Nilesh Shah on Israel impact: Need for correction as Indian markets expecting perfect 10/10 score despite rising oil, higher rates and premium valuation

From our point of view, as oil prices go higher, and they are already high, it hits our current account deficit, inflation, growth and effectively, everything. More importantly, it will also be about supply of oil. It's not just the price. God forbid, if the supply of oil gets disrupted, then we will be in trouble. Today, Indian markets are expecting perfect 10 out of 10 kind of future with oil rising, US interest rates likely to remain higher for longer and our valuation remaining at premium. Clearly, there is a need for some sort of correction or consolidation.

And the good part about India is that our earnings are growing like one and a quarter percent a month. Even if you remain in the same place for six months, the market will be cheaper by 7 to 8 percent. We just need a little bit of pause to reflect on the current situation assuming that things can worsen from here and oil prices could go into triple digits.

Also read: Small-cap stocks expensive compared to historical valuations: Kotak's Nilesh Shah warns investors

From a market perspective, how do you see this playing out? 

There is more heterogeneity in the flows today. There are some flows which are very matured and smart. There are some which are following the momentum. For example, there are flows in small and mid-caps that are more momentum driven. Now, looking at the past six months of those flows, their one-year returns will get impacted. Besides, over the next three to six months, we will get impacted because of higher oil prices and higher interest rates and FPI selling potentially, but our earnings are still growing. But the mature flows will use every correction as an opportunity to enter.

Neither US interest rates nor oil prices can remain higher for long. Both have their own self-correcting mechanism and higher oil prices create alternative sources. And more importantly, this time, higher oil prices are not just demand driven. It is also because of cartelisation. So, there is a 4 million barrel of oil supply which is taken off the table between OPEC and non OPEC countries' cooperation. Can there be political pressure on them, especially ahead of the US elections to at least keep oil prices under control? More importantly, even they will be looking at keeping oil below the three-digit figure rather than above because higher oil prices immediately destroy demand and end up creating alternative sources.

The threshold for that would be above $90? Does that put a cap? 

Yes, absolutely. Also, our ability to bear higher oil prices has increased. We were one third of Russian and Brazilian GDP in 2008. And when oil went up, we were in serious trouble. Today, we are equal to the Brazilian and Russian GDP put together. We may have the ability to bear the pain of higher oil prices. But, you know, when you're looking at a 10 out of 10 score (from a market point of view), a small imbalance will be noticed. Therefore, it's more a market worry than an economic worry.

What is your reading on bond yield rising on Friday?

The market was wondering in some sense how RBI would manage FPI flows. There's about $20 billion plus passive flows and about $10 billion plus active flows to come. So that's about $30 billion coming in. That type of G-Sec supply isn’t there in our market. So, obviously people were expecting RBI to announce some steps to manage FPI buying. On the other hand, what markets heard was that they will be doing open market operations to take away liquidity.

Now, clearly, the primary liquidity on days has been going short because of GST outflows and advanced tax outflows and so on. Though overall liquidity including government balances remain positive, but primary liquidity does become negative.  So, people were expecting announcements to manage FPI demand and against that they have seen liquidity being taken out, so they are  to be a little bit cautious on the yield side.

Is this some kind of cautioning mechanism by the RBI?

I'm really surprised because primary liquidity is already negative. The yield curve is very flat. Maybe this is their way of ensuring that it becomes a little bit steeper. So, this maybe a way to steepen the yield curve rather than raise the entire yield curve. But this was a surprise to the market, no one was expecting this.

Also read: Batsman, bowler, coach: Kotak Mahindra AMC’s Nilesh Shah has worn many leadership hats at fund houses and excelled in each role

Do you see any further risk, of course, now, the war brings another spin to it. How do you see bond markets reacting to them?

I still believe bond markets will be going up and down, because at a higher level there will always be comfort with FPI buying coming into play. We will start moving up the index from June 24 to March 25. And passive flows can only come on index weightage, but the active flows will start becoming attractive and we have $30 billion investments from FPIs in our debt market, but still $10 billion to $15 billion from active flows can come. So, my feeling is that at the higher level there will be natural balancing.

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