What is happening within the metals basket? No doubt it is a huge negative with this excise duty impact. Are you writing this space off now?
Yes. It has reasonable value in terms of multiples, in terms of cash flow even after a cut of may be Rs 4,000-5,000 per tonne but globally, what is happening is governments are definitely stepping in to control inflation. It is not just India specific, we are seeing it happen globally.
Energy or steel companies in a healthy upcycle would make enormous profits but what we are seeing with state-owned upstream energy companies is that the market does not seem to believe that entire profits will go to the company. What could potentially be a concern here is that if that kind of thinking percolates to steel as well, then more than the profit downgrade in terms of estimates, one could see also a bit of a derating on the valuation multiples, which could be medium to long term. That to me is probably a bigger concern.
Steel margins are going down; when China opens, it may come back but the point is if the governments are trying to cap the upside on commodities, then we could have a bit of more structural derating.
Let us also understand what the undertone of the market is? At a time like this we are gripped with quite a bit of volatility. What is the best way for investors in the long haul to cushion against this kind of acute volatility because no real sector has been spared the carnage?
Typically what tends to happen in the second phase of a global economic recovery is a lot of investors think that a recession is around the corner and everyone is very nervous, very nimble and everyone is trying to rotate sectors because no one knows whether US will have a soft landing or a hard landing.
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I guess the fairly accepted view is that the global economy will slow down, especially the US and Europe. No one knows what is the extent of the slowdown as everyone knows that in the last two years, returns have been healthy and so everyone is trying to protect capital and everyone is trying to be in sectors which are spared the carnage.
We have seen rotation from IT to banks to FMCG. Everyone is trying to find the sector which outperforms and nowhere is the valuation very cheap. After the April 2020 bull run, returns have been healthy. It is not that any sector is cheap and the peculiar thing is unlike the last 10 years, this is a correction which is happening in inflation rather than in deflation.
Since 2010, we have gotten used to corrections where FMCG and IT and pharma used to outperform because those were deflationary corrections whereas commodities used to fall and leveraged companies used to come under question. Now in an inflationary scenario, where commodities are doing pretty well, interest rates are going up in a stock market correction rather than going down, the valuation multiples of high price to earning kind of stocks is actually correcting. That means the traditional defensives like FMCG etc. do not work all that well and that is creating a lot of dilemma in fund managers vis-a-vis what can protect capital.
Overall, what we are focussed on is broadly that the domestic cyclicals seem a better option than global cyclicals because India had a big second Covid wave and also from a three-five year perspective, India went through a lot of mini crises in terms of NBFC crisis etc.
The base on three-five years and the base on one-two years is also weak. If one takes performance on a five-seven year basis, a lot of midcap banks, NBFCs, auto and cement stocks have not done much. So they are pretty cheap on long term basis of valuations so I think that is a theme that may protect value but of course this also needs to be calibrated with the fact that if the global economy has a hard landing, then obviously one needs to be reviewing this, but as of now, we are going with the belief that since a lot of countries have opened up only in the last 12 months, the global economy will still do reasonably okay.
What is your take on auto companies? You said that one should bet on domestic cyclicals. Would autos be a part of that list?
Definitely. Autos, real estate, cement, logistics, capital goods are the segments which seem to have relative value. One needs to be nimble and see that the global cycle does not break down totally. But at least, there is under ownership here, there is long term value in terms if you use normalised earnings or price to book or price to replacement value that is attractive at this point of time. And sometimes if you go back to the 2002 to 2008 cycle US slowing down can actually be very good for emerging markets because the key variable for emerging markets outperformance is the dollar. Now if the US slows down without hard landing you could have a situation where the dollar weakens and that is a big boon for emerging markets so in that sense if that plays out then EMs in general will do well and the domestic cyclicals will definitely get a big tailwind of liquidity as well. So yes, overall we think that autos and related segments which are linked to the domestic cycle have relatively good risk reward.
The inference that one can draw from your answer is also the fact that you would suggest to stay away from export facing economies and stocks like the IT companies etc, would that be a fair assessment?
Yes. In terms of valuation multiples, IT stocks are expensive. Maybe as a near term currency hedge, one can have a bit of that because while the dollar may weaken, the Indian rupee has outperformed a lot of emerging market currencies and non dollar developed currencies. Be it Korean won or Swiss Franc or Japanese yen – they have fallen a lot versus the dollar whereas the Indian rupee has not. Even the Yuan has fallen recently. So more as a bit of a hedge bet, I find it very difficult to make a case for being overweight IT
When it comes to the entire liquidity situation owing to the way we have seen that relentless selling by FIIs, what would you say is the biggest factor? Also, what would you expect when it comes to the overall liquidity situation?
To be honest, I do not expect FIIs view to change very quickly. I do not think there is one single reason; I think there are two or three big reasons. One is that India has clearly outperformed a lot of big emerging markets like China and earlier the commodity market like Brazil.
Clearly there is a lot more foreign investor interest in a commodity market like Brazil. India’s outperformance over these big emerging markets has been so sharp that foreign investors seem to find more value in the beaten down markets. The second point is about the currency. So the same thing holds with the currency. Since the Indian rupee has outperformed Malaysian Ringgit or Korean won or Chinese Yuan, whatever commodity importing currency one can think of, the Indian rupee has done well. So, there is a bit of nervousness around the currency as well.
Thirdly, individual stock specific, there are again a lot of bargains globally because India has done pretty well over the last two years. People are finding stocks in Vietnam or Brazil which have a similar growth profile to Indian stocks which are quite cheap. Now given all these reasons, unless the dollar weakens and then maybe the emerging market currencies outperform the Indian rupee (INR), but INR itself does okay, then foreign investors will come back and we will have positive flows.
But until that happens and the dollar is strong, relative to other developing markets, India has outperformed too much at this point of time.
Where within financials do you find comfort? Is it the marquee private banks? Are you looking at exposure to even the PSU banks? Would you like to venture into insurance, NBFCs?
We still broadly find value across financials. As far as the lending space goes, now with the steps over the weekend again, auto is doing well; there are some very good auto financial names which can be very interesting because if auto volumes go up. their top line will do well and also credit quality also typically links with the auto cycle.
So one can look at NBFCs which are specialised in auto financing. Life insurance stocks tick a lot of boxes where typically insurance is a sector which is discretionary in the sense that it grows faster than GDP over the long term because people invest more of their savings as they get rich in to insurance.
It has faced some technical issues because of the big IPO, but that should abate. So life insurance looks good. General insurance, from a 10-20 year perspective probably is one of the best segments to invest in because of the sheer under penetration. Indian general insurance versus US or China is 1:15, 1:20. This goes to show you how under-penetrated we are,
So, wherever one can get a decent bargain in general insurance, that is interesting as well. Even niche segments like microfinance are turning around and I am quite positive on that segment as well. So overall, in financials, there is value across the space.
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