Geopolitical and macroeconomic uncertainty will keep the equity market volatile over the coming months, says Nitin Sharma, Director Research & India Site Head, Fidelity International (FIL). In an interview with Ashley Coutinho, he says despite the recent correction, India is trading at a sizeable premium to most emerging market peers. Edited excerpts:
The market has seen a fair bit of volatility of late. What is your equity outlook for the coming months?
A combination of geopolitical and monetary factors, combined with the uncertainty around the post-pandemic recovery path, will keep equity markets volatile over the coming months. The primary tide will be the shape and speed of the coming quantitative tightening. Rising inflation in just about all major economies would likely lead to more decisive action by global central banks. The Russia-Ukraine conflict, particularly if it lasts, could further strengthen inflationary trends in the near term through likely supply disruptions. Higher input costs will impact corporate margins in multiple sectors. And lastly, there’s a sense in the markets that Covid-19 has turned into an endemic. However, any novel variant and the potential new restrictions could impact financial markets adversely.
On valuation, despite the recent correction, India is trading at about 23x CY2022 earnings, which is at a sizeable premium to most emerging market peers trading at 7-18x earnings. India is also trading at about 15 per cent premium to its own five year average. While we do have the support of likely better earnings growth in 2023, the high valuations do make the markets vulnerable.
How much of a pain point will the surge in crude oil prices be for India? Will it upset the GDP growth projections for the country?
Every $ 10 increase in crude prices lowers India’s GDP growth by around 20 basis points and increases domestic inflation by 30 basis points. Assuming the rise is passed entirely to consumers, a sustained increase in crude prices will end up impacting consumption demand and pulling down the GDP growth rate. It may be noted that overall consumption is still weak in India versus the pre-Covid-19 levels, particularly in the rural areas. Higher crude also will mean a downward pressure on the rupee given the adverse impact on current account balance and inflation. This could potentially bring forward the rate hikes by RBI or increase the quantum of the raise.
FPIs have been on a selling spree since October last year. Do you expect the trend to accelerate going forward?
FPIs have taken out almost $ 15 billion since the start of the year. The selling has largely been led by active funds. This implies FIIs lowering their weight on India potentially off higher valuations and concerns around sustaining the earnings growth cycle. Outflows at the fund level have also been a reason, albeit minor. The impact of FPI selling was substantially mitigated by strong flows into domestic mutual funds and insurance.
As for the likely FPI investment trend from here, a favorable growth profile both for GDP and corporate earnings should eventually lead to a reversal of FPI selling. Beyond the immediate factors, India is seeing various structural reforms around themes such as Make in India that will create a positive backdrop for equity investments and eventually attract foreign flows again.
What is your view on mid- and small-cap stocks?
The Nifty midcap index is trading about 14 per cent premium to Nifty versus a 10-year premium of just about 3 per cent. A mean reversion will lead to relative underperformance by midcap stocks. However, rather than looking at the aggregate index, investing in small and midcap names should particularly follow a stock-specific approach. Look for names with strong pricing power through a business cycle, balance sheet discipline, tangible growth levers, and finally a decent margin of safety on valuations. India is witnessing the emergence of some fine businesses with high entry barriers and these could continue to trade at a premium for quite a while.
What are your estimates for FY23 corporate earnings growth? Will capex pick up this year?
We believe BSE100 will see 18-20 per cent net earnings growth for FY23, led by a fuller return to pre-Covid19 activity level. Some sectors such as autos will see a high growth as inputs supplies ease, while others such as retail and capital goods will see a recovery driven off post-Covid19 opening up and capital spending. However, growth will be dragged down selectively by sectors such as materials that are seeing a cyclical peaking of prices / margins.
Capital spending, too, should see a good growth this year. Apart from a cyclical recovery in multiple sectors, initiatives like higher infra spending by the government and launch of PLI schemes covering several sectors will lead to capex revival. It should be noted that while FPIs have been net sellers in India this financial year, FDI flows have remained robust and will support investments in the economy.
Which sectors are you betting on right now?
We are a bottom-up investment house and to that extent, our approach is stock-specific rather than taking a broad view on sectors. Having said that, we do believe that select sectors can deliver a positive surprise on earnings in the coming quarters. These would include banks, autos, diversified financials, real estate and utilities. On the other hand, companies in telecom, media, materials and pharma sectors could find it difficult to meet consensus expectations. Given the uncertainty on geopolitical and macroeconomic fronts, investors will need to be careful around taking a sector view.