After consistent Fed funds rate increases since March 2022, R Venkataraman, the Chairman of IIFL Securities foresees an earnings recession led by Western economies also infecting EMs (emerging markets) and India.
Hence, he says it is difficult to be very optimistic about primary market revival when faced with the prospect of an earnings recession.
"Generally, the IPO momentum picks up when sentiment is strong. In India we are as yet unsure of inflation trajectory, monetary easing, etc," he adds.
Among sectors, Venkataraman with more than 28 years of experience in the financial services sector likes lending financials, especially the top two PSU banks - SBI and Bank of Baroda which were battered when the Adani worries shook the market.
Do you expect a significant rally in the pharma sector? If yes, will it be broadbased or select stocks?
Pharma stocks have rallied over the past month, on expectations that pricing pressure in the US generic market has bottomed-out, owing to supply chain disruptions at a few of the generic companies. While this will be a short-term relief for the sector over the next 1-2 quarters, we believe that after this 1-2 quarter of base reset, the macro challenges of the US generic market will come to the fore again.
In our FY23-25 estimates for 18 pharma stocks under coverage, we have already assumed 8-10 percent CAGR in aggregate US revenue for the coverage, and we believe these numbers already reflect the short-term benefit from supply chain disruptions. We continue to prefer India-focused pharma companies over export/US generic-centered players. And the rally already seems to be reversing.
What could be the possible biggest risk for the equity markets in the coming year?
We foresee an earnings recession led by Western economies but also infecting EMs (emerging markets) and India. The rapid and large interest rate increase by central banks has seemingly happened with inadequate attention being paid to the lag effect of monetary tightening last year.
As earnings suffer a slowdown, discretionary spending, specifically capex, would take a hit, impacting future growth and hence immediate multiples. There could be some relief when central banks pivot and start cutting, but timing this is difficult.
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Other risks would be flare-up in crude if OPEC cuts production, or geopolitics – for instance if China blockades Taiwan then supply of advanced chips globally would impact companies, including the seemingly impregnable Apple.
What do you make out of commentaries by large IT companies announced quarterly and full-year earnings so far?
Until now, they said that growth in the US especially in BFSI moderated as discretionary spends were delayed or cut, based on customers sensing macro worries. However, IT companies seem to be still maintaining that this is transient, sentimental, and should not impact medium-term prospects.
IT companies also seemed to suggest that customers are racing to integrate AI (artificial intelligence) into their businesses, and this would provide opportunities quite soon.
Our view is that macro risk is still being underestimated as is the risk of AI (especially Co-pilot, the software that can program) impacting the revenue growth of Indian IT.
Do you see a strong revival in the primary market only in second half of this calendar year (as we have only five IPOs so for in current year), though it is dependent upon secondary market conditions?
It is difficult to be very optimistic when faced with the prospect of an earnings recession. Generally, the IPO momentum picks up when sentiment is strong. In India, we are as yet unsure of the inflation trajectory, monetary easing, etc.
Order inflow in capital goods companies has been weak. Industrial credit growth has been 6 percent on a 3-year CAGR basis. Given this, we don't yet have the makings of risk on sentiment. Perhaps when inflation comes off a bit, and central banks start cutting, sentiment can reverse, and then the IPO acceleration will be seen.
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Do you see sectors like paints and other building materials may witness consolidation given the competition is heating up?
In Paints, it is a bit more difficult to talk about consolidation as the mainstream companies are large and well entrenched, and new players seem to be inclined to spend money on market reach than inorganically.
Consolidation in the Building materials space (tiles/bathware, pipes and woodpanel) has been gradual, aided by 1) raw material headwinds; like sourcing gas for tiles, PVC/CPVC for Pipes and latest being timber scarcity for woodpanel players and 2) a gradual shift of consumers/intermediaries (marketplaces) towards branded players.
However, pricing power in key segments like tiles, plywood, laminates and PVC pipes is still with the unorganised segment (eg. Morbi for tiles). Larger organized players have some pricing power in a few segments like MDF, CPVC, and sanitaryware where the presence of unorganised players/import substitution is low.
Given low capex/ attractive asset turns and the presence of clusters (like Morbi and Yamunanagar) the shift to organized players will be steady and gradual. Strong branding and advertising remain the key to sustained growth for larger building material companies. We don’t see imminent consolidation currents.
The theme that you love the most for FY24?
We like lending financials, especially the top two PSU banks. SBI and Bank of Baroda were battered when the Adani worries shook the market, but have remained subdued thereafter, whereas the Adani group has scaled down its growth plans and hence the risk has diminished.
The PSU banks are thus not likely to face as much risk on account of refinancing/rollover of existing Adani debt as they may otherwise have. They have repaired their balance sheets in the last 4 years, asset quality concerns are not flaring up, growth is decent, regulation is far more proactive and protective, and valuations are dirt cheap.
Do you think the bulls may turn confident after the Federal Reserve's meeting in May 2023?
The market widely expects the US Federal Reserve to pause the rate hike sequence and then pivot soon. In such a circumstance, bulls are not an endangered species. But when the earnings recession from all the hikes of the last 12 months (500bps) comes, bulls will run for cover, as will everyone else. Stay defensive.
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