What are you making on the quality of earnings which have come so far? Almost half of the Nifty earnings on Nifty weightage terms, have declared results. It clearly shows that top line growth exists, but margin pressures are there. How did you analyse the commentary and the quality of earnings so far?
On the results front, as usual it starts with IT and then financials and the other sectors. The margin pressures started a year ago. It is not a recent phenomenon. But normally, it is observed that if revenue growth is in mid teens or higher, then the margin pressures are absorbed while if it is lower, then it becomes a challenge to absorb it.
So as far as the result season is concerned, there have been some concerns over the margin across segments. It may be in IT, in some cases it is also about the NIMs which also saw some pressure. It has nothing to do with inflation in case of NIMs, but broadly that has been the same theme so far. Some of these elements probably were known in the market and the market has started cutting earnings for the same reason. However, apart from IT, the issue is different but while in other sectors the issue got aggravated by the recent war situation and associated with raw material prices across the board, the cost inflation has actually got reflected in some of the results in cement and among others. So yes, it remains a concern in the near term.
Do you feel that this is the worst of the margin pressure and inflation peak would be made between this and the coming quarter?
Yes. This time around it is different. What is different when it comes to margin pressure is the cost inflation because of supply constraint. Unlike normal times, probably during 2004 and 2008, it was more demand-led cost inflation, maybe commodities, maybe power or any other element.
This time around, it is more of a supply constraint-led and when it comes to supply constraints, the near-term triggers for this inflation have been geopolitical issues. Though in some commodities, it got aggravated more by under investments in the last five to 10 years. But the recent trigger for it has been supply constraint and that too triggered by geopolitical issues.
In my opinion, if the sanctions and the associated geopolitical issues abate in near term, that can lead to the reduction in the raw material price pressure. Especially for India, what matters is crude and that is where the focus is. So it is definitely not in demand. It is not that demand is increasing so much that it warrants such high prices. It is definitely supply led and if there is some reservation, then that should come down.
What are your overweights right now? If interest rates continue to rise, it is not coming down in a hurry then, which sectors will perform well in this kind of a market?
Already, the market has played out a part of it. The outperformers in the market so far in this calendar year have been producers; so it can be a commodity producer. It has also been around utilities and this has been the trade so far in the market. Going ahead, when this inflation abates remains the key question, especially since it is triggered and hovering around geopolitical issues and this could be repeated.
What matters to the consumption story of India is crude oil and because it adds a huge burden on the country.When it comes to this inflation, the consumption stories definitely get hurt because there is a double whammy of raw material price inflation on one hand and demand translation because of that.
What are your thoughts on midcaps and smallcaps on valuation terms? Traditionally, they traded at discount to largecaps. How do you analyse the valuation? They are trading as a basket.What is the earnings quality they are likely to post because these companies get more disrupted on margin front and rising rates scenario?
True. When it comes to midcaps, your observation is right that the valuations are at a premium. If you take any sector from consumer to IT to any other financial services, the only segment where it remains as always at discount to the largecap. These valuations are high for multiple reasons and especially it is also the outcome of the rally which has happened in the last two years.
In midcaps, there are multiple segments. The beneficiaries of geopolitical tensions, China plus one policy and supply constraints, are more in midcaps and in sectors like chemicals and textiles. Beneficiaries of some of the policy changes have been in the industrial segment, sugar segment and so forth. When one looks at midcaps as a pack, the market has rewarded a lot including industrials but after that rally, the valuation in some of these segments are really high compared to their historical averages.
In that context, if one looks at largecaps and Nifty, the financial services and the consumers which comprise around 50-55%, have got derated because of the challenges in the consumption segment. The point is that the weightages of that segment is higher in the largecaps and that is why on the index front also, largecaps have underperformed compared to midcaps.
When $95 billion starts getting taken out of the international market on a monthly basis in the form of liquidity withdrawal by the Fed, how do you see global markets reacting? How much of this tightening is in the price and how will it impact emerging markets?
The global markets have already reacted. They reacted with inter-related factors, whether it is a rising interest rate cycle or reducing the liquidity. That has been playing out now for six to eight months – both in the developed as well as the emerging market, probably in India. A part of the businesses are beneficiaries and they have a sizable weight in some of the indices and that has been doing well.
One can always question whether the valuations are right or not, but those beneficiaries have been there in Indian indices versus global. As far as global markets are concerned, it is playing already. Some of the markets are down 20-20% and it is the outcome of both rising interest rates as well as the earnings not getting delivered as expected earlier.
India again at a stock specific level, has seen sizable corrections this calendar year in multiple stocks and that is where the market at the aggregate level has not gone anywhere while the stocks are down sizably in various segments.