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“While the market looks to be in a fair zone at this point in time, it can always undershoot on the downside as the growth outlook has weakened and one should be prepared for more downside. But investors who are looking to invest from a long-term perspective, it is a good time to start looking at individual stocks where the valuations are attractive and where the earnings outlook is not impacted to that extent,” says Mahesh Patil, CIO, Birla Sun Life AMC.

It is bad and in some cases will it get worse before it gets better? Or are we nearing the bottom of this panic?
We have seen a good amount of selloff in the global markets and a very good correction. In a way, a lot of the negatives are to some extent priced in –whether it is rate increases, inflation, global growth slowdown, earning downgrades – all are known and so, the market should probably take some support over here.

On the valuation basis also, the rerating in the PE multiples are expected on the back of an increase in interest rates that has also happened to a large extent. The valuation multiples on a trailing basis would be near long term 10-year average multiples though on a price to book value, it will be slightly expensive. For the time being, the market looks likely to consolidate but there has been a significant slowdown in global growth. In India also, we have not seen much downgrade but the increase in interest and inflation will impact growth as will earnings downgrades.

At least for the next few months, the Fed has said it would continue with at least 50 bps rate hikes in the next two policies. In that environment, while the market looks to be in a fair zone at this point in time, it can always undershoot on the downside looking at the sentiment and the growth outlook has weakened and to that extent, one should be prepared for more downside over here.

But investors who are looking to invest from a long-term perspective, a lot of stock prices have now corrected to very good levels and we have seen a huge correction in individual stock prices. It is a good time to now start looking at individual stocks where the valuations are attractive and where the earnings outlook is not really impacted to that extent.

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We are in an earnings downgrade cycle which will last for another two or three quarters. Why do you think the market should come back because now estimates are getting challenged across the board for IT, metals, autos as well? What is the bull case scenario there? If earnings are contracting, why should markets go higher?
The market always looks slightly beyond the next few quarters. That is what it has given in the correction also and it is similar when they bottom out and start looking forward. Once it gets a sense that whatever growth we are witnessing is getting priced into the earnings downgrade which probably will happen by the end of this quarter or probably second quarter, we should see that in the earnings. Then, one will take a cue from there on how the valuations are looking and what is the forward outlook.
But even before that, the reason for the markets to correct has been the high inflation, which has prompted the policy makers to go aggressive in terms of rate hikes and decreasing liquidity. It looks like inflation has peaked out, at least globally. If it starts to cool off significantly more than what one is expecting, then market will start to believe that the rate hike to the extent expected may not happen and that could be a reason for the markets to start bottoming out and looking forward.

It is important to look at how the inflation trends pans out because obviously the demand destruction will have an impact in terms of prices and that is now starting to be seen in the US data which came in a few days back.

What would be the right asset allocation at this juncture. Those of us who invest in SIPs, what could be the right breakup?
As I mentioned, the market is now in a fair value zone. Six months back, the market was trading above say one standard deviation or more compared to long term average. Now it is in the fair zone and in that context, overall allocation to equities should now be in line with normal target allocation. If your target allocation was say 50% depending on risk profile, one should now get closer to that level.

There could be some small downside from these levels because one never knows where the market will bottom out but within equity also, larger allocation is still suggesting that it should be in largecap and flexicap or multicap funds. There is still some amount of uncertainty. In a lot of sectors where the outlook is pretty unclear because of supply side disruptions.

The larger cap space, which has seen immediate corrections after the entire selling, will provide more stability to the portfolio. So go for a 50-60% allocation to a largecap, multicap or a flexicap fund. Midcaps and smallcaps have seen a good correction of almost 33% down from the recent peak but near term, there could still be volatility. If one has a three-year view, it is a good time to slowly start making investments in the smallcap and midcap space. I would recommend 15-20% allocation in the mid and smallcap space.

IT companies are growing. Valuations are not that stretched but that sector has got completely bombed out in last two-three months. What are we missing right now?
The IT sector is following what is happening in the US, in the Nasdaq and we have seen decent corrections in all the technology stocks globally and there is a good correlation between Indian IT companies and the global IT names. What we are seeing is essentially a PE re-rating.

I do not think there is a big downgrade to earnings impact over there. The IT sector still offers a fairly good amount of visibility over the next two years. The market is fearing that because the US market is going down and there is some probability of a US recession. That will start hurting the discretionary spends and towards the IT sector.

However, IT spends this are more towards growing the business and not more towards digital, cloud migration and cyber security, which is not likely to be impacted as much. The sector was trading way above its all long-term average PE multiples and rightfully so because of the strong growth outlook.

But with the recent correction that we have seen in the IT sector, the sector offers a very good risk reward because we are not seeing any major downgrades to earnings. There is some margin pressure but the rupee is also likely to depreciate. We see the rupee depreciate a bit from here and that will offset it. These companies generally have a very good free cash flow. The market should be focussing on companies where free cash flow generation is strong and most of the large IT companies are now at a free cash flow yield of around 4% or 5% or so.

So the Indian IT slide has more to do with the global selloff but the way they are positioned, at least on the growth side, one does not see much of a problem over there. At these levels, they offer fairly good risk reward and I do not expect any further re-rating from these levels at least for the large IT names.

Just to clarify, that is for the largecap IT names that you are talking about. has been flirting with a 52-week low; trading at a 20 time forward earnings and about 23 to 24 times. You are talking about the largecaps or the midcaps which turned out to be far more expensive?
Now with some headwinds, looking into the sector in terms of slight growth and discretionary spends, midcap IT could be slightly vulnerable. The pressure there is also on the cost side when we are seeing a tight market on the labour side. They could probably face some challenges over there and normally when we see the sentiment a bit negative the midcap IT tends to correct more and the contraction in the multiple is much larger over there.

We have seen a good amount of expansion in multiples in the midcap IT names in the last two years. There probably could be some more room for the PE correction and from that perspective, in this environment, I will go more towards the largecap IT names.

(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of Economic Times)


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