In conversation with Alok Agarwal, Senior Fund Manager - Equity, PGIM India Mutual Fund

Corporate earnings growth is coming back and economic recovery is on track.

Q) What is your outlook on the overall Indian equity market for 2022?   

The Indian economy has shown strong resilience from the jolt of the second wave of covid. A large part of market returns in the last 21 months was likely due to unprecedented liquidity and record low rates. In 2022, we are likely to see market returns be more driven by earnings than valuation expansion. We are positive about the market in general but sceptical about rich valuations in select pockets. 

On the positive side, corporate earnings growth is coming back and economic recovery is on track. On the negative side, the key driver of the markets in recent times – lower rates and high liquidity – seem to be changing course. The multi-decade high inflation in most countries coupled with all-time low rates is forcing central bankers to review their easy-money policies. Withdrawal/reduction of such liquidity may not be supportive of a further increase in valuations. 

Nifty is now trading at one year forward P/E of 21.4x - which converts into an earnings yield of 4.67 per cent, which in turn continues to be higher than 1-year G-sec yield of 4.32 per cent. Hence, while equity is trading at above-average valuations, the relative valuation is still not stretched. Given, the strong rally in the last couple of years and potential for raising rates sometime this year, we expect returns to come primarily from earnings growth with little room for valuation expansion. 

After a prolonged lull (4 per cent CAGR FY12-19), Nifty EPS is forecast (as per Bloomberg Consensus) to grow 15 per cent annually FY19-24 (FY22-24 at 17 per cent). The market began pricing in strong medium-term prospects for the Indian economy a bit early, and despite the recent pullback, Nifty P/E is 1.5 SD above its 10-year average with the equity risk premium still near historic lows. While P/E multiples are elevated for equities globally, India’s P/E premium is high too, capping relative performance. Nifty was up 24 per cent in 2021, outperforming the Emerging Markets Index which was down 4 per cent. 

Electorates in India’s largest state of Uttar Pradesh and four other states will elect new assemblies in 1Q 2022. The outcome of these state elections could be a pointer towards public perception on economic matters. 

Q) Which are the sectors that will generate alpha this year?  

 We prefer sectors with visible earnings growth – Industrials, HealthCare, Large Banks, Materials. 

Macro set-up is favourable for the capex cycle to pick up. Real lending rates are at decadal lows. Effective corporate tax rate has come down to 25.17 per cent from 34.95 per cent earlier - there is evidence of corporate tax multiplier to be greater than one and boosting both private capex and FDI flows. Corporate deleveraging - Debt-to-Asset ratio for Sensex companies is at its lowest since FY04-05 and the interest coverage ratio of private listed firms is at the highest levels since 2010. Corporate profitability has shown a strong rebound post-pandemic and the Corporate Earnings to GDP ratio has started upwards after falling for 9 years. The free cash flow-to-capex ratio of listed firms is at multi-year highs - this could reduce risk aversion and push private investment. Economic policy uncertainty has fallen to post-GFC lows and is shown to have strong statistical linkages with investment. Improved bank balance sheets could provide a supportive credit environment. The Bank Credit Growth in December 21 came in at 9.2 per cent YoY – highest since September 19. 

With rising awareness after the Covid, the per-capita spending on Healthcare is likely to go up, plus India is a major supplier of lot of medicines across the value chain 

Q) What is your take on inflation and interest rate going ahead?  

Despite years of easy money, it was surprising to see almost no impact on inflation in developed countries. However, in the last few months, inflation has picked up pace – due to the confluence of easy money, sharp economic recovery and supply chain bottlenecks. 

As long as inflation was in check, it was easy for central bankers to continue with easy money and low rates policy. However, now inflation is reaching multi-decade highs. US CPI Inflation is highest in 39 years, Germany Producer Price Inflation is highest in 70 years, China WPI inflation is close to a 13-year high, India WPI inflation has been in double digits for 9 straight months for the first time in 29 years. It is difficult to dismiss such multi decade-high inflation across the world as transitory anymore. Higher inflation also has political implications. Hence, central bankers have started indicating that they would go in for tapering of bond-buying and also hike rates in 2022. 

US 10 year yields are already at 2-year highs and the same is the case with India 10 year yields. Hence, markets too seem to be expecting rate hikes this year. What remains to be seen is when does this rising inflation come back within comfort zones. India’s RBI has been projecting CPI inflation to be within their comfort zone for the next few quarters. 

Q) How has the PGIM Hybrid Equity Fund performed? Is it a good bet for investors in the current market scenario? 

PGIM India Hybrid Equity Fund invests 65-70 per cent in domestic equity, 10-15 per cent in global stocks (via PGIM Global Opportunities Fund) and remaining in Fixed Income. The current market scenario is quite different from the rally we saw in last 2 years. Earnings growth is coming back but the easy flow of liquidity looks challenged. In such a scenario, an investor would be better off with some protection in the portfolio. Hence, the hybrid class of products (including PGIM India Hybrid Equity Fund) offer a reasonable combination of equity participation and protection through fixed income. 

Q) Do you see the broader market continuing with its momentum for this year also and what is your take on their valuation?   

The rally in the last 22 months has been broad-based with small and mid caps handsomely outperforming their larger peers. Historically, we have seen that such periods of outperformance and underperformance are cyclical in nature. Given the current market conditions, the risk-reward is increasingly shifting in favour of larger caps. However, given the large basket size, there are always opportunities in select areas in the broader markets, which cannot be ignored. Additionally, certain promising sectors are present only in the broader market. 

Valuations are stretched in select pockets, but some segments offer a reasonable growth-valuation mix. 

Nifty Midcap 100 Index is trading at 23.1x one-yr fwd PE, which is 10 per cent premium to Nifty, compared to the historical average of 5 per cent discount. 

Nifty Small Cap 100 Index is trading at 20.6x one-yr fwd PE, which is 2 per cent discount to Nifty, compared to the historical average of 20 per cent discount. 

Given the current market status of higher than average valuations (as a result of the sharp rally since Covid lows) coupled with likely rising rates and falling liquidity, one should have relatively lower returns expectations compared to what we have seen in recent times. 

Q) What is your view on new Fintechs companies that are being listed now? Do they make good investments now? Can they create wealth for their investors?  

Indian start-ups have been on a fundraising roll, driven by venture capitalists. 

India saw the birth of 42 unicorns in 2021, compared to a total of 30 till end-2020. It brings India’s total unicorn count to 72, the third most after the United States and China. 

Indian companies have raised a record US$ 15 billion via IPOs this year. Earlier, firms needed to show several years of profits before listing. But, with some changes in rules, Indian start-ups found their way into the listed universe. 

The juggernaut was working fine until a couple of recent large IPOs failed – one had a poor run after listing, the other was not fully subscribed. 

As we enter 2022, we have the risk of rate hikes and valuations. However, the Indian market has deepened for all start-ups and the outlook is bright for the longer term. India’s tech and finance start-up scene grew rapidly over the past decade. 2021 became a breakout fundraising year, due to China’s corporate regulatory curbs that are prompting some investors to pivot to different geographies. 

China is still well ahead in venture capital funding. But for the first time, India surpassed China in venture capital funding growth during the first three quarters of the 2021 calendar year. Venture capital investors invested US$ 20 billion into Indian companies during the first nine months of 2021, up 150 per cent from the same period in the previous year. This compares with 100 per cent growth in China where capital investments increased to US$ 67 billion. 

Fintech companies in India are predominantly focused on the “payments side” of the business. India is a unique market because of the government-backed UPI payments infrastructure which does not attract any charges. Hence payments are more of a customer acquisition tool for Fintech players in India and not earnings accretive. Many fintech players have to slowly transform their business models towards different segments for monetization. Lending and collections require years of experience and is not easy skill to master. The regulations for Fintech players are still evolving and remains a key unknown and risk factor.