India valuations fair amid global turmoil, says Gohil of Credit Suisse wealth

Jitendra Gohil of Credit Suisse Wealth Management

Globally, investors are betting that the collapse of Silicon Valley Bank (SVB) and potential troubles at other smaller banks will force the US Federal Reserve to give up rate hikes for some time and pause. But Jitendra Gohil, director at Credit Suisse India’s wealth management unit, believes it would be too optimistic to expect the Fed to cut. In an interview with Moneycontrol, Gohil said he sees a 25-basis-point hike in the fed funds rate next week and no risk of contagion from the SVB collapse.

Banking troubles have hit sentiment in India as well, bringing down valuations across the board. Gohil believes Indian equities deserve relatively rich valuations versus their emerging market peers. That is because inflation here is less of a worry compared with the US and the Reserve Bank of India (RBI) is mindful of growth. Also, corporate earnings may see pressure but nothing dramatic. Cement, banking, multiplexes and tactical picks based on consumption are what Gohil recommends investors must look at. Edited excerpts:

What do you expect from the Fed post the SVB collapse?

What has happened over the past few days is that the banking sector came under significant pressure. So, the earlier expectation was that the Fed would hike the rate by at least 50 basis points (bps). And now people are expecting 25 bps on a consensus basis. But it is optimistic to think that the Fed will cut as some analysts are expecting. Our view is that the Fed will raise rates by 25 bps. What is important is the guidance from the Fed. The banking problem is extremely worrying, and it makes sentiment weak or negative. But we don't think it will have a major contagion effect.

In 2022, markets had begun to price in Fed rate cuts by the second half of 2023. Is that expectation gaining ground now?

We should note that the yield is swinging very rapidly in the US, right, from 3.4 percent to almost 4 percent, and now, down to 3.6 percent. So, I think the Fed needs to be very consistent in approach, and we feel that the Fed is going to aim towards a higher rate for longer. They may not try to change their view dramatically in the upcoming meeting. The market may try to anticipate something, and they might turn around too, but our job is to guide what is the right thing to do. We think the Fed should raise the rate by 25 basis points and keep it there. And hence, our view on equity is negative.

SVB collapse has had no direct impact on Indian firms. But have we seen the worst in terms of sentiment?

Sentiments have a short-term impact, but what matters is the fundamentals. Have yields been corrected in the US? The answer is yes. The dollar has weakened, unlike in previous risk-off situations when the dollar had gained. This is good for emerging markets. Another positive is that oil has also fallen below 80. I believe that weaker global growth is good for India. For instance, last year when the markets corrected 20 to 30 percent elsewhere, Indian equities made a new high. Weaker growth elsewhere tends to have a positive impact on India because commodity prices start to fall. And this time around, the dollar has also weakened. So, that is also somewhat positive. We don’t have a major impact in terms of a direct impact on our startups. As of now, it looks like we should be able to weather this volatility.

If we talk about the emerging market basket itself, do the negatives outweigh the positives?

The numbers are very interesting because generally when we see risk-off sentiments, emerging markets see significant outflows and problems. But this time around, China is reopening, so that gives support to emerging market flows. Secondly, emerging markets countries did not provide a substantial stimulus during covid and hence the inflation here is under control. So, just to give you a perspective, for the US and Europe, the target inflation is somewhere around 2 percent. Their inflation is running three to four times more than that. But in India, the target is 2-6 percent. We are still closer to that level. So, relatively I would say that emerging markets have managed their crises frugally. I wouldn't say every country did really well, but large economies like India did not provide a substantial stimulus. We are a little bit cautious in the first half not because of the earnings risk, but more because of the valuations, which now approaching a fair zone after this correction.

Indian markets are generally viewed as expensive versus their EM counterparts. Do valuations look reasonable now?

So, the valuation has already been corrected from 22 times to 18 times (price-to-earnings ratio) now.  We have been very vocal that India should trade at a higher valuation than pre-covid levels. The average valuation for pre-covid is somewhere near 16.5. India’s fundamentals are far superior to what they were before the Covid pandemic. One reason is the government balance sheet has improved dramatically, and the budget has become more transparent. Second, corporate balance sheets have improved dramatically. Third, our banking system was in the doldrums before covid but NPL (non-performing loans) ratios have come down. In fact, this is going to improve in the next couple of years. So, I think all these points towards India being able to command a better valuation compared to historic levels.

The argument is that why not sell India and invest in other cheaper markets? But funds hold so much of other markets, the value of their India holdings is near a 10-year low. Our weight in the MSCI Emerging Market Index has gone higher, almost doubled. We have seen that in the past that FPIs (foreign portfolio investors) have come to India at around 18,000 levels when they were selling at 16,000. I think 17 times the PE ratio is a decent number where we are currently, and there is not a major downside from here. In the second half of this year, there will be a lot of clarity in terms of how the Fed is going to behave. There could be more tailwinds coming in after June. We might see more supportive arguments for equity as earnings would catch up to justify the higher level of valuation.

Okay, so does that mean the corporate earnings outlook is positive? Do you see more improvement here?

I feel that the market is a little bit optimistic about earnings.  Fortunately, we have seen things haven’t been cut so badly as of now, despite so much of inflationary pressure, consumption not picking up, and margins being under pressure. On a QOQ basis, we feel the margins should start to improve. And hence there could be some tailwind from this. However, the global growth slowdown can start to impact our topline growth. Hence, we are a little bit cautious in the near term and believe that earnings might see some kind of sideways movement. But from a medium-term perspective, we think that the market is underestimating growth in India.

From a one-year Nifty Target perspective in March 2024, I would be investing based on one-year forward earnings, which is March 2025. We think there could be a 5-10 percent correction, but if we apply an 18 times PE ratio one year from now, we can see a 12-13 percent upside in the Nifty. In other words, we expect some correction but not a sharp one. So, in earnings, yes, there could be a correction, but that will not be dramatic.

Do you think inflation is as worrisome for us as it is for the US?

We did an analysis a couple of years ago that India can weather around 6 to 7 percent of CPI inflation. Only after 7 percent, India starts to see fundamentals deteriorate. I think up to 6 percent inflation can be tolerated. But if we are too aggressive in terms of controlling inflation, to bring it to 4 percent, then our nominal growth falters. I think around 5 to 6 percent inflation and 5 to 6 percent of real economic growth is an optimum level. And I think the RBI has also understood that. The moment inflation started shooting up about 7 percent, they came out with the first 50 basis point rate hike. Almost 65 percent of the population is 35 years of age, we need jobs and we need time to generate jobs. And for that to happen, we need better nominal growth.

What is your expectation with the RBI’s monetary policy?

We expect no rate hike in the upcoming policy meeting. If there is a sudden rise they might have to tighten, but our view is that looking at the inflation trajectory over the next few months, looking at global developments, the economy needs some support. So, I think the RBI has some elbow room to pause. So, that would be a small tailwind for Indian equities.

What sectors are you looking at right now that may give clear upsides?

The sector that we like in the near term is definitely cement. We are in March and before the monsoon construction activity is generally solid and the data points and the channel check suggest that cement demand is picking up. The second is the banking sector, where the valuation is around pre-covid levels and probably below, as well, for some. Right now, the banking sector is doing pretty well and valuation is not very demanding. There could be pockets of opportunities and one should look at banks from a medium- to long-term perspective also. We are not buying expensive banks and PSUs. Tactically we were extremely overweight, and now we have cut down significantly on our PSU exposure. We are looking at second-tier banks, as well. We are cutting our exposure to PSUs and moving to private banks. Another sector is multiplexes.

Are there any trends that you are positive about?

We are very positive in terms of the premiumisation trend. So, we think that per capita income is going to see a dramatic improvement — if India can clock 10 percent nominal GDP over the next three years, then we are going to add 100 lakh crore in additional GDP on a higher base. Some of the premiumisation stocks are worth looking at and we should remain overweight for the next few months. We like it structurally as well. Lastly, we think the world is going to face inflation concerns because they are now cutting their dependence on China. India's labour cost is cheap and the government has done a phenomenal job in terms of ease of doing business. So, I think that contract manufacturing will do well, be it in chemicals or other sectors.

Are there any sectors that you would avoid?

We are avoiding the IT sector. We think that the valuation is higher than average, and there will be a downward correction in earnings. (We are) More cautious after the US banking issues — Indian IT has a higher exposure to the BFSI segment. I think otherwise consumption is weak, you have to be extremely selective there. We are still waiting maybe for one more quarter before we take calls on consumption.