With domestic equity markets scaling higher and valuation rising, it is now time for investors to tread cautiously.
With domestic equity markets scaling higher and valuation rising, it is now time for investors to tread cautiously. Although sectors like aviation, travel, and hospitality have definitely taken a hit, there are some pockets that will benefit from the trends that might emerge if the economy continues to gradually recover, said Sampath Reddy, CIO, Bajaj Allianz Life Insurance in an interview with Kshitij Bhargava of Financial Express Online. While Sampath Reddy is of the firm belief that foreign investors can’t stay away from India for long, he also has some advice on how investors should read the June quarter numbers. Here are the edited excerpts.
Equity markets have gone significantly up from where they were in March, what is your view on valuations right now
The fact is that market valuations were at a significant discount when they fell sharply in March, but we have to look at what will be the impact on earnings of companies because of the coronavirus. In the financial year 2020, equity markets were looking at around 15% to 18% earnings growth in the fourth quarter, instead, they went down 20%. So instead of corporate earnings growing by 15% for full FY20, they actually registered flattish to negative growth. Also, we have seen large downgrade in earnings growth for FY21. So if one believes that it was a one-off situation then it needs to be understood that markets do also take note of the near term earnings. But, if you look at equity markets that are around 11,000 level for Nifty index and earnings have taken such a cut-back I would say investors have to take a cautious step. However, if you are looking to invest as a long term investor, then things are different and one may continue to invest using a systematic and staggered approach.
When do you think Foreign Portfolio Investors will come back?
FPIs have generally been positive and overweight on Indian stock markets for a very long time. During the Lehman crisis time (global financial crisis of 2008-09) and a few other occasions there have been large FPI outflows. Otherwise, generally, India is an attractive market because of its demographics, diversified set of companies, and robust market system. I do not think Foreign investors would be away from Indian markets for a very long time. India cannot be ignored. We will continue to attract good flows and it is just a matter of time, once this uncertainty reduces, then FPI investors will come back, and we have already seen this happening in the recent liquidity-driven rally.
The world is expected to change, what are the sectors that you believe might gain from this?
If all economies are opened up soon and things could come back to normal, and if a vaccine is found soon, then the economy will continue to gradually recover to pre-pandemic levels. But if Covid cases continue to escalate then it may lead to market volatility and hamper the partial recovery in economic indicators we have seen (with the risk of lock-down being re-imposed, as being in some states recently).
Also, some fundamental behavioural changes are expected as a result of the pandemic, with offices looking at their structure, and what percentage of manpower can work from home. Big technology companies have said that they will shift a certain number of employees to working from home. So the acceptance of work from home is going to rise, that is a change that we are likely to see going forward. Along with this, digitisation is becoming a norm, as more and more industries are looking to go digital. The insurance industry is now looking at new digital modes of doing business. As this happens, some sectors will suffer like travel/tourism/entertainment will be impacted in the short term, and commercial real estate could see a shortage of demand because of work from home and the economic slowdown The broader trend is that digitisation will be the key trend and it will be accepted more, going forward.
Companies in the infrastructure and capital equipment sector will take time to revive. In these uncertain times, sectors that are better placed. They are the likes of the consumer sector, even though FMCG sector has higher valuation multiples, but in terms of visibility of earnings and growth, they are much better placed. Pharma is also relatively better placed, they were largely struggling but now is better positioned amidst the health crisis, and with FDA & pricing related issues expected to be behind us now. IT services also are looking to do good, as they are expected to be less affected amidst this uncertain environment, with cash-rich balance sheets, higher RoE, and reasonable valuations. Sector like Hotels and Airlines are obviously hit in this.
Financials are in a tight spot, it is expected that the near-term future is not looking good. How do you assess the situation?
There are some sectors like aviation hospitality that definitely will be badly hit by the coronavirus situation and along with this, I believe financials is another sector that is going to see some setbacks. In the last few years, if you see, things were picking in the sector in terms of credit growth and asset quality. Retail loans were doing good, and even corporate NPAs appeared to be behind the curve. But given the current situation and economic slowdown, there is going to be a significant impact on MSMEs and small businesses, and there is going to be a loss of income for self-employed people. This will obviously hit the banking sector’s non-performing assets.
This is the reason why the Reserve Bank of India had to come up with the Moratorium for 3 months then again extended it because there was visible pain in the system, where people were not able to pay their loans. If this was not done there would have been real challenges for the banking sector in terms of capital adequacy. So obviously this sector is going to take a hit and face some headwinds in the form of a rise in NPAs from MSMEs and also from retail loans (like self-employed people). There is a lesser risk from people who are employed and earning salaries, so that pocket is safer, but other pockets for banks are in a problem. The problem in banks will not be visible immediately, and will start to show up once the moratorium ends, and economic slowdown becomes more visible.
We continue to like large private banks that have a strong liability franchise and are adequately capitalized.
A lot of banks are looking to raise capital, will it be tougher for smaller banks in such a scenario?
Yes, a lot of banks are trying to raise capital, some have already done so and a lot are in the process of raising money to improve capital adequacy ratio, in case things go bad—which is a good development. It is good that the banks are focusing on the main point which is that they have enough capital to tide over these times.
I think most will be able to raise capital, even the smaller ones. Maybe the bigger banks will raise money at two times the price to book, and the smaller banks will raise money at lower multiples.
How should this quarter’s earnings be looked at by investors?
To some extent, the market is already ignoring the fact that the first quarter of FY21 is going to be bad and in spite of that the equity markets have rallied quite well in the last one or two months. But, the equity market is not going to be only focused on the near term; it does take the long term also into account especially in a situation like this. So quarter 1 numbers are going to be bad and that is somewhat discounted, but recovery is not going to be rapid, and we are cautiously optimistic because of the significant rally that we have seen in the market from the March lows.