In an interaction with Niraj Kumar, Chief Investment Officer, Future Generali India Life Insurance Company Ltd

We remain constructive on the markets and believe that India’s outperformance is likely to continue, asserts Niraj Kumar, Chief Investment Officer, Future Generali India Life Insurance Company Ltd

What is your outlook on equity markets in the short to medium term? Do you expect markets to consolidate from here onwards? 

Global equity markets have staged a strong rebound over the past month or so with most of the markets delivering high single-digit or early double-digit returns. The rebound was triggered by a weaker-than-anticipated US Inflation print for October 2022 and the consequent expectation of slower rate hikes in the US henceforth, further aided by deeply oversold readings on various technical parameters. However, on a trailing 12-month basis, almost all the markets except for India and Brazil have delivered negative returns. Indian markets' strong performance over the past 12 months was aided by strong earnings growth, strong domestic liquidity and extremely sharp management of the economy by both the Government and RBI. 

The structural outlook of the Indian economy remains sanguine, which in turn bodes well for the equity market returns going forward. Even though the forward valuations have corrected as earnings have caught up over the last one year, while markets have stayed range bound, we believe that valuations are not cheap and hence don’t expect any multiple expansion. Thus, going forward, returns will therefore be a function of earnings growth which we expect will be in the early double digits. We remain constructive on the markets and believe that India’s outperformance is likely to continue.  

How has the Q2FY23 earnings season fared, will margin pressures persist for select sectors due to rupee depreciation? 

Overall, the Q2FY23 earnings season was good but it had wide sectoral disparity. Sectors that fared well include Financials, IT, Autos, Telecom, Hotel and Tourism while sectors that fared poorly include Cement, FMCG, Metals & Mining, Oil & Gas etc. Financials benefited from strong credit offtake, increasing margins due to the cumulative impact of pass-through of 190 bps rise in repo rates & benign credit cost. IT also saw a continuation of strong revenue growth as the sector continues to benefit from the compressed digital transformation journey of the clients. Autos benefited from strong operating leverage and the early onset of the festive season, while the hotels and hospitality sector were the prime beneficiaries of the pent-up demand and opening up of the economy. 

In terms of sectors that delivered poor earnings, the major hit was for the consumers of commodities as the high-cost inventory got consumed this quarter, which along with sharp rupee depreciation accentuated the margin worries. With a nearly 30 per cent fall in commodity prices across base metals and energy commodities, we believe we have seen the worst of the margin pressure and expect margins to rebound across sectors in ensuing quarters.   

What are the pertinent risks facing equity markets in H2FY23? 

We are living in a very fragile global economic environment. The financial markets are intertwined and hence risk could emanate from any corner of the world. Prima facie, the biggest risk that we perceive is from the lagged impact of the sharp rise in interest rates. The interest rates in the western world have gone up on an average by 200-400 bps and are yet to translate into actual higher borrowing costs, as the reprising happens gradually. 

Another source of risk for the equity markets is the declining global liquidity, as the central banks are unwinding their balance sheets. Since the onset of Covid, the US and European central banks pumped in more than USD 8 trillion in liquidity which has started getting unwound. A fall in liquidity can cause some dislocations in the financial markets. Asset allocation also remains a material risk to Equities. The spread between Bond Yield and Earnings Yield has reduced materially due to the rise in interest rates. This is making fixed income a very lucrative investment avenue. And finally, the much-talked-about imminent recession in US and Europe is another potential risk. Nonetheless, we reckon that the recession this time around is likely to be a shallow one and that India will have limited impact on the same given its long-term domestic structural drivers remaining intact.  

Which 3 investment trends would you bet on for the long term and which sectors seem attractive at current valuations? 

We like domestic economy-oriented investment themes. Although we are likely to see some moderation in growth in 2023, we believe that we are likely to see strong GDP growth over the next 5-7 years as significant reform measures like Insolvency and Bankruptcy Code (IBC), GST, Digitization (JAM trinity) start bearing fruit and drive significant efficiencies in the economy. Based on this view, we like the Banking and Financial sector (BFSI) which is going to finance strong economic growth. The banking sector balance sheet across both private and public sector entities is in its best health in over a decade. 

Credit growth has picked up to high teens, stressed assets are falling, Provision coverage is very high and Net Interest Margins are rising which provides visibility of strong earnings growth and rising return ratios. The other sector that we like is Infrastructure. There is a very strong pick up in Government CAPEX rising 50 per cent YoY in H1FY23. We see a strong continuation of CAPEX trends as we head into the general elections in 2024. Sectors such as Roads, Railways, Telecom etc. are showing strong growth trends. More importantly, both BFSI and Infrastructure are offering stocks that exhibit Growth at reasonable price (GARP) characteristics which are also our investment philosophy. 

Apart from this, we are extremely constructive on discretionary consumption. As the per capita incomes grow beyond USD 2000, discretionary consumption can grow at exponential growth. However, valuations in this pocket are a bit stretched and hence investors with only a long-term horizon will benefit from this theme.