Daily Voice | Why this ace investor thinks valuation alone can't trigger a 10% correction in markets

The long-term average valuation multiple of the Nifty over the past two decades or so has been about 15x on a one-year forward earnings basis. From this perspective, current valuations at about 20x are at a premium, boosted by easing inflation in an abundant global liquidity scenario.

But, over last two decades, composition of the index has moved in favour of relatively structural businesses which command higher multiples vis-à-vis cyclical ones; and hence adjusted for that, this premium is not as large. Moreover, earnings growth outlook over the next couple of years of mid-teens is better than the average of this historical period. Also, there is increased confidence in the longer-term structural growth outlook of India, especially in a relative global context.

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However, as the run-up has been rather swift, more in mid-caps and especially in small-caps in the space of a quarter or so, fears of markets looking extended get heightened. The Nifty having given returns of about 14 percent, within less than four months, which generally is the expectation on an average for a full year, consolidation for a while cannot be ruled out.

As far as short-term corrections or run-ups are concerned, they can’t be called out on a consistent basis, as the markets have a mind of their own. A 5 percent kind of correction can occur at any market level and given the recent fast-paced run-up, it is a distinct possibility.

A bigger correction, of let’s say 10 percent, if any, will not be triggered by valuations alone and could be driven by any global events like spike in oil prices, geo-political matters, or something else rather than domestic issues.

From a domestic perspective, we expect a decent earnings season and in July, the monsoon has also bridged their earlier deficit. For a patient investor, who is not looking to time the markets, there are high-quality businesses out there that will compound their earnings over the long term.

One of your favourite sectors that can't be kept out of portfolio...

The consumption theme has multiple shades and we like many of them, given the favourable Indian demographics, a higher proportion of youth population, low base consumption levels, rising incomes and aspirations, premiumisation, and increasing distribution reach.

While near-term focussed valuations always appear high in this sector, we keep the perspective of the long-term opportunity in terms of its sheer size, the multi-decade growth runway and the strong moats and high quality of the businesses that operate in the space.

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Having said this, the economy offers opportunities across various sectors, and we are interested in several pockets, including financial services, manufacturing and healthcare.

Do you expect over 15 percent earnings growth for FY24? Which sectors will take the driver's seat?

Earnings growth for FY24 are likely to be in that ballpark region. A number of sectors like telecom, cement, capital goods, paints, oil marketing companies, NBFCs, and steel are expected to post better earnings than the overall market.

Your take on retail inflation for the rest of financial year...

Retail inflation or CPI at 4.8 percent in June was higher than the market expectations. This was largely due to seasonal spike in vegetable prices, primarily tomatoes, which were also impacted by the erratic weather and deficient rainfall in different parts of the country.

Inflation in this segment is likely to remain high for the next few months till supply issues are sorted out. Prices also increased significantly in few other components of the food basket. However, government interventions like stock limits and also higher imports should have a cooling-off effect.

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Most constituents of non-food inflation remain on a downward trajectory. Core inflation has now been below 6 percent for the last few months and is likely to be benign given base effects and lower commodity prices. So, while inflation for balance of the year is likely to be higher than the June print, we expect it to remain below 6 percent for the year.

Do you expect the Fed to take a pause in rate hike cycle for a longer period after a likely rate hike in July?

In the latest print, US inflation fell to 3 percent, below 4 percent levels for first time in two years, though aided by high base effects. Core inflation, which has been quite sticky, also declined meaningfully. While the fight against inflation might not be over, for example, the core at 4.8 percent is still higher than long-term average of 3.7 percent, the larger part of the battle is done.

Disinflationary impulses are getting entrenched. So, the Fed might take one more hike and then go on a pause.

The US business cycle has slowed down substantially, and this has been accentuated by the tighter credit conditions due to the financial stress in the banking sector. While probability of a recession have reduced somewhat, the yield curve remains inverted (10-year minus 2-year yield curve) and has been so for a year. This inversion in yield curve has been a reliable indicator of recessions in the past.

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