With an inflationary trend in various economies and central banks increasing rates, uncertainty is the name of the game. True, the India VIX–which tracks volatility and therefore fear in the markets–has dropped since early March. But, Rajesh Bhatia, MD & CIO, ITI Long-Short Equity Fund, told Moneycontrol that there could be a sharp reversal in stock valuations in the coming months because of price-rise worries.
Excerpts from the interview, in which Bhatia talks about the near-term concerns and how a tactical play would serve an investor well.
With increased uncertainties, would you say it has become more important to protect the downside ?
Certainly, the risks to the equity markets have risen in the last few months. The recent unusually high volatility that is being experienced by the Indian markets is due to the demand-supply equation in terms of flows to the markets. While FII have been heavy sellers, it is being neutralised by the equally substantial buying by domestic investors (institutions and retail alike). The result is that markets have been almost flat in the last six months or so, despite very high swings in between.
It is important to step back and realise that we are not in normal times. There has been an extraordinary increase in money supply by global central bankers triggered as a response to first, the Global Financial Crisis (GFC) of 2008 and subsequently, the Covid-19 pandemic of 2020. One of the aims of this Quantitative Easing (QE) policy was to support asset prices, including equities. And we did see a sharp upward re-rating of Indian equities since March 2020. But with rising inflation, there is a risk of a sharp unwind of this extraordinary response in the next few months. So what has been a tailwind for equity markets it is feared could become a headwind. This is noticeably making markets nervous, including in India. Having said that, it is difficult to gauge the depth and duration of the unwinding of the stimulus. So to navigate the upcoming environment, we do believe it is important to have a tactical risk-adjusted approach to your portfolio, which can protect your downside or generate healthy returns for either outcomes that can emerge.
Which are the sectors that you think will do well in this inflationary environment? Why?
We like IT, Telecom, Insurance, private banks and select consumer stocks from here on. We are also likely to increase cyclical bets as we either get a better handle on inflation trajectory or if valuations decline for these stocks to make them attractive. Regardless, cyclicals are a part of our tactical portfolio which we increase or decrease depending on our short term views also.
Which sectors would you stay away from? Why?
We are likely to avoid sectors which are likely to be impacted by rising interest rates. It would be useful to see how housing finance companies cope, in terms of margins, from rising rates. Several sectors are already impacted by rising costs or very poor consumption demand (such as autos, cement, consumer staples and so on.). But everything is at a price. If these stocks come down meaningfully, we are likely to be buyers. To us, price is as important as business prospects.
What parameters that signal that a stock is ripe for shorting?
As pointed out earlier, we look for a variant perception of changes in business prospects of a stock. If we are ahead to see the trend and the valuations don’t reflect our thesis, they become good short opportunities for us.
Today, more than ever, we are witnessing equity valuations of several sectors (such as auto, gas distributors, media, retailing) decline thanks to the markets’ apprehension about potential disruption to their businesses models due to change in technology. The incumbents are at a risk of losing their edge (even possibly an existential threat!). These situations offer long-range weakening opportunities which can be shorted to generate alpha.
There have been sectors in the past, which put some players on a consistently weaker footing (for example telecom sector over the last five years) due to changed sector dynamics.
Also, with business cycles becoming shorter, thanks to global macro driven economic environments, cyclicals offer shorting opportunities again and again. Examples are autos, metals.
Lastly, there are also opportunities in India of overleveraged or weak governance companies. So there is a diversity of opportunities for the short canvas.
What is your take on holding cash to play the falls when the market panics?
There is something to be said about asset allocation. I think the key determinant of attractiveness or otherwise of an asset class is the risk-return of the asset class in the cycle. I am reminded of a quote by Ben Graham. His attitude towards asset allocation and portfolio construction was that it should be “ready for either outcomes”. What he meant was that by all means participate in equity to protect purchasing power and grow wealth, but it should never compromise your financial strength or peace of mind.
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