Daily Voice | This strategist is constructive on banks over medium term, but cautious on IT space

Sunil Tirumalai of UBS Securities India

With bank deposit rates on rise, retail flows into equities have started showing early signs of a fatigue. This combination of lower EPS growth, falling household support, and high valuation premium relative to emerging markets indicate that the 2023 trajectory would be influenced by valuations, Sunil Tirumalai of UBS Securities India says in an interview to Moneycontrol.

He keeps his year-end Nifty target for 2023 is at 18,000. The strategist with more than 17 years spent in the equity markets remains constructive on the banks over the medium term due to strong fundamental tailwinds from accelerating loan growth, and benign asset quality (close to historical lows), though the near-term positives seem priced in the recent rally.

Why do you think valuations will influence the market trajectory?

First, our internal estimates show Nifty EPS is likely to grow at a slightly slower pace over the next three years compared to the last five years. However, the Nifty is trading at a premium to its five-year history. Second, thanks to record flows from households, India is currently trading at 90 percent premium to emerging markets (EM).

However, with bank deposit rates on rise, retail flows into equities are showing early signs of fatigue. This combination of lower EPS growth, falling household support, and high valuation premium relative to EM makes us believe that 2023 trajectory would be influenced by valuations. We see lower risks to EPS growth going forward. Our year-end Nifty target for 2023 is at 18,000.

What keeps you bullish on banks?

While the near-term positives seem priced in the recent rally, we remain constructive over the medium term due to strong fundamental tailwinds from accelerating loan growth, and benign asset quality (close to historical lows).

Given the expected slowdown in global growth in coming year, which sectors look interesting? Do you think the consumer discretionary and real estate segments are expensive?

We're overweight on domestic-facing sectors, including banks, consumer staples and select auto names. While we are underweight metals and mining, IT services, consumer discretionary and real estate.

Should one stay away from IT sector in coming year, though looking attractive after recent correction?

Analysis of 20-year data shows that Indian IT sector revenue growth is strongly correlated with leading US/European companies revenue and operating profit and that the street has generally missed estimating big turns in the global corporate revenue cycle.

Second, IT sector's valuations move with a 2-3 quarters lag to interest rates, implying, a further derating ahead.

In our view, while the market may be anticipating the revenue and valuation headwinds, we think the quantum of the impact is likely underestimated. Therefore we are cautious on IT.

Do you expect slowdown in household flow to equity in coming year?

We are already seeing early signs of fatigue in household flows to equity. Retail direct flows to equities has turned negative for the first time in September quarter after 6 quarters of record inflows.

Household flows have a high dependence on bank fixed deposit rates. With 1 year government bond yields trading above bank FD and loan growth outpacing deposit growth, we expect banks to further increase deposit rates.

As deposit rates fully reflect the rise in yields we expect households to further move away from risky equities into fixed deposits.

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