Dear Reader,
Things just got real for India’s retail equity investors. While macroeconomic worries have been around for some time, many retail investors don’t attach much importance to them. Good companies outlast bad macros is how they view it.
Foreign portfolio flows may have slackened as overseas investors grappled with various factors. These range from an end to the easy money era, geopolitical rumbles, China’s relative attractiveness after its economy reopened and India’s high valuations countering its brighter economic prospects. Then there is the never-ending debate on whether high frequency data in the developed world points to strength in the economy, and therefore rising interest rates, or to weakening growth and therefore heralding lower inflation.
The uncertainty is certainly caution-inducing but then you have Indian retail investors slam-dunking Rs 20,534 crore by way of net inflows into equity mutual fund schemes in March. If you follow the money, then the message is, what’s not to like about Indian equities? There is the timely (for equity investors, that is) pause by the RBI’s Monetary Policy Committee in April. The optimists are reading it as a pivot. This week’s CPI inflation print falling to 5.66 percent, a 15-month low, may make them even more optimistic.
But there also those who have warned that stock valuations, and not just in India, are not factoring in a risk of negative surprises in earnings. This school of thought believes that for the Fed’s tightening to work, as measured by a convincing fall in inflation, growth must slow which in turn will be evidenced by weakness in jobs, prices and growth. In turn, that signals financial pain for companies but what’s not clear immediately is who will get affected and by how much. For instance, job cuts were seen as saving costs for companies but if they are preparing for tough times, what will those mean for earnings?
TCS and Infosys’s results provide a glimpse of how these surprises may play out on the negative side, although some other sectors could surprise on the upside as well. But the first flush of India’s software company results is decidedly negative for sentiment. Infosys’s local shares were spared because markets were shut on Friday but its NYSE-listed ADR fell by an eye-popping 10 percent. Investors will be hoping there are some counter narratives that emerge over the weekend, so that Infosys’s domestic shares don’t play catch up with the fall in its ADR. TCS’s results also saw its shares slip by 1.6 percent, which was relatively mild.
As my colleague Madhuchanda Dey notes in her analysis of Infosys’s results, its fortunes changed within the space of a quarter, as the third quarter saw it increase its FY23 revenue growth guidance from 15-16 percent to 16-16.5 percent YoY in constant currency terms. But, what it achieved was 15.4 percent and its operating margin declined sequentially. The revenue growth guidance for FY24 is in a low but fairly wide range of 4-7 percent.
Weaker demand from the US financial sector is the main reason for a change in performance and outlook. Management commentary from both Infosys and TCS is bleak, and at least the near term may see that play out. However, sudden turns and twists in the global economy, as we have now become accustomed to, could well mean an upward revision to estimates. If you were sitting on the fence, you may be tempted to jump into the camp of buyers. Before you do that, however, do read Dey’s takes on what investors in TCS and Infosys should do.
These results are a rude wake-up call for software stocks as investors will brace for coming turbulence, but they should also make investors in other sectors a bit cautious. The effects will be felt in different ways. A slowdown in hiring by one of the largest employers of India’s skilled and upwardly mobile workforce is not good news for the consumption sector. Unless other service sectors pick up the slack, if the slowdown continues for long, it will weigh on discretionary consumption. But that’s for later.
Investors need to wear their anything-is-possible cap as this earnings season moves forward. For instance, falling raw material costs may be good news for agrochem companies but the sales outlook has become clouded because of global demand worries, wrote my colleague R. Sree Ram, a concern for stocks such as UPL.
Investors tend to look at variables based on the positions they hold, for instance, by viewing the fall in raw material costs as a reason to be optimistic if they are invested in a sector. But, if demand turns weak then a lower cost base will be small consolation. The main question then is whether a fall in costs can make up for a fall in sales growth or worse, a decline in sales itself. In many industries, it does not. This is particularly true for those where the fixed costs are high as a percentage of costs, in items such as power and wages.
If companies such as Infosys were unable to predict the downturn they faced in the fourth quarter, if supposedly clued-in stock market analysts were unable to spot it either, then retail investors should be kind to themselves in not being able to spot nasty surprises such as these. They may show up in the forthcoming quarters. For instance, this week we pointed to moderating growth in rail freight traffic and bank credit but two-wheeler sales may finally recover from a long stint in the trough and outpace passenger vehicle sales in FY24.
What should investors do is a million-dollar question for which, at the risk of repetition, unfortunately there are no easy answers. How far central banks will go to bring inflation down to their tolerance levels is not clear. Some are already holding the white flag but others could still hunker down and hike rates. The next FOMC meeting in May will give an idea of what the Fed’s next move is. But, management commentary should be a main factor to watch out but do remember that even after digesting every word spoken by the Infosys management, the Street could not predict the growth slump.
Even a pause may not be good enough, especially if it comes in the face of confidence that weakening economic conditions support a lower inflation outlook. The first criterion will have a marked impact on companies worldwide as some of the largest economies will slow down. Just as COVID saw a concerted effort by central banks to save the world economy from a death spiral, we are now seeing a similar (even if not as well coordinated) effort to snuff out the aftermath of runaway inflation.
Forecasting is a risky proposition in this environment as analysts tracking software companies are finding out. But it does seem like FY24 will be the year when victory over high inflation will be achieved. Eventually, rate cuts will come into the picture but it is best not to speculate when and follow the data instead.
Till then, the going may be tough for companies. Sure, the long term does seem unchanged and when central banks revert to a less hawkish policy tone, investor sentiment and corporate performance will both rebound.
What’s in an investor’s control is to revisit your portfolio, assess asset allocation, concentration risk and take steps to rebalance if needed. Consult your advisor, if you have one. The main reason is that If the drawdowns are deep, then recovering from a severe blow can take time.
We had a number of articles this week that help you make sense of what’s happening and what investors should do as well. Do read from the links given below.
Investing insights
Discovery Series: Krsnaa Diagnostics -- Multiple catalysts at work
Mphasis: Does the price correction present an opportunity?
Titan Company: Yet another shining performance
Why is yellow metal’s glitter not rubbing off on this leading gold-financing NBFC?
Speciality Restaurants: Geared up for the next level of growth
Power Grid Corporation of India: Poised for better performance
Craftsman Automation: Riding the CV momentum, higher aluminium use in auto sector
GM Breweries: Sunny growth prospects at an attractive valuation
Subros: Wider EV adoption, PV demand augur well
Sector insights
What does revised gas pricing mean for the CGD sector?
The Chip Wars: Why India should have a long-term, comprehensive chip plan
Winning the (net interest margin) NIM game in FY24 will be tougher for banks
Markets
Are small tweaks enough for BSE to improve market share?
The fixed income party’s not over, only the venue has shifted
Chart: Financialisation of savings
SEBI pushes for responsible messaging by advisors and analysts
Dollar index (DXY) on a descent – What does it mean for Indian equities?
Start-up Street: Looking beyond Silicon Valley for capital
From the Financial Times
Mohamed El-Erian: Banking tremors leave a legacy of credit contraction
Housing sector gets a rate hike breather, but uncertainties loom
Ruchir Sharma: Why America’s big companies keep getting bigger
Martin Wolf: Japan, Germany and the challenge of excess savings
The rent is still too damn high...
Economy
Par or sub-par monsoon? — Bracing for the worst case!
Chart of the Day: Global food inflation moderates further
IMF sees real rates falling sharply, but don’t ignore the caveats
Slump in global demand for PCs will hurt China the most
Remembering BR Ambedkar as a monetary economist
Geopolitics
The Eastern Window: How to stop Myanmar from acting as China’s spying arm
The CPEC is a metaphor for Pakistan’s failings Others
Green Pivot | Can Musk magic break the climate curse?
Planning your personal finances, the RRR way
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