Daily Voice | Rate cuts will happen later than when markets are expecting, says this fund manager

What is your outlook for equity markets?

We do believe that eventually there will be a time when the rate cuts will happen, but they will happen later than what the markets are expecting. Till then, markets will continue to be in a zone of uncertainty.

Indian markets rallied a bit in May, but that is simply India clawing back some of the underperformance vis-à-vis emerging markets witnessed earlier in this calendar year. I think FII (foreign institutional investor) flows are going to be critical going forward.

FIIs bought over Rs 24,000 crore worth of equities in May. Do you think they have made a comeback?

I think we need a consistent period of three-four more months of FII inflows, and then we can be bullish about Indian markets. Right now, constructive would be the right word.

So constructive and not bullish. How much of your assets under management (AUM) is now invested in equities?

At the moment, about Rs 2,000 crore of the Rs 13,000 crore AUM is invested in equities. According to our model, a yield gap of 1.3 or below indicates bullish territory. Two and above is bearish territory. Right now, the difference between bond yield and earnings yield is 1.5.

So, the case for increasing equity allocation is growing by the day, but we are not in the bullish zone yet. Currently, 10-year government bonds with a 7 percent-plus yield look good for a two-three-year investment horizon.

Which sectors will you load up on, once the yield gap is below 1.3?

Banks. It is largely a domestic sector. Credit growth of 11-12 percent can be comfortably achieved over the next few years. The net interest margin (NIM) of ICICI Bank is at 4.9 percent and Kotak Mahindra Bank’s is at 5.8-5.9 percent. These are solid numbers. Along with this, low credit costs make the sector very attractive.

Private sector banks have an unfettered ability to take a larger market share of both loans and deposits. As PSU banks grew risk averse in the past few years due to a growing bad loan book and stretched balance sheets, private banks were able to address the gap in the market. We find that they continue to be best placed to deliver consistent growth over the next few years and hence we will continue to be more bullish on private sector banks than PSU counterparts.

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But as deposits get repriced, there is a fear of margin pressure for banks. What is your view?

NIMs are at peak levels, so obviously, margins will compress from these levels. But the resultant scenario would still be very decent margins. Earlier, credit costs were eating into 4 percent NIM and the follow-through to the bottom line was small. Today, credit costs are low, so NIM net of credit costs will continue to be at historic highs.

Government capex is in full swing while private capex is not catching up. What do you think are the reasons?

Setting up a plant and increasing capacity takes two-three years. You need to be in a zone of certainty to do so. At the moment, global factors are not too supportive. Capacity utilisation for India Inc is still around 75 percent. At 80 percent, it becomes very difficult for an industrialist to not think of increasing capacity. It's almost a decision taken out of your hands because you don't want to miss out on the next demand cycle. At 75 percent, I think we're still not there yet.

Pockets like renewable energy and data centres are seeing capex spends, but on an aggregate basis, capacity utilisation still needs to move up.

Looking at the domestic scenario, what other sectors are you bullish on?

Real estate. It will be a cycle that will last for the next three-four years. It is rate-sensitive but it is driven more by real rates rather than the nominal rate. Real rates are still 0-0.5 percent. End-user demand is strong, especially from cities like Mumbai, Pune, Hyderabad, parts of NCR and Ahmedabad.

In India, mortgages are typically floating, unlike the US where people get locked into a 25-year rate. Now that we are talking about interest rate cuts, it is a relatively easy decision for a homebuyer to get into a loan obligation. Interest rates on home loans are linked to an external benchmark rate (like the repo rate) and, hence, whenever there is a policy action from the RBI (Reserve Bank of India), these rates change and are immediately reflected in the individual’s loan commitment. To put this in numbers, home loan rates rose by about 200 bps (basis points) in the past year, reflecting the repo hike by the RBI. With the RBI poised to cut rates towards the end of the year, home loan rates are also set to progressively decline, which could further boost demand for real estate.

Also Read: Investor participation fuels surge in cash volumes as Indian markets rally

Which sectors are you underweight on?

We are underweight on two sectors—IT and metals. Metal prices surged due to supply chain disruptions, the Ukraine-Russia war, and the China reopening theme gave a further boost to the price upcycle. But now, we are in a zone where those prices are difficult to justify, especially with the lower growth rate in China after its reopening.

We are underweight on Indian IT companies because their biggest end user—the US financial sector—is going through some serious challenges. IT spends are still treated as discretionary spends, and for a bank trying to cut costs, the most obvious thing is to not award any new project.

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