentum in the near term. But if we take a 6-12 months’ view, a lot depends on the global factors and that makes me a bit cautious from a 12-month perspective.

There has been a lot of churn as the market continues to try and find opportunity within every pocket. Going forward, what is going to be the area to bet on? What outside of IT is going to be an interesting outperformer going forward?
I believe that the economic trajectory has bottomed out globally as well as in India and the economic growth momentum is definitely looking quite bright over the next 12 to 24 months at least and hopefully beyond that as well. That calls for some change in sector and stock allocations. What has worked in the last five or 10 years may not work in the next three years to five years because the growth outlook today is much better.

In the Indian context, we are sitting at the bottom of the cyclical economic trends and I believe that some of the expensive defensive names that have done pretty well in the last five years, run the risk of underperformance going forward. Some of the cyclical names — on the property side and some of the industrial names — would be outperforming going forward.

Since you are tracking global indicators, are you seeing any danger of a topping out? Some of the technical indicators are pointing towards that even though the sentiment is far from selling. What should this mean in terms of impact in India which has been driven by a lot of domestic investors in the last couple of months?
Globally, the one variable to watch out for is what is happening to the rate outlook and many other things. But if you ask me what is the one indicator that we should be looking out for, we should be focussing on the US five-year inflation expectations. Those have been going up over the last three to six months. My sense is irrespective of whether the US inflation returns or not, we as equity investors need to be worried about whether there will be an inflation scare. The five-year inflation expectation would be a good indicator of how close or how far we are from that inflation scare.

So, the global risk that we are running is there could be an inflation scare which will cause the global markets to sell off and the emerging markets and India will not be spared. That is the one risk that we need to keep in mind from a global perspective. From the Indian perspective, the 10-year bond yields, the risk rerates have been held down and managed quite well by the RBI but if you look at some of the other non-benchmark yields like the 15-year bond, it is now more liquid than the 10-year yield. The true indicator of what the yields are is the 15-year in my view and not the 10-year.

It is quite obvious that as the economic growth recovers in India, RBI will be going a bit slow on liquidity infusion. Currently there is a lot of excess liquidity which will probably begin to come down, the yields will begin to go up and the risk free rate will start going up. Theoretically there should be some market derating. That is what I meant when I said look at the market from a 6-12 months’ point of view. I see the risk free rates in India going up by 50 to 75 bps and that will cause the market to de-rate in terms of PE multiples. Thankfully we are in the middle of pretty strong earnings growth and so the market PE multiples going down can be offset to a large extent by the earnings growth that we are witnessing. But from a 12-month perspective, one should not be budgeting for more than single digit returns.

What is the dictating factor — is it growth visibility or is it valuation?
I would say both but clearly the global as well as the Indian strategy that we clearly like is that of value. We have a value bias in the selection of stocks and sectors and we are looking at segments where we have seen big underperformance because of the earnings growth related or other economic reasons.

From the near-term perspective, the housing market recovery is something that we continue to be very bullish on. We have been talking about it for the last three-four quarters now. The housing market recovery was shaping up quite nicely before the Second Wave hit us and now once again the trends are picking up. The June property registration data for Mumbai, for Delhi and for Maharashtra show that the housing market recovery which was visible before the second wave is now beginning to be visible once again.

That is one segment of the economy which we are very bullish about and obviously there are multiple ways to play that through the stock market. One way is through the property developers but then there are the other related themes like cement, building material, housing finance companies etc.

Do you think a large part of the prognosis of the housing market recovery is based on the assumption that interest rates will continue to remain low?
Not exactly. Interest rates have come down and in the last five-six years, the mortgage rates have come down from 11% to close to 7%. A 25-50 or even 100 bps jump in the interest rates or mortgage rates is not really going to have much of an impact on the housing market recovery. So, that is a key factor.

The key factor according to me is going to be how the demand supply and the pricing situations unfold because ultimately it is one of the single biggest investments that anybody makes in his or her lifetime and everybody wants to time the market. The biggest driver for property demand in my view is the price momentum. There is a lot of pent-up demand and a lot of people who have been postponing the purchases for a long period of time would jump in. Interest rates going up by 50-100 bps would not really have much of a negative impact. The pricing momentum will be key.

The other theme which is playing out in the market right now is this renewed focus on PSUs and especially PSU banks led by . After its results came out, it almost turned out to be a rerating moment for the entire PSB pack. What is your view on the state-owned companies?
Value as a theme is working quite nicely globally and also in India. The best manifestation of value in India is in the state-owned enterprises — be it banks, utilities or some other segments.

Many of the global investors have stayed away from that space for a long period of time because of ESG concerns. Some of those concerns are slowly getting addressed and the fact that the government has stepped away from the ETF based disinvestment, which was a big overhang for many of these PSUs, has definitely helped. The value theme has helped as well. I believe that some of these state owned names will continue to do quite well, some of the large banks will do well. We also quite like the utility space which not only offers a high dividend yield but also quite low PE multiples. Some of the company level strategic changes are helping to improve the ESG ratings as well. So some of the PSU names definitely look pretty interesting.

What about opportunity within the broader market and how can investors capitalise on this momentum?
I have mentioned a few sub-sectors already – housing and related. Apart from that, we continue to like commodities as a theme. We believe that the valuation in the steel segment is still very attractive and while the stocks have had a run, the valuations continue to be supportive and the support is coming from the Chinese supply side dynamics as well. So that is one space that we definitely like along with the large financials.

I am going to stick largely to the large private sector banks within the financials because I want to guard against being over optimistic because some of the asset quality concerns or provisioning related issues might still crop in the June and September quarter results. I want to guard against that. Insurance as a segment is looking quite good as well. There are various options and lots of good sectors but one needs to be selective from the next six months to twelve months perspective because I do worry that some of the global risks that we just discussed and the risk of rising yields in India will probably cap the broader market returns over the next 12 months.

Are you trimming earnings expectations for FY22 owing to the kind of restrictions seen during the Second Wave?
The earnings growth in FY22 should be pretty strong. We have a low base helping us. For the broader market, we are looking at a 30% plus earnings growth for FY22 but that is already factored in. I do not think that 30% plus earnings growth for the current year is going to be any source of big excitement because the market is already factoring that in. What the market performance will be dependent upon is how the estimates change for FY23.

For FY23, we are looking at the broader earnings growth to be in the range of 15-18% and so it is still quite good. There could be some small revisions on the downside after the June quarter results but the extent of those potential earnings revision on the downside could be lower because as I mentioned earlier, the economic recovery and the economic data points that we are tracking post the second wave are surprising on the positive side. So the pace of recovery is looking pretty good. Now the pace of vaccinations has also picked up. So yes about 30% plus for this year and 15% plus for next year is what we are looking at.

What is the outlook for global facing companies like IT and pharma? Would you continue to find more comfort from the large caps vis-à-vis some of the midcaps?
Yes. IT as a sector continues to be interesting especially when we are looking at the US GDP growth in CY21 and CY22 cumulatively. It is going to be almost 12% cumulative GDP growth for the US economy. I do not remember when we last saw this type of growth. So it is clearly optimistic for the IT companies from the demand perspective. But having said that, one key thing that we need to keep in mind is that over the last 12 months a lot of IT companies have benefitted on the margin side because while the revenues were coming in because of the lack of travel, a lot of costs were under control.

But as the global economy opens up and we get back to the normalisation of travel, business, etc, in due course of time the costs are going to catch up as well. While the revenue outlook remains pretty good, there could be some disappointments or revisions on the downside as far as the margins are concerned. We have to keep that in mind but we still like IT space selectively.

You have got picks across segments and preferred performers and some of the heavyweights across segments. Is it really a holistic portfolio that you are looking at?
Yes that is right. There are several opportunities. Some of the sectors we are cautious about include consumer staples. It is expensive and the growth trajectory here will be much more limited compared to the other sectors. Consumer discretionary is the other segment where we will see some subdued trends. Telecom is the third segment. So these are the two-three segments where we are a bit cautious but broadly across several sectors we would definitely look to pick stocks which offer value.

What is your advice for people who want to get rich?
I am not into advising retail investors but one simple advice from my side would be that investing is a pretty serious business and requires certain skills. I believe it should be left to those who know it best, basically the investment managers. I know many people like to buy individual stocks and while some of those can give great returns, my sense is that for an individual with a day job, may not be able to keep up with the latest developments so to speak. I would say that mutual funds or professional advice would still be the best way to go. Take the long-term approach and look at investments at least from a 12-24 month perspective and longer than that if possible.


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