Volatility should be used to advantage by increasing allocation to equities: Gopal Agrawal, HDFC AMC

The sell-off seen in the markets over the last few days can be attributed to the new variant of the virus. If the impact of the new variant is serious, we may see some of the opening up of economy stocks/sectors get impacted for the short term. If the variant sustains for a prolonged period, one can see more stimulus measures and lower interest rates in the economy. While we may see volatility over the short term, the long-term outlook for the Indian economy remains robust given the low-interest rate scenario, strong balance sheets & earnings, and the reforms undertaken by the government over the past few years.

So, from a medium to long-term investors' point of view, any volatility should be used to advantage by increasing the allocation to equities.

How should investors look at rebalancing their portfolios?

As of October 31, 2021, the Nifty50 was trading near 21.5x FY23E price to earnings ratio. While price to earnings multiple is relatively high compared to the historical average, it can be considered reasonable in view of the low-interest rate environment and healthy corporate earnings outlook.

Further, the ratio of India’s market cap to GDP (based on CY23E GDP) is near 90% which is largely in the range of 60-100% in which equity markets have trended during the past 10 years. Further, the gap between 10-year Gsec and 1-year-forward Nifty50 earning yield* touched 2%, slightly higher than its long-term average of 1.7%. (*Earning yield = 1/(one year forward P/E)).

Thus, in our view, most indicators are suggesting that markets are almost fairly valued.

Going forward, we expect returns from equities, over the medium-to-long term, to be in line with overall economic growth. Further, corporate earnings growth is likely to track nominal GDP growth from FY23 onwards after seeing a robust improvement in FY22.

In view of the above, while markets hold promise over the medium-to-long term, one should moderate return expectations in line with the expected growth in nominal GDP.

We remain optimistic about the economy and equity markets over the medium-to-long term given the fall in COVID-19 cases and relaxations in restrictions, easy financial conditions and low cost of capital, comfortable external sector, supportive monetary and fiscal policies, likely improvement in corporate profitability, healthy GST collections, etc. Investors should follow asset allocation and rebalance their portfolios on a timely basis.

Do you see the markets becoming more polarised in the next few months? Why/why not? Which sectors are likely to provide support?

NBFC crisis in 2017, followed by demonetisation and GST coupled with the US-China trade war had resulted in a meaningful slowdown in local and global growth. During this period, companies that were able to sustain earning growth from lower interest rates and benign commodity prices had outperformed.

With a positive economic outlook, lower interest rates in the economy, deleveraging of corporate balance sheets (Debt-to-equity ratio has fallen from 0.99 in 2016 to 0.71 in 2021), and a sharp revival in earnings, we feel that going forward, the rally will be more broad-based.

In the large-cap space, the turnaround in the NPA cycle, revival of the telecom sector, digitisation wave, and decarbonisation trend globally are likely to drive profits of the large-cap companies. In the mid and small-cap space, as we see the global supply chain shift away from China to EMs coupled with a revival in capex cycle in India, companies in the industrial manufacturing sector are likely to benefit.

Further, companies that are part of the PLI scheme and are part of the mid-and small-cap segments are also likely to see good growth. So, over the next 3-5 years, we can expect a broad-based rally in the markets.