Motilal Oswal's Raamdeo Agrawal says corporate earnings will have to justify valuations

In 2022, Indian markets outperformed in the teeth of global headwinds like high inflation, a strong dollar and interest rate hikes. How different would 2023 be?

You just laid out all the uncertainties of 2022. So there is no one factor. Looks like 2023 will have some of these things, while some might reverse. It is very tough to think through what will happen in the next 12 months. For example, the Ukraine war was not part of the deal when 2022 started. Much can happen in the global economy in 12 months. Will there be a recession? What will happen to energy prices? How about Ukraine? China? All these things will have a huge impact.

I don't know the answer to all of this. All I know is that though they’ll pose risks, those are already priced in to a large extent but there may be completely new risks, which nobody has a clue of.

Equally, happy things may happen too. Inflation in the US could correct sharply, boosting the markets. The Ukraine invasion could be called off. I think it'll be a mix of good and evil forces. It'll be volatile but I don't think it’ll be worse than 2022. I think 2023 will be better.

Which sectors will be back in vogue? Your wealth creation study speaks extensively about the financial sector.

Right now things are slowing down. We’re almost at 22-23 PE. Corporate earnings must justify that. Earnings for 2023-2024 were supposed to be strong but those projections have been cut. Now we’re talking of only about 10 percent. But the moment earnings take a turn, markets will also take a turn. If they grow to about 15 percent, the markets will fly, while if it’s 10 percent or less, the markets will be range bound.

Also read: New-age firms are still not cheap and continue to make losses, says Raamdeo Agrawal

Do you expect the macros to change anytime soon? Do you expect the US Federal Reserve to go slow on rate hikes?

I hope inflation comes down and the Fed tightening slows down but I think we are quite far from their target of 2 percent inflation. So I think all of 2023 will go in addressing that. Markets are smart. If they sense a change in the air, then they move ahead of time. Such things can revitalise the markets. But that’s unlikely to happen in 2023.

Any specific themes that you'd like to focus on this financial year?

Tech is my favourite. Right now it is out of favour, so valuations are reasonable.

Wealth creation is about consistents and volatiles. We have to focus a lot more on the consistents. When we focus on consistents, valuation takes a back seat. It doesn't matter if you paid 17 when you should have paid 12. Okay, one year you won’t make money but thereafter, as the company grows, you will make money.

With volatiles, if you end up paying a high price, that can crash by 80-90 percent, and then you're stuck. Eventually, you may want to exit at those low prices. So my focus will be to increase the consistents in my portfolio. Only 15-17 percent of the companies are consistent. Rest are all volatile. Making a sector call is actually very tough right now.

Would you be more bullish on something like the midcap IT space?

Yeah, of course. IT large caps are seriously large. TCS’ turnover is about Rs 1.5 to 2 lakh crore. Infosys is about Rs 1 lakh crore. At that level, you can maybe hope for 10-13 percent growth.

Midcaps, while smaller, are not small. They can compete with TCS, Infosys, etc. These mid-sized companies are well-positioned. That's where I think you can get 15 to 20 percent growth but finding good returns is going to be tough in tech too. Unless you find some niches that can grow 30 percent maybe. Since the industry is out of favour, you might end up buying them at a PE multiple of 15-18.

Where do you think we will see greater traction this year, defensives or cyclical? Which seems cheaper?

Of course, the cyclicals are cheaper right now and consistents or stable companies are more expensive. But where do we see growth? If a stable company delivers good growth, then you're sorted. But in a slowing economy, your growth predictions also go awry. Your company will give a guidance of X, they'll achieve X minus 5. The growth might be 40 percent, but not 60 percent, and the markets will be disappointed. This will happen to a lot of successful companies. One has to see if the growth is already built into the price of a company. One has to be very careful. More than the market you know what delta and alpha works for you.

Is India relatively expensive compared to emerging markets?

Yeah, by historical standards, it is expensive.

Do you think the markets will correct, or do you think India is going to continue to be priced at a premium?

Structural change is happening in India. Retail money has been pouring in continuously since 2020. Even though the markets have not been so great of late.

If that holds, you will have enough buyers whenever the market corrects, and if you take the market too high — it's already at a 60-70 percent premium to emerging markets — FIIs will come and sell. If the prices are irrational, even promoters will sell, for 50 percent of the holdings are with promoters. What will a promoter do if they take the PE from 30 to 50. He may say, "Okay, here's 5 percent of the company for you at this price." If that happens, and it will happen, some companies will definitely offer enough stock at a certain price. If we pull up the valuation beyond a point, we'll see a lot of selling.

We've seen some degree of FII traction in the last six months. How do you view FIIs in the larger scheme of things because DIIs (domestic institutional investors) have been consistent over the last six, seven years.

India’s share of the global market cap has grown. We're at about 3.5 percent because we have not corrected, while the world has corrected by 20 percent. So our share has gone up.

If this continues for three, four years, our share could grow to 5 percent, while the share of others will come down. At some point in time, somebody is going to ask them, ``What is your position on India?’’ They will have to say, "Sir, we are short on India.’’ And they will be told to change that. So at some point, FIIs will start buying with a vengeance. At that point, domestics will be buying as ell, and the market can climb further. But I don't see that happening in the near future because emerging markets aren’t that attractive right now.

We've seen Indian markets outperform for seven consecutive years. Do you think 2023 is when Indian equity markets will pause and consolidate?

Indian equity markets have seen huge outperformance last year. The PE multiple, which is at 23 now, might come down to 21 after a year if the index stays roughly where it is.

So, according to you, corporate earnings growth can make or break the market in this calendar year and 15-16 percent is what the consensus is projecting?

No, I don't say the consensus is 15-16 percent. It will be more like 10-12 percent but there are a lot of global factors. If the Ukraine war stops tomorrow, and commodity and energy prices come down further, then India looks awesome.