IT could be staring at more downgrades in Q1, says Krishnan of Marcellus

IT could be staring at more downgrades in Q1, says Krishnan of Marcellus

Dark clouds  of uncertainty loom over IT (information technology) . Relentless selling pressure has already battered the IT pack, and some believe there may be more pain ahead.

Indeed, Krishnan VR, smallcase and a Fund Manager at Marcellus Capital Partners LLP, believes the IT sector may be staring at more downgrades in Q1 FY23-24.

With a wealth of experience spanning a decade, Krishnan is no stranger to the tumult of equity and debt markets. He was previously with Morningstar, where he contributed to developing investment products, and prior to that he was an analyst at D.E. Shaw & Co, and Goldman Sachs Asset Management.

In an interview with Moneycontrol, Krishnan shared that he sees fixed income as the way to build a rainy-day fund, but equity as the way to wealth.

We are not staring at political uncertainty, and inflation is also under control, unlike some Western countries, which are facing a recession. Plus, I believe the market is factoring in the continuity of the existing government post next year’s general elections. Further, in the past few years, government initiatives such as the PLI (production-linked incentive) scheme have helped increase productivity, which has in turn expanded the GDP. Bearing all this in mind, I don't think the markets are expensive.

I think India is a longer-term story than people realise. While you might look at valuations based on trailing indicators and say that it’s very expensive, when you look at the growth potential, India is like an oasis amid a slowing China, and other countries facing geopolitical uncertainty or recession.

So what investors are discounting right now is where India will be in the next 5-10 years from now, and they don't want to miss it which is why the Indian market is still attractive at record highs.

I look at fixed income as a way to build a rainy-day fund. When I say fixed income, what I am talking about is G-Secs, where there is no liquidity or credit risk. That way, I can get that money whenever I want and also earn some interest. By investing in fixed-income products you can never make any real money because your real returns will be minimal.

To generate inflation-beating wealth, equities would be the way to go. If one simply invests in the index, one could easily earn nominal returns of 12-14 percent. Net of inflation, one would still be earning upwards of 5 percent on the investment.

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The only way we hedge our equity investment is by buying good quality companies. If you do that, you tick all the right boxes, namely, clean accounts, prudent capital allocation, and competitive advantage. And that automatically limits your downside. If you choose a company that dominates the industry, it is the price setter. The price setter will have pricing power, which means if need be the company could pass on any increase in costs to its customers. The other strategy is to have scale. In case a portion of the business goes to zero, you still have other segments to bank on.

Banks generally benefit when the Reserve Bank of India (RBI) increases the repo rate. During the pandemic, rates slumped to record lows. But in 2021, inflation became a concern following the Ukraine war, which drove the RBI to increase rates.

Generally, when the headline rates go up, the banks also re-price their loans. And usually, the repricing of loans is quicker than the repricing of liabilities. Though with a lag, increasing rates benefit lenders, and since the equity market knows that, it starts baking in the benefit. I think this benefit is largely behind us. This means that the repricing of loans and expansion in the net interest margins of these lenders has mostly been factored into the valuation of these banks. What we are now looking at now is how responsibly lenders grow their loan books.

With financial services still comprising close to 40 percent of the benchmark index, the banks will make up the biggest chunk of the earnings. But what needs to be watched is not just the growth in loans, but also who they are lending to — to know that loans don’t turn sour.

There are some good IT companies in the large, mid and small-cap segments. If you look at the share price of some of the large IT companies, it seems the softness might have already been factored in. While demand shouldn’t be a challenge for the next 10 years, the next 10 years may not be as rosy as it’s been. But neither will it be so bleak.

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There is definitely more pain ahead in the near term. That is because their overseas clients, who are feeling the heat of inflation, have turned cautious in terms of spending which does impact technology players. This could hurt the earnings of IT companies in the near term.

We like the specialty chemicals space actually, because of the China-plus-one angle. China dominates the active pharmaceutical ingredient manufacturing space, and we see an opportunity here.

Western drug-makers who depended on China for all their requirements are now thinking of diversifying the supply of key starter materials. . Even if 10 or 20 percent of that opportunity moves to India, it will almost be a big change in terms of trajectory for the company because the scale of these companies is small so a minuscule increase in demand could also create a big difference.