Given relatively improved bond yields and the looming increase in deposit rates, 2023 could be a year where asset allocation for domestic flows could find a balance between equities and fixed income, says Ravi Gopalakrishnan, CIO – equity, Sundaram Mutual Fund. In an interview with Ashley Coutinho, he says segments within industrial manufacturing and financials and select themes within consumer discretionary continue to provide interesting long-term investment opportunities. Edited excerpts:
What are the key triggers to watch out for Indian equities this year?
Going into 2023, global growth is slowing and is likely to remain subdued. In the second half of the year, inflation prints are expected to soften on account of base effects and moderating demand, around which a Fed pivot could be anticipated. From an India perspective, activity indicators remain reasonably strong, as evident in credit data, automobile sales, real estate activity, GST collections and government spending. The lagged impact of interest rate hikes on demand is a variable to monitor in coming quarters. Elevated government capex, improved execution on flagship social infrastructure and PLI schemes and a shift in central bank narrative from inflation to growth are the key triggers to anticipate. A pick-up in rural sentiment and demand, which has been lagging hitherto, is another key catalyst for sustaining improved consumer confidence.
Indian equities seem to be richly valued at this point. What is your take on valuations?
Aggregate earnings growth today reflects a mix of slowing external sector and a resilient domestic economy. Indian equities have witnessed strong outperformance last calendar year, driven by relatively better growth in economy and corporate profits. Relative valuations have expanded compared to other EMs. It is natural for markets to consolidate in the short run as near-term headline valuations are a notch above their historical valuation ranges. The large macro-trade driven by easy liquidity and benign rates is possibly behind us. Yet there are several interesting trends are at play in various sectors and our preference remains towards businesses with improving growth visibility and earnings resilience. We believe segments within industrial manufacturing and financials and select themes within consumer discretionary continue to provide interesting long-term investment opportunities.
What are your expectations from the Budget?
The Budget could focus on fiscal consolidation, sustain capex in defence and social infrastructure such as railways, urban housing and piped water, and possibly expand PLI to few other sectors.
What is your take on mid and smallcap stocks at this juncture?
After a stellar performance in FY21, the mid & smallcap indices have been largely through a phase of consolidation since end 2021. The revenue growth and earnings resilience of many smallcap segments do get tested during phases of sharp rate hikes and demand moderation. We are currently in one such phase. At current valuations, the earnings growth differential with largecaps could narrow, compared to sharp differential in the post-pandemic year of earnings rebound. For 2023-24, we expect the mid and smallcap segments to consolidate. Investors need to focus on individual businesses to assess medium-term drivers against the current valuations. Several export segments such as chemicals and industrials have seen the opportunity landscape improve amid a weak global macro. On a bottom-up basis, several mid and smallcap companies riding on factors such as localisation of sourcing, ability to grow in adjacencies, strong brands with ability to take market share from unorganised players, sound balance sheets to pursue inorganic growth provide interesting opportunities to evaluate from three-to-five year perspective.
Which sectors will thrive or benefit from the global slowdown? What is your view on external facing sectors such as IT, pharma and materials?
Sectors such as chemicals, pharmaceuticals and engineering goods with established manufacturing strengths and capabilities are seeing improved business visibility owing to shift of manufacturing lines from developed markets to India. Policy reforms implemented in recent years also target at strengthening such sectors and create scale. On external-facing sectors, while we remain moderately underweight on software, pharma and materials, we believe the process of reset in growth expectations in these sectors is already underway; post the correction in software and pharma (custom manufacturing) during CY22. Materials as a pack is expected to remain volatile given its sensitivity to global growth and the dynamics of the property market within China.
What is your view on banks?
Corporate credit has just started looking up and the confluence of growth, improved profitability and positive asset quality trends continue to underpin our positive view. Lenders with strong liability franchise and a reasonable mix of floating rate loans remain well positioned in this phase of rate cycle. This would include both reasonably large private sector and select PSU banks, with both of them having direct linkages to growth across corporate, MSME and retail credit. Private banks continue to hold on to marketshare gains across deposits, high-yield business banking, small SME portfolios and retail loans. For PSBs, with most of them having improved provision coverage ratios and capital adequacy in the recent years, the confidence on growth and improvement in RoA trajectory remain catalysts for valuation differentials to narrow with their peers.
What is your take on earnings growth for India Inc in the December quarter and CY23, given the global slowdown? Could you elaborate.
We expect corporate profit growth to be around low-double digits for Q3FY23. This would be a blend of higher growth in financials and moderate growth in software and staples. We expect earnings growth to moderate in 2023-24 and remain at low-double-digit pace, on the back of a sharp global slowdown, which is weighing on exports, and the progressive fiscal and monetary policy normalisation at home. Contribution of exports of manufactured goods to growth has already started to slow down, partly offset by services exports.
On the domestic side, revenue growth for several consumption segments, driven by pent-up demand and inflation-driven price hikes, is likely to revert to long-term trends. With impact of interest rate-hikes flowing through the system, we expect topl ine growth to moderate while softening of commodity price pressures could aid improvement in profitability. Rural demand remains a wild card and could hold surprises on the back of normal monsoons, focused fiscal spend on social infra and improved wage growth.
Will domestic liquidity sustain this year?
With structural drivers for consumption and investment improving, we expect long-term domestic flows to continue to find its way into equities during market corrections. However, given the relatively improved bond yields and the looming increase in deposit rates, 2023 could be a year where asset allocation for domestic flows could find a balance between equities and fixed income.