“We expect volatility in the financial markets to persist till more clarity emerges on central bank policy and the direction of the global economy,” Chirag Mehta, CIO at Quantum AMC said in an interview to Moneycontrol.
Given the headwinds, further correction and consolidation cannot be ruled out but there is a clear opportunity emerging from a valuation standpoint in select pockets, he said.
He expects some slowdown in domestic equity buying as the volatility scares investors. However, “Indians are still under-allocated to equities. We should thus, see the trend of increasing allocations continue over the long term,” he said.
Edited excerpts of the interview:
Do you expect the market to see more correction considering the current macro environment and its impact on growth and earnings?
High inflation, Russia’s invasion of Ukraine and China’s COVID lockdowns are all taking a toll on global growth. Central banks are facing the challenging task of bringing down inflation, without triggering a recession. Historically, tightening monetary policy into a period of economic deceleration hasn’t gone well.
Understandably, investors are nervous. But given that there’s a real possibility that central banks may accelerate the slowdown with their aggression, they may reconsider their hawkish stance, going forward.
We thus expect the volatility in financial markets to persist till more clarity emerges on central bank policy and the direction of the global economy. Given the headwinds, further correction and consolidation cannot be ruled out but there is clear opportunity emerging from a valuation standpoint in select pockets.
Do you see any possibility of slowing down of domestic inflow into equity markets if the global macro situation persists for long?
The relentless FPI withdrawals from Indian shares that we are witnessing are a result of global risk off sentiment, India’s relative premium valuation, stronger dollar, and higher US Treasury yields. While this may sour domestic investor sentiment to some extent, sentiment will be supported by robust domestic macroeconomic conditions in the form of sustained economic recovery, thriving exports, strong GST revenues, etc.
On the other hand, with global supply chains under stress, and energy prices firming, imported inflation will continue to persist for the foreseeable future. This will impact corporate margins and consumer spending in the short term, and warrant tighter policy by the RBI, which too will weigh on sentiment.
The current rate at 4.4 percent is still below the pre-COVID levels. So, we can expect further rate hikes. Real rates in India still remain negative and there is a risk that the surge in financial savings seen over the last few years may reduce as households seek protection in physical assets during inflationary times, as was seen in the last inflation cycle from 2008-2013 where CPI averaged close to 10 percent and the share of financial savings dropped from 50 percent to 30 percent. So, we expect some slowdown in domestic equity buying as volatility scares out investors. However, Indians are still under-allocated to equities. We should, therefore, see the trend of increasing allocations continue over the long term.
Do you expect a major slowdown in global growth as the UK already seen contraction in growth in March 2022?
As the war between Russia and Ukraine continues, Vladimir Putin has initiated an energy war by cutting off gas supplies to Poland and Bulgaria, threatening to do the same for other “unfriendly nations'' that refuse to pay in rubles. The European Union on the other hand is mulling a complete ban of Russian energy imports. This will further fire up inflation in the EuroZone which hit a record high of 7.5 percent in April.
A combination of higher inflation and tighter monetary policy will drag down growth in the continent, with France already stagnating and Italy contracting in the first quarter. Given the fact that the Bank of England and the European Central Bank can only do so much to bring down supply-constrained inflation, the continent could be staring at a slowing growth and persisting inflation for some time.
Do you think the pain of inflation and rate hikes by central banks is yet to be digested by the equity market?
While some of the dynamics have been priced in, there could be more pain ahead based on how the cocktail of geo-economic and geo-political factors play out. Thanks to years of easy money, the pandemic, and the war-induced supply disruptions, inflation is at multi-decade highs. Central banks like the US Federal Reserve have embarked on their most hawkish policy in over two decades to bring down price pressures.
Expansion of central bank balance sheets has been a huge driver of gains in global risk assets in recent years. Thus, a reduction is likely to have the opposite effect. Higher interest rates will compress stock valuations as discounting rates go up. Higher the price-earnings (PE) of the stocks, higher will be the sensitivity to change in interest rates. Highly leveraged companies will see pressure on earnings due to interest cost going up. Further slowdown in the global economy is a very real threat now and emerging markets tend to suffer more in a such scenario. Closer home, the pace and extent of the RBI’s policy tightening too will impact the markets. But, we believe India is on the cusp of a cyclical recovery which has been dampened to some extent due to inflation which has pushed back growth by two-three quarters which the markets have already started to price in.
As there is relentless selling pressure, what are those pockets that are looking attractive now?
A portfolio comprising businesses with reasonable valuations and less leverage will be best suited in this environment. We believe the current global macro challenges do not derail the domestic cyclical recovery, though it might delay it a little. Our portfolio is tilted towards cyclicals like banking, consumer discretionary, building materials and utilities as India’s economy sees a cyclical uptick in the next couple of years.
Is it time to buy technology stocks in bulk, as the IT space fell more than 16 percent in the last one month?
We are comfortable with the growth prospects of the IT sector in the medium term, but valuation comfort has been eroding due to the sharp run-up. If the current correction in IT continues it will offer a good entry point.
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