India's equity markets have seen strong momentum amid a surge in inflows from foreign institutional investors, while flows into domestic mutual funds, especially small and mid caps, have remained strong too. Benchmark BSE Sensex and NSE Nifty hit life highs last week. But, what should investors do now? Is there more upside and which are the sectors are looking good? Mahesh Patil, the chief investment officer of Aditya Birla Sun Life Asset Management Company shares his views.
Q. Equity markets are in a strong momentum right now, benchmark indices have touched new highs recently. Why are the markets moving up?
Globally we have seen that there has been a risk-on rally. Interest rates have mostly peaked out, inflation is under control and the underlying growth is still very strong. Anticipation of earnings growth downgrades has also not occurred. In fact, the growth rates have been revised upwards. In India as well, GDP growth last quarter was better than expected which is a good sign for earnings.
Globally, we have seen a rally in the technology stocks, that has also kept the market up. Markets are now expecting that any recession in the US, won't be very big.
In India, we have seen that earnings growth numbers have been fairly good. In lot of sectors, the outlook is still positive. Banks reported good numbers, the auto sector is reviving, real estate is doing well, travel and tourism is doing well, as are industrial and capital goods.
In India, GDP growth for FY24 should be around 6.5 per cent and earnings growth is expected to be in the low teens even after strong earnings seen over the last two years. So, we expect to see good returns because of these factors.
In India, more than 70 per cent of the stocks in BSE-500 are now above their 200-day moving average, which is a good indication of how broad-based the rally has been. Also, FII flows have been very strong in the last three months; we had almost $5 billion average inflows in the months of May and June.
We think investors have realized that the hope trade, which was there in China has not materialized because Chinese growth has not really come back as strongly after the lockdown was removed. They see India as a good structurally long-term story, hence the reason for such strong flows. At the same time, FIIs are now also looking at mid-caps, not necessarily large caps.
There could be some period of consolidation, but the market has broken above that level. Our outlook remains constructive, at least from India perspective.
Q. Are markets still fairly valued after the rally?
The market just crossed the peak made in September 2021. In that interim period, earnings have grown. FY23 earnings growth was around 10-11 per cent. So, valuations are now only slightly above the long-term average. If we look at the PE multiple, it'll be slightly above, say 4-5 per cent higher, than long-term average, which is not very expensive.
For long term investors, one should still stay put because there's nothing negative as such on the fundamental side. The India story continues to remain strong. We are now seeing revival in the rural economy as well. Along with that, we are witnessing some pick up in private capex. Given that, the sustainability of earnings growth looks much better.
Even sectors like IT for example, which is dependent on global growth, which is likely to slow down, there also we are looking at around 10 per cent earnings growth this year, which is reasonable considering the macro scenario.
We think one should continue to invest; however, we would not recommend aggressively buying here. But SIPs should continue as we cannot anticipate when the next correction happens. And looking at the liquidity, we reckon the chances of any big correction are not there really, unless globally there is a risk-off event.
Q. Have interest rates peaked?
In global markets, because of the fact that underlying growth is still very strong, based on jobs market data, I think there could still be one rate hike. So, around a quarter back, the market was factoring that there could be rate cuts in this calendar year. Now, that is not the case.
In India, inflation is well within the band and the food inflation, which was a concern is expected to be within control given better crop harvest. Our view is that domestic interest rates have peaked out, but they will not come down in a hurry. Extended pause is what we would expect at least until the end of this fiscal year.
Q. How much will high interest rate have a bearing on corporate earnings and investments?
While rates have gone up, they have moved up from a very low level. Normal rates are somewhere where we have been before, hence it is not been too high for us, like what has happened in the US where the increase has been very sharp.
Secondly, the corporates have deleveraged significantly in the last two-three years. So, the overall corporate debt to GDP or corporate debt to equity, is almost at a decadal low. So as a result of that, the direct impact of increasing interest rates on profitability will be much lesser, because the overall debt levels are not as much as it used to be earlier.
On the impact on investment decision making, we think that is not likely to change much. That will be more dependent on demand recovery. If the domestic demand recovery is good, capacity utilization levels improve, we would see investments pickup, though it might get delayed a bit. The capex recovery is probably getting pushed forward a bit because of the high interest rates and because of the global growth uncertainty. Hence, we expect a lot of corporates to be in wait and watch mode in the near term.
Q. Corporates have deleveraged significantly, and that has benefited the banking sector as well. Credit growth is strong, deposits are picking up... What's the outlook for the sector?
Last year was healthy for banks because of margin improvement. Now, some portion of the loan book is linked to the repo rate. So, interest rate on such loans increases immediately as the policy rates go up. Deposit rates were lagging. We think to a large extent, margin improvement is now done. And we will probably see some margin contraction. But overall, the banking sector will still see a decent growth.
Earlier the market was expecting that credit growth this fiscal year will come down because nominal GDP growth for FY24 will be down YoY. But we are still at around 14-15 per cent credit growth, slightly lower compared to last year, which is robust. The retail credit growth is still very strong. While corporates have deleveraged and corporate growth is low, corporate releveraging cycle will start slowly and that should also increase the corporate credit growth as capex picks up. For the banks, the overall NPAs are still low.
This year, we expect the NBFC sector to do better. We should see margin improvement in NBFCs and the growth in NBFCs has already been much stronger as they are mainly the retail side. So, we have slightly moved our preference from banks to the better performing NBFCs. However, banks will also do well, and if we look at the overall sector, valuations are reasonable.
Q. What are the other sectors that you like right now?
Discretionary consumption structurally looks good. Near term there has been some slowdown on the discretionary consumption because of interest rates. But structurally in India consumption will increase, because of increase in per capita income and premiumization. So, that is an area where we would like to build with a three-five-year view.
Then, there is a recovery in the industrials and capex story. It is still early days, but if we look at all the industrials sector companies, they are continuing to show an increase in order book. In defense, the government is trying to procure more indigenously, which is a driver. The capex-related theme looks good, but valuations are on the higher side.
We are also positive on real estate. Even though mortgage rates have gone up by almost 200-250 basis points, underlying real estate demand remains fairly strong and inventory levels have come down significantly. The real estate cycle is coming out after almost eight years of down cycle. So, we think there are more legs in this space.
Also, other sectors where we are positive on are tourism, hotels, pharma & hospitals. Even the auto sector looks interesting. There is a recovery playing out. Two-wheeler sales are still below pre-COVID numbers, because rural economy has been weak and the price increase in autos was very high in the last three years. But that is also now slowly improving.
Q. There is still lot of uncertainty around monsoon and the impact El Nino will have. How much will this impact demand?
That is there, but I think there are other factors, which are balancing it out. Since the beginning of July, we have witnessed good rainfall and the deficit has reduced sharply. That has taken care of some of the shortage which is there. So, I think it should not be such a big worry. It is still early days, but currently looking better now than what it was a couple of weeks back.
As we move towards the elections next year, we will see some money moving into the hands of the rural as well as the bottom of the pyramid group. That should aid in propelling consumption.
We are also benefiting from the lower commodity prices. There has been a reduction in prices of the energy basket. Therefore, we will see some margin improvement this year, which should benefit overall earnings. Overall, we are looking at a healthy double-digit earnings growth for Nifty.
Q. How do you see the mid and small cap space?
The India growth story does look more sustainable for long term because of the reforms. Obviously, elections and other things could be the risk factors. Otherwise, we see that a lot of sectors are looking up and mid-caps and small caps should do reasonably well in that environment. We are also seeing good inflows here.
Valuations have moved up now, but again they are not excessively overvalued. The earnings growth is also likely to be stronger, in the mid cap and small cap. So, if we take a forward-looking view, it might not look as expensive as it looks on a trailing basis. So, it becomes a bottom up or a stock specific story.