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DAILY VOICE | China Plus One, manufacturing emerging as megatrends in India, says Tanushree Banerjee of Equitymaster

Despite the possibility of better earnings in the next fiscal, a sharp and unexpected up move in US interest rates can suck liquidity out from Indian markets and cause valuations to crash, says Banerjee.

March 31, 2021 / 07:18 AM IST

Tanushree Banerjee, Co-Head of Research, Equitymaster, believes in playing long and steady and is not the one to be swayed by short-term moves. Investors should take at least a three-to-five-year view on stocks and invest in businesses that can stay resilient irrespective of macroeconomic or market risks, says Banerjee, who has 15 years of experience in equity research and is an expert at picking bluechip stocks.

She is also the editor of StockSelect, a premium stock recommendation service, in which she suggests safe bluechips for the long term. In an interview to Moneycontrol’s Kshitij Anand, she talks about the risks rising inflation and bond yields pose to the Indian market, the sectors that are likely to hog the limelight in FY22 and the next chapter in the smallcap story. Edited excerpts:

Do you think that an unexpected up move in US interest rates can suck liquidity out from Indian markets?

In its latest policy meet, the US Fed signalled that it expects to keep interest rates unchanged, at least until 2023. This means cheap liquidity is here to stay in the medium term. But, the Fed’s stance is based on inflation expectations. The US 10-year bond yields have already moved up from 0.5 percent in August 2020 to around 1.6 percent in March 2021.

So, if there are big surprises on the inflation front, the Fed could be forced to change its stance on interest rates, too.

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Despite the possibility of better earnings in the next fiscal, a sharp and unexpected up move in US interest rates could suck out liquidity from Indian markets and cause valuations to crash.

The recent rise in the US bond yields has led to a knee-jerk reaction on Dalal Street. Which is the level which will reverse the trend for equity markets, with the money moving from equity to bonds?

It’s really difficult to predict the exact yield at which fund flows would start moving out of global equities and get into bonds. Like I said earlier, bond yields have moved a bit over the past seven months.

And the move could be sharper if the inflation numbers turn out to be sharper than what is estimated. Now, markets are not really factoring in very aggressive inflation expectations.

So, there definitely could be knee-jerk reactions in the markets if and when bond yields show a sudden up move.

FY21 resulted in a good 70 percent rally in the Sensex and the Nifty. Do you think investors should pare their expectations for FY22?

FY22 will be a year when earnings of most companies will be higher than historical averages, purely due to the low base effect.

So, markets will see the earnings per share growth of companies, across sectors, looking stronger. As a result, the price to earnings multiple could also look benign.

But it could be very risky to invest based on such near-term expectations.

Rather, investors should consider at least a three-to-five-year view on stocks to invest in businesses that can stay resilient, irrespective of macroeconomic or market risks.

Taking a long-term view will not only help steer clear of stocks that are in speculative territory but also help investors get the advantage of compounding in high-quality businesses.

The vehicle scrappage policy is finally out. What will be its impact and which are the stocks that are likely to benefit the most?

The vehicle scrappage policy is likely to have a big impact on the automobile sector. High-grade scrap will convert to high-grade steel and aluminium for the automakers and this can lead to cost savings by up to 40 percent.

Top automakers like Maruti Suzuki, Tata Motors and Mahindra and Mahindra have evinced an interest in setting up vehicle-scrapping units in public-private partnership mode.

According to industry estimates, it will cost around Rs 18 crore to set up a scrapping centre if the land is leased but if the land is purchased, a centre is likely to cost around Rs 33 crors.

So, despite the tax incentives being offered for setting up scrapping centres, the profitability of such a venture would depend on the cost of setting up and the volume of scrappage.

But the vehicle scrappage policy also needs to be viewed in the context of some lessons from the past.

Post-2009 economic crisis, the US government launched the ‘Cash for Clunkers’ programme which encouraged people to scarp old vehicles and move to less polluting ones. The objective here, too, was to boost consumption and economic activity.

So, while this programme did stoke the growth of automakers for a couple of quarters, it also pushed households that could not afford into higher debt for their vehicles into a sort of debt trap.

Now, since India cannot afford yet another such NPA crisis, the vehicle financing banks and NBFCs, offering loans for new vehicles, will have to frame very carefully the policies for extending such loans.

Which sectors are likely to hog the limelight in FY22?

I prefer to look at sectors and megatrends based on their wealth-creating potential over the coming decade. And over the next decade, I believe there are several megatrends acting as tailwinds for manufacturing companies.

This is not just about disruptive technologies or new policies that could stoke growth for few sectors (like the scrappage policy and electric vehicle policy for auto sector). But there are two underlying megatrends here, which could last for a long time to come.

One, global manufacturers see India evolving into a supply chain hub over the coming decade, thanks to innovation, automation and cost advantages. So, they are setting up capacities in India or shifting them here from China.

Two, after years of stagnancy in capex plans, Indian manufacturers are finally gearing up to set up capacities for new-age products thanks to the PLI (production-linked incentive) schemes.

So, the most efficient manufacturers, across the board, should elicit a lot of investor interest.

Small and midcaps hogged the limelight in FY21. Do you think the momentum will continue in FY22 when compared to largecaps?

We at Equitymaster believe that the fundamentals for smallcaps have improved drastically over the last few years. Be it the quality of earnings (cash flows from operations) or leverage ratios, smallcap companies are better placed now as compared to the last few years.

Amid a tough macro-economic scenario, we believe smallcap companies that enjoy market leadership and are backed by solid fundamentals and management will continue with the strong performance.

While the runup in smallcaps has been sharper than largecaps in a post-Covid rally at 0.4 times, the smallcap to Sensex ratio compares well to the long-term average. It is in fact even currently much lower than the range of 0.6x to 0.8x in the previous peaks.

The institutional ownership in smallcaps, though rising, is still well below the levels seen in previous bull phases in smallcaps.  In a low yield world, as the search for alpha intensifies, we expect the flow of money into smallcap space to continue.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Kshitij Anand is the Editor Markets at Moneycontrol.

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