The US Federal Reserve started tightening its easy money policy earlier than expected two months ago, responding to high inflation. It has decided to end bond purchases in March 2022 and hinted at three rate increases next year.
According to Neelkanth Mishra, co-head of equity strategy, Asia Pacific, and India equity strategist, securities research, at Credit Suisse, monetary authority meetings will be important in 2022 as central banks in the developed world calibrate the level of tightening to retain their inflation-fighting credentials without triggering a recession.
On earnings in the coming year, metals and some sectors with global exposure may see downward revisions, whereas domestic cyclicals like financials, industrials and cement as well as some domestic consumption names should see upgrades, says Mishra, who is rated among the best analysts in India by the Institutional Investor and Asia Money polls.
The likely normalisation of monetary policy in India, results of important state elections, disinvestment of large companies, and a potential 5G spectrum auction are among the key factors for the market next year, says Mishra, a gold medallist from the Indian Institute of Technology, Kanpur. Edited excerpts from an interview:
What is your economic growth estimate for 2022 and what are the associated risk factors?
We expect output in the fiscal year ending March 2023 (FY23) to be 12-13 percent higher than in FY20. This is around 6 percent below the pre-pandemic path, or where the economy would have been if not for Covid-19. This is also 4 percentage points higher than current consensus forecasts, as well as those of the Monetary Policy Committee.
There are risks to the upside as well as downside to our forecast. Downside risks arise from global growth concerns, as we believe end-demand outside the US is weak, and that is being hidden by the fog of supply disruptions and bull-whip effects; volatility in global financial markets as they trade on inflation signals from the US that few of the current generation of traders are familiar with; another spike in global energy prices, and of course, from a new and more dangerous Covid variant necessitating more activity restrictions or slowing down the pace of normalisation.
Do you expect further corporate earnings upgrades in the coming quarters? What sectors will drive upgrades in the Nifty EPS?
We need to look at changes to FY24 forecasts – this may appear to be too far away to have much visibility, but a year from now that’s what the market will be trading on. One must also remember that in each of the pre-Covid years in the previous decade, Nifty EPS forecasts had seen substantial downward revisions in the 2.5 years it takes for the first forecasts for a year to become reality.
We have instead seen upgrades to FY23 this year and we expect some upgrades to FY24 as well, around 5 percent from current levels. We believe metals and some sectors with global exposure may see downward revisions, whereas domestic cyclicals like financials, industrials and cement as well as some domestic consumption names should see upgrades.
Will India’s premium to global and emerging market equities remain elevated in the coming years?
A P/E (price/earnings) premium for a sector or a market reflects stronger growth as well as better visibility – if earnings even three years out can be forecast in a reasonably narrow band, the market starts pricing them in; this is the reason consumer staples firms, for example, trade at higher-than-average multiples. As this holds true for several listed names in India – healthy underlying economic growth, and a turn-for-the-better in the earnings cycle in several sectors – India’s P/E multiples are higher.
The low-single-digit annual growth in profits between FY12 and FY19 was due to nearly every sector seeing a growth slowdown: banks’ balance sheet clean up, slowing IT services revenue growth, weak commodity prices, a downcycle in global generics pricing, and so on. Many of these trends are reversing.
That said, market valuations tend to be volatile, moving above and below what can be called ‘fair’ value, as they are affected by crowd behaviour and have self-reinforcing tendencies. India’s premium to global equities has been in the range of -5 percent to 35 percent in the past decade. In September, it had reached decadal highs. After some correction, it is now off the peak, but is not at a level where the market looks attractive.
Why do you prefer domestic cyclicals over global cyclicals, and why are you overweight on financials, industrials and cement in Credit Suisse’s 30-stock model portfolio?
We believe forecasts for domestic growth need to be revised up, and those for global growth are likely to see downward revisions. Further, while most sectors on 12-month forward earnings are expensive versus their own history, some of the domestic cyclicals appear relatively cheaper on FY23 and FY24 earnings. If domestic growth forecasts see upgrades, as we expect, these stocks become relatively more attractive.
What are the key events to watch (domestic as well as global) in 2022?
Meetings of monetary authorities would be important as central banks in the developed world calibrate the level of tightening so that they retain their inflation-fighting credentials, but at the same time not tighten so much that they trigger another recession. They also need to worry about the fiscal impact of higher rates, given the elevated debt-to-GDP levels in the US and the EU. The US Federal Reserve has already started tightening faster than was expected just two months ago, responding to high inflation prints.
Similarly, the conclusion of the 20th Party Congress in China can allow the government to increase focus on economic issues. Continued normalisation of monetary policy in India is also likely next year, as evidence of stronger-than-expected growth comes in. In India, results of some important state elections, if adverse, can affect outlook for economic reforms as well as policy. Several other developments like disinvestment of large firms and potentially 5G auction could also provide important catalysts to the market. India’s inclusion in the global bond indices is also likely next year, which can reshape the macroeconomic backdrop somewhat.
What are your broad expectations from the upcoming Union Budget?
It will be interesting to see how the Centre adapts to the stronger-than-expected receipts this year while setting the deficit target for next year. It can choose to set a lower deficit target, accelerating the adjustment to the stated 4.5 percent by FY26, or decide to spend more on sectors like health, education, defence procurement, or further growth in infrastructure spending, like on railways.
Given that growing the denominator, i.e., nominal GDP, is a faster path to bringing down the debt-to-GDP ratio, which is currently at worrying levels, it would be preferable to spend more, particularly as the bond market is primed for higher deficits. At what point to wind down the significantly higher subsidy spending on food and fertiliser would also be an important decision. The government may also need to work with state governments, which are sitting on significant surplus cash (Rs 2.9 lakh crore at last count), primarily as lockdowns hurt their ability to spend. As this is spent, the economy should see another boost.
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