DAILY VOICE | India's growth cycle to be led by consumption segment, Dhananjay Sinha of JM Financial prefers these 5 sectors

There are concerns on valuations across the world and even for Indian markets, as our benchmark indices are on the expensive side on global comparison. And even at the broader market level, strong retail participation enabled by huge surplus liquidity, corporate deleveraging, weak credit demand and growing deposits, the valuations for smallcap segment relative to largecaps or benchmark indices are at an all-time high, higher than the bubble valuation in 2017.

Thus, there is a scope for some correction for better valuation to emerge. The key question is what will trigger that correction?

The Evergrande crisis has rattled investors globally. Do you think it will lead to a correction across the globe, including India, or it is a short-term concern?

The Evergrande crisis has definitely impacted the market sentiment, as it is seen to denote systemic risks embedded in the Chinese economy, which has been a major driver for world and global growth.

In addition, global investors have invested heavily in China in the aftermath of the pandemic because it was the only country that did not contract in 2020. But China's housing sector crisis was looming even before the episode and the Chinese government was trying to reign in the bubble. There were also concerns of overheating and over leveraging.

Hence, we think the Chinese authorities will allow the markets to induce necessary correction and refrain from announcing any bailout plan.

The episode also reflects China's structural plan to converge back to its objectives of the common good, away from over-investments and over-leveraged economy.

Thus, the Evergrande episode, along with similar responses to the default risk of even state-owned enterprises, indicates that China may have adopted a long-term process of macro adjustments. Hence, markets can undergo the corresponding realignment, which can mean slower near-term growth and phases of correction of 5-10 percent.

Have you spotted any trend at FII desk? Which are the favourite sectors and not-so-favoured one?

Portfolio flows have seen a significant moderation since March 2021 after a good $36 billion surge after the pandemic shock. Lately, there has been some pick up as markets have taken a benign view on the US taper trajectory.

There have been some interesting changes. Unlike earlier episodes, FIIs have gone beyond just the largecap list and invested in a large number of mid and small-cap stocks along with strong retail participation in the smallcaps. That possibly explains the frothy valuation in the broader markets. So, the FII flows have seen multiple sectors benefiting.

Which are the sectors that one can invest in from the perspective of a couple of years?

In the context of expected normalisation of global and domestic liquidity in the coming months and years amid slowed post-Covid trend growth and high valuations, we believe that investment strategy should be closely aligned with the emerging business cycles and visibility of earnings and sales growth.

We expect India's growth cycle to be led by consumption sectors on the back of improved employment arising from the normalisation of operation across multiple sectors, as of now, most sectors are operating at 20-30 percent lower operating levels compared to pre-Covid.

In addition, we can expect continued support from government spending in infrastructure, defence, and development programmes.

So our preferred space will be consumption sectors including stapes, durables, discretionary, autos and auto ancillaries, and pharma. We also think IT sector has a structural tailwind in the form of rising order wins and income growth, which might continue.

Residential real estate in IT hubs can be considered as a second derivative of the booming IT sector. Within the industrial segment, we are selective, focused mostly on consumables.

What is your reading of the Federal Reserve’s policy meeting outcome and its commentary?

The Fed's new normalisation guidance is falling in line with our expectation of "uneasy taper" guided by scaled-down growth outlook and scaled-up inflation projection.

The Fed adopted an affirmative position on the trajectory of monetary policy normalisation, with its patience with high inflation now receding as it has begun impacting growth. The insistence on the transient nature of high inflation has waned considerably.

The advent of quantitative easing (QE) taper from November 2021 is a sealed outcome and rate lift-off starting from 2022 is now an emphatic view of FOMC members. They see a series of seven rate hikes till the end of 2024. The speed of normalisation can be hastened if inflation remains persistent.

In the base case, we maintain our projection of US money supply (M2)/GDP declining from 89 percent currently to 80 percent by end-2024. This should have a downside bias to Indian markets multiple.

…Thus, US monetary policy normalisation should generally extend the moderate pace of FII flows as we have seen April 2021. The trajectory of US dollar will be contingent upon what other central banks too. ECB has also started debating on tapering, it is expected to follow the Fed.

Metals have fallen 10 percent in the last month. Do you expect some more correction?

After having delivered 3-4x stock price performance over the last 18 months, we think the metal sector, particularly steel, can be a drag for years to come. The recent 8-10 percent correction is the beginning of a prolonged phase of underperformance. Further correction is a high-probability scenario. Given the extrapolative rise in global metal prices, especially for steel, there is a proportionate chance of a correction.

Metal companies have gained from rising cash flows enabled by surging price realisation and used it for deleveraging. Some are planning aggressive expansion. We were a ‘buy’ in the commodity sectors since March-June 2020 but now we think the best scenario is baked into the stock prices. We were ahead of the curve in reversing our bullish view since mid-May 2021 but our hypothesis is materialising now.

The Evergrande crisis and the Chinese slowdown, along with lead indicators from the most overheated metals markets in the US and Europe, are telling us that the resurgence of the metals sector is exhausting.

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