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'Earnings growth needs to sustain along with benign interest rate and ample liquidity for significant market upside'

We believe the Nifty50 performance has been relatively polarized driven by top five to ten stocks and broader market is still attractively valued.

November 28, 2020 / 10:21 AM IST

The direction of the equity market is determined, primarily, by valuations, earnings growth, liquidity and interest rates, said Gopal Agrawal of HDFC Asset Management Company, in an interview to Moneycontrol's Sunil Shankar Matkar.

We saw a strong earnings growth in Q2 with better margin and improved balance sheet. Nifty50 index crossed 13,000 mark recently, for the first time, showing more than 70 percent rally from March lows.

Hence, he feels for significant upside from these levels, earnings growth needs to sustain along with benign interest rate, ample global and domestic liquidity, etc.

HDFC Asset Management Company, the investment manager to the schemes of HDFC Mutual Fund, is one of India's largest and most profitable mutual fund manager with Rs 3.5 lakh crore in assets under management.

The Senior Fund Manager at HDFC Asset Management Company believes that worst is largely behind us and economic activity should improve sequentially.

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Further, driven by a low base, normalisation of activity, pent up demand and supported by fiscal & monetary measures, growth should rebound in FY22, he feels.

Edited Excerpt:-

Q: Moody's has raised the growth forecast for the next fiscal year FY22. Do you think the second wave of coronavirus pandemic across the world is likely to impact economic growth in coming months? What are your economic growth expectations for FY21 and FY22, why?

We are currently witnessing strong rebound in consumer spending, auto sales, home registration, power demand, GST collection, etc. Further, in the last three weeks, the world has received strong data on the efficacy of COVID-19 vaccine from three pharma companies. There can be some impact of COVID-19 spread during winter but with effective vaccination, things are likely to improve over time. While due to the impact of lockdown, GDP is likely to contract in FY21, we believe that worst is largely behind us and economic activity should improve sequentially. Further, driven by a low base, normalization of activity, pent up demand and supported by fiscal & monetary measures, growth should rebound in FY22.

Q: Market had a strong run of 70 percent from March 23's low point. Do you think the rally will continue and make fresh record highs in coming months given the ample liquidity and positive development on the vaccine front along with improving economic data points? Or is it a time to turn cautious and book profits?

The direction of the equity market is determined, primarily, by valuations, earnings growth, liquidity and interest rates. We saw a strong earnings growth in Q2 with better margin and improved balance sheet. Nifty50 index crossed 13,000 recently and is trading at 22.2x FY22E as on November 24, 2020 (Source: Kotak Institutional Equities). These are reasonable valuation multiples, especially considering the low-interest rate environment. However, we believe the Nifty50 performance has been relatively polarized driven by the top five to ten stocks and the broader market is still attractively valued. Also, while recovery from the bottom is strong, it should be kept in mind that Nifty50 Index is only slightly above the highs achieved pre-COVID. As of end-October, the 10 year Nifty50 CAGR stood at around 7 percent and lagged growth in nominal GDP. Historically, periods where Nifty50 returns have been below 10 percent CAGR for a 10-year period, it has delivered good returns in medium to long term. However, for significant upside from these levels, earnings growth needs to sustain along with benign interest rate, ample global and domestic liquidity, etc.

Q: How the current economic situation is suited for launch of HDFC Dividend Yield Fund and what does it indicate generally? Why do you think there is enough investor appetite for funds launched in this category in the market?

Low-interest rate scenario, relatively higher dividend yield and attractive relative valuation make it suitable for investors to consider this product with a medium to long term horizon, subject to market risks. The risk-reward metrics of this product is between Large-Cap and Large & Mid Cap funds as dividend-yielding companies, typically, have mature businesses and strong cash flows which make them less susceptible to volatility.

Low-interest rates tend to make dividend yield stocks relatively attractive. Repo rate has been reduced by 250 bps in the last 2 years. Currently, 1 year G-sec yield is hovering around 3.4 percent while NSE NIFTY Dividend Opportunity 50 Index (NDOI) itself offers 3.8 percent yield. The spread between the two has fallen from 5 percent in October 2013 to -40 bps currently. Given the comparable dividend yield vis-à-vis fixed instrument along with the possibility of capital appreciation, prospects of good dividend yield stocks look good in my opinion.

Since its availability, the valuation of Nifty50 TRI index relative to NDOI is near life-time high. Historically, whenever it has happened, both tend to converge over next few years. For e.g. high difference prevailing during 2011-12 converged in 2016-17. This could result in capital appreciation apart from dividend accrual for investors.

In the last 13 years i.e. since the time it is available, NDOI has outperformed Nifty 50 TRI in 8 out of 13 years. However, in the last 3 years, it has underperformed. Given the low-interest rate & ample liquidity, there is a possibility of reversion to mean over time, in my view.

Q: Banking & financials sector witnessed strong buying interest from last month. Do you think all worries are over for the segment and the indices will hit new highs in coming months?

BFSI sector corrected significantly on fear of COVID-19 impact on increasing NPA in the sector. Though the jury is still out, initial trend and commentary from major banks suggest that situation is not as bad as feared. In addition to this, most of the large banks are well-capitalized with equity fundraising done and pre-provisioning operating profit to Loan book is close to 3 percent. This implies we are unlikely to see a reduction in book value in the current crisis period.

Q: Do you think September quarter earnings really give an indication of strong earnings growth in the coming years?

Q2 result season was followed by strong festive sales along with improvement in power demand and commodity prices. Q2 result has shown strong de-leveraging by corporates driven by improved operating cash flows and reduction in debt. The strong willingness of Indian Inc. to improve the health of balance sheet augurs well for sustainability and increased dividend pay-out, thus, higher ROE over time.

Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Sunil Shankar Matkar
first published: Nov 28, 2020 09:51 am

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