"We could foresee two challenges for the markets. One is the potential deficiency in rainfall, and the second factor is higher global inflation may lead to tighter global monetary policy," Sanjay Chawla, Chief Investment Officer – Equity at Baroda BNP Paribas Mutual Fund says in an interview with Moneycontrol.
On rainfall deficiency, "my estimates are that this could at best be a sentiment dampener and may not actually impact the crop output much since the water table levels are reasonable in the food grain bowl region," he says.
Sanjay Chawla, with over 33 years of experience in fund management, equity research, and management consultancy, believes the quality of earnings is expected to be incrementally better - no single sector would dominate earnings growth. "From now onwards we could see normalized earnings."
Q: Any thoughts on the March quarter and full-year earnings announced so far? Do you see the possibility of earnings downgrades in any sector?
On an aggregate basis, results for the quarter ending March 2023 are by and large in line with the estimates. Historically we have noted the early results are usually in a line. The swing comes in the latter half of the result season.
This quarter is likely to witness some unexpected swings in margins. Since the commodity prices have fallen meaningfully, depending upon the inventory that the company is carrying, there may be margin variations for a quarter within the sector. We have already witnessed in the case of certain cement companies wherein the margins were lower-than-expected despite the input prices having fallen since they were carrying more high-cost inventories.
The good news is the quality of earnings is expected to be incrementally better - no single sector would dominate earnings growth. This plus the fact that all base effects (Covid time low base and recovery time high base) are over and from now onwards we could see normalized earnings.
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Q: Your take on consumption space? Do you see a slowdown in overall discretionary spending?
Post Covid consumption sector had seen unusually high offtake. The savings were the highest and there was some revenge spending. This led to a significant jump in pent-up demand across discretionary and non-discretionary categories. Case in point being leisure travel and exhibition space witnessed a spurt in demand without a commensurate increase in capacity.
A couple of headwinds the consumption sector is facing - Rural slow down, higher inflation leading to increased selling price impacting demand and in general the wealth effect from equity markets have been lower this juncture. Global events, including the impact of the financial system and the increase in interest rates, tend to dampen sentiments.
This is not the first time we have seen a slowdown in the consumption sector. There is enough latent demand to continue to drive growth in the long run-notwithstanding the short-term sentiments continuing to border with negative basis. Once the sentiments change the demand is expected to come back.
Q: Do you think the net interest margin to peak for banks in the coming quarters?
Net interest margins (NIMs) are a function of the lending rate and deposit rate. If the lending rates rise beyond a certain threshold, then it starts impacting credit growth. With RBI pausing at the last MPC (Monetary Policy Committee) meeting, there is an expectation that lending rates may not rise significantly from hereon.
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However, banks are facing challenges in deposit growth. The incremental cost of deposits is going up faster than the lending rate. With Credit-Deposit growth for most of the system being at a near optimum level, incremental growth will need to be funded by a higher cost of deposit. If the present trends continue, NIMs are likely to be impacted in the coming times.
Q: Should one wait for some more time before going for bottom fishing in IT services sector?
There is no doubt that the IT sector is trading at interesting valuations compared to its recent history. Last couple of years we had seen demand surging and waning. During Covid, we had seen the demand surging with enterprises accelerating the pace of digitization. We had seen a surge in recruitment to bridge the talent gap based on renewed demand. Global IT spends also increased from high single-digit to low double-digit.
Post-pandemic, we have seen Global IT budgets normalizing to marginally higher to mid-single digits. What we are witnessing is valuations factoring in the slower growth.
In recent times we have seen renewed worry in US Banks. The BFSI segment contributes to a large proportion of most of the large IT companies’ revenue. Uncertainty in the Financial system is at the least going to postpone the demand. This may result in lower IT spend than what was estimated initially.
Q: Which are the factors that can go against the equity markets run in current financial year?
In the recent past, we have seen many factors going against markets- the Pandemic impacted the world, then we had Russia invading Ukraine leading to the spiraling of global commodities. India was particularly vulnerable since the crude spiked to over $100 per barrel. This could have had some serious impact on the current account deficit and fiscal situation of the country. However, each of the negative episodes was deftly handled by the Government because of the resilience of the people of the country.
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We could foresee two challenges for the markets. One is the potential deficiency in rainfall. This is on the back of three successive good rains India has received. My estimates are that this could at best be a sentiment dampener and may not actually impact the crop output much since the water table levels are reasonable in the food grain bowl region. This is of course assuming the deficiency is marginal and in alignment with the early estimates put out by the agencies.
The second factor is higher global inflation may lead to tighter global monetary policy. This could lead to lower liquidity flow to Emerging markets like India and the risk of trade may come back on the table.
Q: Are we done with the rate hike cycle (Fed as well as RBI)? What is the possibility of an interest rate cut?
Fed is following a single-point agenda of ensuring inflation is under their tolerance level. If they continue with the same objective, then they may hike the rate albeit at a slower pace than what we had witnessed earlier. I am in the camp that rates are higher for longer-even if the rates may not rise they may continue to be elevated levels for longer than what the market is anticipating.
Based on the rate and inflation in India, if the country was financially decoupled from the world, then India would not have to raise rates. However, the differential between India and USA rates is at the narrowest range compared to its recent history. Hence if India wants to ensure stable forex markets then it may have to follow Fed. I believe that the quantum of rate hikes in India, if any, may be much lower than what FED does.
Q: Which are the sectors/themes that must be part of the portfolio for FY24?
Indian equity markets are trading at valuations that are in line with historic averages with earnings expected to grow faster than the last 5 years. This offers an interesting opportunity for long-term investors who want to create wealth.
One theme which seems to be firing well is the capex cycle. There are multiple drivers-Railways, offset clause of defense, PLI schemes, China plus one strategy and numerous other factors including India moving up in ease of doing business.
In addition, we had seen the budget also allocating higher amounts for infrastructure spend. Also, we shall have General Elections in CY2024. Such elections are always preceded by large Government spends creating rural employment and leading to consumption.
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