MC Interview | Why this investment strategist feels emerging market returns look attractive to FIIs

What is your earnings growth estimates for FY24? 

The typical earnings growth estimate on the Street is in line with the expectations for the nominal GDP growth. Within this, the wildcard which could surprise, is the IT pack. This is a possibility to consider seriously given that the Fed has indicated that it is at the peak of the rate hike cycle and would likely pause and eventually start cutting the rates if the inflation data is benign.

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The inflation trajectory in the US appears to be favouring this scenario. By the second half of FY24, the economic slowdown, and the consequent cost-cutting and lay-offs in the US industry, is likely to be behind us. The street estimates are probably quite pessimistic and this is where things could turn out to be different. If that happens, then IT could surprise.

Given the past issues and new rules from the RBI on expected credit loss (ECL) the Street is quite cautious on the PSU banks. However, now the balance sheets are quite strong for most banks, including the government-owned banks. With most PSU banks still in the valuation range of price-to-book of less than 1, and still at very low RoEs (return on equity), the outlook for an earnings acceleration as they reach normal RoEs on the back of demand for capital for the new cycle of capital investments from the public and private sector is quite high.

Retail demand should also be positive for the banks’s growth. Even the private banks are at valuations and RoEs lower than their historical metrics. Overall, given the favourable valuation metrics and expected demand growth for capital, the banks look well-positioned to surprise.

If there is no macro-economic or geo-political surprises globally, the outlook appears quite positive for an earnings beat.

Also read: Optimistic that growth will be close to our projection of 6.5% -RBI governor Shaktikanta Das

Do you see good numbers being delivered in the coming quarters too? 

As discussed, the financials are more likely to improve going forward, and then deteriorate. There are always risks to any view and those hold. The global economy is still uncertain with risks of bank failures in the developed markets. Also, how the geo-political tussles between various countries work out also needs to be seen.

There's also the probability of developed markets going into a recession for some time. All those global uncertainties and risks could have spill over effects on the Indian economy.

We should always be aware of the risks and also keep in mind that investments in securities market are subject to market risks. Also, that no discussion about the future can be made with any certainty. All future expectations are based on probabilistic scenarios which could eventually work out quite differently. An understanding of scenario analysis and probabilities and high risk tolerance are a must to invest in equities markets.

Are you less negative than before on IT and consumer segments?

We have been positive on IT for nearly five years now. We continue to be optimistic about the impact of technology, digital transformation, cloud, 5G/6G, Internet of Things and Artificial Intelligence (AI) on the global economy over the next couple of decades. It is likely to transform the World as we know it. Things are likely to be done quite differently in the future.

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Many existing business models are likely to be disrupted and transformed by new ones. All of this is likely to be carried out by technology platform companies, mostly from the US, and technology service providers, mostly from India. This puts the Indian IT companies at the epicentre of this transformation. This makes us positive about IT, despite some bumps on the road as we saw recently.

We are positive on the consumer demand, however, our opinion remains that most consumer companies in the Indian markets, for example, FMCGs, appear quite overvalued to us. The sector is likely to see growth, but it could come from new companies with new products. Thus existing players are likely to continue struggling with relatively slower growth. This combined with the high valuations makes us less optimistic about them.

Do you think the headwinds being faced by the US can raise worries over global growth in FY24?

The biggest uncertainty for the US is the impact on banks and economic growth given the accelerated rate hikes of the Fed in the previous 12 months or so. The impact of rate hikes takes effect with a lag. It is possible that the full effects of this are still not played out. Other than that, the geopolitical risks, such as, Russia-Ukraine, China-Taiwan, the US-China cold war, the threat of terrorism etc. are all playing in the background.

However, all this also creates opportunities. India is being seen as a strong contender to take the place of China in the new global supply chains. The headwinds facing the US could also turn out to be overstated and the reality might be more benign. The opportunities unlocked by the new AI platforms might be much bigger than anyone understands today.

Keep in mind that 2024 is the year of elections in both India and the US. This makes it likely that the respective governments would attempt to guide the economies in such a way as to show their term, especially the final year, in a positive light. Their goal should ideally be to have a strong growth, high employment, low inflation and overall positive outlook for the future. On balance, we are optimistic about the global and domestic economies for FY24.

Do you expect FII inflow to continue for the rest of the financial year considering the likely end for rate hike cycle?

As we saw in 2022, with the Fed rate hikes, the cost of capital became higher and thus some FIIs were forced to re-evaluate their capital allocations. Relative to the risk-free rate, the expected returns from the emerging markets did not look sufficient to compensate for the higher risks. Also, liquidity was being drained out by the Fed at nearly $100 billion per month. Naturally, FII outflows happened.

However, now the Fed rates are probably at a peak and probably likely to be cut in coming quarters. With this outlook of future Fed rate being lower, the expected returns from the emerging markets start looking quite attractive for the FIIs. However, the liquidity drain is going to continue. But the Bank Term Funding Program might have potentially triggered significant liquidity through a different door.

Which are your favourite bets among private sector companies?

We are quite constructive on the IT sector. We also like financial technology infrastructure companies, such as, stock exchanges, banks, and even rating agencies. We also believe that companies working on railways, defence, electric vehicles and clean tech face a favourable future in terms of growth opportunities.

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