Markets seem to be discounting the imminent damage to the economy and earnings of companies as a one-off and are possibly bracing for a healthy recovery in earnings in FY22, says Unmesh Kulkarni of Julius Baer India,
With the strong undercurrent of global liquidity, unlocking picking up and the strides made in the development of a COVID vaccine, a major correction is unlikely. If markets were to correct from the current level, it will be restricted to 10-15 percent, Unmesh Kulkarni, Managing Director Senior Advisor at Julius Baer India, says in an interview to Moneycontrol's Sunil Shankar Matkar. Edited excerpts:
Q: The market is at a five-month high, with broader indices also performing at the same pace. Should one raise equity exposure in a portfolio now or wait for a correction?
The question in everyone's mind is whether markets will correct after this strong rally and if so, when this correction will come about? We think that the equity markets are currently disconnected from reality. The current ground reality is that the Indian economy will witness negative GDP growth in FY21, the COVID-19 cases are still on the rise in practically all parts of the country, massive business disruptions have taken place and several companies are going to see their earnings growth getting shaved off over immediate couple of quarters.
Despite all the negatives, the markets have been moving northwards. The factors that have been driving the markets include: (a) the huge liquidity created globally by various governments and central banks, which is finding its way into risk assets, hunting for yields (b) the depreciation of the US dollar over the last few months, which generally augurs well for emerging markets; FPI flows into the Indian markets have resumed (and surged), (c) expectations of a vaccine getting invented somewhere in the world soon (d) the quarterly results coming in better than the significantly muted expectations and (e) a lot of HNI/retail money sitting on the sidelines, which seems to be getting committed as the FOMO (Fear of Missing Out) feeling catches up. Markets seem to be discounting the imminent damage to the economy and earnings of companies as a one-off, and possibly bracing for a healthy recovery in earnings in FY22.
Indian equity markets are certainly not cheap. In fact, they have turned expensive, both in terms of trailing and forward valuations. We expect some correction to happen sooner than later, once all the good news (e.g., vaccine) is priced-in. A timely correction would be healthy, as it would prevent the building of a larger bubble in equities.
For investors, increasing equity allocation at this juncture (post a 45 percent rally from the March lows) could be fraught with risk. Staying completely out of the market, on the other hand, or waiting for a correction would also mean betting against the momentum created by the strong global liquidity flow (which may continue for some time). So a prudent strategy would be to (a) stagger investments across the next six months to one year, to ride out volatility (b) use price corrections to increase allocation more aggressively (within one's asset allocation limits) and (c) extend the investment horizon, as incremental returns from the current valuation levels may take time to manifest.
Q: Which are the sectors that can generate ample wealth over the next two-three years, especially after COVID-19?
The sectors/themes that we expect to show improvement or fare relatively better include:Healthcare: The sector is seeing a secular revival after a lull over the last three-four years
Consumption-oriented: Consumption remains a structural theme for India with its attractive demographics and rising income levels
Sectors or segments where India can emerge as a global manufacturer/supplier to the world (taking some share from China): Chemicals, engineering products, auto ancillaries, textiles, etc
Digitisation: IT (with increasing digital spends by companies)
Telecom/ecommerce: It is benefiting from the work-from-home culture
Certain rural plays: tractors, agri-inputs, 2 wheelers due to good monsoon as well as the government’s thrust on the rural economy
There may also be some merit in looking at select beaten down / value / inflation plays such as utilities and select commodities, especially if the dollar continues to remain weak.
One more interesting segment could be the discretionary consumption space (especially high-ticket) which has borne the maximum brunt of the COVID pandemic; post the COVID issue, the sectoral leaders can emerge much stronger and make a strong comeback.
Q: What is your advice to new-age investors who entered the market during the lockdown?
Timing the market is becoming increasingly difficult, as markets seem to be moving in one direction, driven by the massive global liquidity. It becomes even more important that investors stay disciplined and not take any decisions in haste. Investors who are fully invested in equities and have seen their portfolio valuation surge in the last couple of months can look at rebalancing their portfolio a bit through some profit-booking. On the other hand, investors who were sitting on the sidelines and are now feeling left out, this is probably not the time to jump into the markets out of desperation. One should go about systematically building one's equity allocation, through a mix of staggered investment over time and lumpsum investment in price corrections.
New-age investors who have just about entered the markets are clearly enjoying the party but they must understand that markets are made up of both 'greed' and 'fear' elements and it is not advisable to get carried away by the stellar performance that their equity investments have staged in a matter of four months. It is best to work out a long-term strategy for their portfolio, including proper asset allocation, diversification within equities across stocks and sectors and periodic rebalancing, with an eye on the underlying fundamentals.
Q: The RBI has announced a one-time loan restructuring but with riders. Will it solve banks’ NPA problem?
The measures seem to be in the right direction, as a further extension of the moratorium could have resulted in increased uncertainties and therefore taken negatively by the markets. A one-time loan restructuring is expected to provide the much-needed respite to the genuinely stressed segments of the economy.
Greater clarity on the NPA situation will probably emerge only over the next couple of months. The markets have already built in a scenario of escalation of the slippage number as reflected in the relative underperformance of the BFSI space in the last few months.
Q: Do you think the market is due for a major correction that can pull the Nifty down to 10,000-mark or it is just consolidating around current levels to march towards 12,000 in the coming weeks?
The Nifty is certainly in the expensive zone, following the strong market rally, and given the sharp deterioration in earnings outlook. It is therefore reasonable to expect a market correction. However, given the strong under-current of global liquidity and the fact that the unlocking is progressively picking up, besides the anticipation of a vaccine being around the corner, we do not expect a major correction; it could be restricted to 10-15 percent, if markets were to correct from the current levels. However, if the markets keep rising unabated, the risk of a steeper correction also increases.
Q: The broader markets are looking strong. Do you think midcaps and smallcaps can beat benchmarks this year, especially two years of underperformance?
With the onset of COVID, there was a general flight to safety and quality amongst investors, with a preference for companies with strong balance sheets, cashflows as well as companies with a larger size, market capitalisation, considering that they could relatively better manoeuver the challenges. As a result, there was a bit of lopsided performance within the markets. In 2019 too, if one looks back, there was a polarisation in the markets as investors flocked around a handful of "quality" companies, and these companies became more and more expensive. As a result, midcaps generally lagged the Nifty index and the Nifty companies in the last couple of years.
With a lot of the bad news already known to the market, and given the strong rally in the Nifty and largecaps since March lows, the market action is now becoming more broad-based, as witnessed by some catch-up performance by the midcaps over the last couple of months, especially the ones where the performance has not been too bad as expected. Assuming that markets don't correct too much and the COVID situation doesn't go too much out of hand, we expect the catch-up by midcaps to continue over the next 6-12 months, as investors seek some value plays in the market.
Q: Pharma is the leading sector in the current rally. Will you still buy into the sector and are you bullish on the space?
We believe that pharma (and healthcare in general) is a longer-term theme in the Indian markets. The pharma sector had a strong run in the first half of this last decade (between 2011-2015), after which the sector went totally out of favour due to price erosion in the US generics market driven by increased competition and consolidation in the US distribution market, several FDA related issues faced by Indian pharma companies and high valuations (as growth expectations were running high).
We are of the view that many of these structural issues are now behind us and pharma companies are now in a new phase of growth. The companies should also see monetisation of the investments done by them in the last few years in areas such as biosimilars, niche/specialty generics, etc. The sector, therefore, is expected to continue to attract flows from investors. However, given the strong outperformance of the sector in this Covid-period due to its corona-proof nature (or even perceptibly benefiting from the COVID situation), Pharma stocks could very well see some consolidation or correction. However, any such correction would be a good buying opportunity for investors having a three-five year time-frame.
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