In an interview with Moneycontrol's Kshitij Anand, Relli said that coronavirus has disrupted the economic growth momentum in India and postponed the earnings recovery by a few quarters.Edited excerpts:
Q) Indian market cap touched $3 trillion this week. Does the rally make you cautious or bullish at current levels?
A) The fact that the journey from $2.5 trillion market cap to $3 trillion has happened in just 159 days (16 Dec 2020 to 24 May 2021) gives joy and at the same time raises the need for caution.
The previous $0.5 trillion rise took 1255 days. On the one hand, the current speed of rise in market-cap reflects the coming of age of listed corporates in India in adverse pandemic times (including midcaps in the latter part of the rally), and on the other hand, it also reflects pockets of possible over discounting of positives in an era of easy money and lack of other alternatives for investment.
Q) The second wave is not yet over for India, and the third wave is expected to hit in October. Do you think the market has factored in third-wave impact? What is the kind of impact you see on markets, as well as earnings?
A) The second wave may have peaked out in most states as per the projections by a few agencies. The lockdown and its consequent effects on the economic activities create a lot of hardships across the strata of the society, apart from impacting the Govt finances and fiscal situation.
The psychological impact of the virus on people who have lost their near and dear ones or who have had a tough recovery will be difficult to overcome in a hurry, although time heals all wounds.
A third Covid-19 wave remains a possibility after 2-3 quarters as per some experts and having coped with two waves, the administration is better equipped to deal with it.
In this period more and more people could get vaccinated or acquire herd immunity. However, if new variants with unexpected impact on health emerge, then it would bring similar pain to people and finances.
As it is, people generally are fed up with all the restrictions that they have been observing for the past more than a year.
The markets have not factored in the impact of the third wave. Whether such a wave will hit India or not, and if yes in what manner is yet unknown.
Also, Indians have now learnt to live with such restrictions though not at full productivity. If and when an equally deadly third wave hits India, markets will have to factor in the postponement in earnings recovery and the consequent impact on Nifty EPS, apart from the negative impact on the fiscal situation.
Easy money policies followed globally have resulted in the valuation expansion taking the burden when earnings growth has been sluggish. If a similar situation prevails when the third wave hits, valuation expansion will offset to some extent the negativity of earnings shrinkage.
Analysts and investors have faith in the India story over the medium term and hence may not sell out in a big way even if the third wave hits, though some correction due to patience running out may follow.
Q) Small & midcaps have remained resilient in the past few months but with most businesses remain shut on account of lockdown that could well continue for some more time – do you think the outperformance will continue?
A) Small and Midcap space gives a chance to earn alpha to the investor. Although big has become bigger lately under disruptive times, there are quite a few niches where small and midcaps tend to do well, especially when the potential in an area is limited, response required by customers is fast, order sizes are small and customized etc.
In such areas, MSME enterprises run by clean and efficient management tend to do well and can attract valuations that are higher than comparable largecaps because their base is small and the potential to grow is large.
Small and midcap indices made new highs after the Nifty and hence these spaces are still playing catch-up.
In COVID times some of these enterprises could be hit due to labour or fund shortage, but there still may be quite a few of these who will continue to do well.
Q) The Warren Buffett indicator is above Long Term Averages at 92%, according to a report. It has come down from a high of 105 in FY21. Do you see this as a sign of caution?
A) While this indicator is widely followed and works well in most economies, India has its unique characteristics. India’s GDP does not capture a lot of activities that are either informal in nature (including a contribution by housewives) or are out of formal channel due to the unaccounted nature of transactions.
The estimate of the proportion of this number varies. If one includes this portion, then the denominator will rise. Also in India, a lot of PSUs and private companies (including startups) are not listed and hence the numerator is also depressed.
But, the impact on the denominator is estimated to be much higher than that of the numerator. Hence, the actual indicator number may still be lower than the long term average.
We in India may have to closely watch P/E, PEG, PBV ratios on an absolute and relative basis considering the unique advantages India offers to investors.
Q) Where do you see smart money moving in various sectors and why?
A) A lot of money has gone into cyclical as investors felt that the economy (post the recent Budget) will start firing on all cylinders. The second wave of Covid has delayed that process.
Reforms undertaken by the Govt over the past few years have also led to the possibility of a lasting turnaround in a few cyclical sectors.
The commodity boom in the global market has led to expectations of better times for sectors producing these. Apart from that healthcare and chemicals has also attracted a lot of smart money over the past few quarters due to competencies of Indian industry/labour and the China+1 factor.
Internet-based businesses are also seeking the attention of smart investors as these could grow exponentially and there is a dearth of such stocks in India.
Q) Lot of IPO have hit the market so far in FY21 and many MFs have taken a big bite out of it. What are the factors which fund managers look at while investing in an IPO?
A) Fund managers typically put a small portion of their AUM in IPOs (unless the mandate of the scheme is to invest mainly in IPOs).
They do not invest with a view to sell soon after listing but want to track the company closely to add more shares after reviewing the company’s performance over a few quarters.
They look at the industry stage, management credibility/competency and the unique strength of the company to decide whether they should invest in an IPO.
Q) From an FII perspective, how is India placed in terms of valuations when compared to global peers. Are we still attractive?
A) Indian has always quoted at a premium to EM index. This is due to its size, its rule of law, its demography, well developed financial system, respected Central Bank, the breadth of skills available at employee and entrepreneur level etc.
India keeps getting its share of flows from the EM allocation and also country-specific flows. At times it receives a higher share and at other times, it receives a lower share.
India witnessed FPI outflows in April 2021, for the first month since last September, likely driven by cautious sentiment toward the second wave of the pandemic in the nation.
Covid waves 1 and 2 have disrupted the economic growth momentum in India and postponed the earnings recovery by a few quarters. Growth is just postponed and is not lost forever.
Hence, depending on the monetary policies followed by the global central banks and interest rate/inflation trajectory globally and India is still an attractive destination.
It is just that some investors may want to fine-tune their entry on dips to have a higher margin of safety.
Q) Which are the key risk to the current bull market? Nifty is down by about 5% from the highs – do you see more downside before things stabilise and why?
A) The fact that we have not seen a deep correction over the last few months could mean that the Nifty is headed higher despite the known negatives in terms of economic slowdown, delay in corporate earnings revival due to Covid-19 waves, etc.
Having said that our markets face the global risks of monetary tightening and consequent unwinding of carry trade, geopolitical risks, commodity price rise affecting our BoP and fiscal deficit, recurrence of Covid-19 in some form or other over the next few quarters hindering a return to normalcy.
Locally the risks include inflation remaining stickily high, interest rates rising to combat inflation and/or protect the currency, partial failure of monsoon and its impact on rural spend, the fiscal situation getting more precarious, and credit rating of India being considered for a downgrade etc.
Q) According to CMIE report, 11 lakh jobs have gone amid rise in COVID. This will hit the economy and earnings of India Inc. Do you think this will put banking and financial sector including NBFCs at a risk in the near term?
A) BFSI sector continues to face the risk of higher slippages due to the second wave of Covid that has impacted businesses across sizes/industries and has led to layoffs.
The RBI has been playing a proactive role in helping banks and NBFCs to face this challenge and emerge in a better shape. Govt has also been supportive in this regard.
We feel that if the Covid situation comes under control soon, most of the people who have lost jobs will again get jobs, although some of them may have to reskill themselves to be more employable.
If the growth momentum picks up well, we will not be surprised if after a few quarters, people start talking about shortage of labour. BFSI sector in the meanwhile has learnt to live with such events and may have to make more provisions in the interim.
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