Economy likely to see cyclical upturn, says DSP Investment Managers' Sambre

'This may be driven by enhanced government spending in core areas,' says Vinit Sambre, head - equities and fund manager, DSP Investment Managers

The economy is likely to see a cyclical upturn from the second half of the current financial year, which bodes well for the broader markets going forward, says Vinit Sambre, head - equities and fund manager, DSP Investment Managers. In an interview with Ashley Coutinho, Sambre said while valuations of the Nifty 50 index are rich compared to historical averages, pockets of value are available in sectors such as financials, healthcare, IT and agri inputs. Edited excerpts:

What is your outlook for the market? What are the key risks to watch out for?

FY21 results from corporate India reflect a strong recovery in business post the first wave of the Coronavirus (Covid-19) pandemic. The markets are holding up well despite the onset of the second wave of the Covid-19 pandemic on the expectations of a similar recovery like last year. The pace of recovery, however, could fall short of expectations due to a lack of pent up demand, rising prices on account of raw material inflation, impact on rural India which supported demand last year, and the emotional drain as the Covid-19 pandemic affected many more households during the second wave. These could potentially lead to earnings downgrades and hurt the market momentum. The other risk stems from tapering of global liquidity by central banks at some point in the future as it is quite obvious that excess liquidity has been one of the important drivers of equity uptick last year. Lastly, the euphoric rise in many poor quality small cap names is also a cause for concern.

What is your take on current valuations?

While the valuations of the Nifty 50 index are rich compared to historical averages, there are pockets of reasonable valuations available in sectors like financials, healthcare, IT and agri inputs. We believe one way to address the anxiety with respect to higher valuations would be to moderate the return expectations for the short term and increase the time horizon in the markets as the earnings growth over next few years would lead to normalisation in valuations.

What are your thoughts on earnings growth in Q4? Will earnings growth improve in the coming quarters?

Rising raw material prices and the second wave of the Covid-19 pandemic may impact earnings growth for the next one or two quarters. However, our base case is that over the next few years, the economy is likely to see a cyclical upturn. This may be driven by enhanced spending by the government in core areas, investment accruing due to PLI schemes, investment happening in select sectors where India is globally competitive (like chemicals, textiles, healthcare and automobiles) to meet customers' requirement who are looking at an alternative to China. We expect these factors to lift the economy from a slow cycle and drive earnings growth over the next few years.

How do you assess the impact of the second wave of the Covid-19 pandemic on economic activity and GDP growth?

It is a bit too early to assess the real impact of the second wave as we are still not out of it completely. We have seen economists cutting the GDP growth estimates between 0.5-1 per cent for FY22. Corporate India expects a gradual recovery starting in the second half of the current financial year. We believe that corporates are better placed currently in terms of their balance sheet strength to withstand the pandemic impact. Our analysis of more than 500 companies shows that the net debt has declined by around 33 per cent over the last two years from FY19 to FY21. This is a healthy sign.

Do you see the outperformance of broader markets to continue in the coming months?

As mentioned earlier, our base case assumption is that the economy is likely to see a cyclical upturn which makes us feel that the outlook for the broader market is likely to be good going forward. However, the unorganised sector is likely to go through a challenging phase due to a lot of operational bottlenecks it is witnessing.

Which sectors are you betting on in the coming months?

A few engineering companies may benefit from PLI investments and the growth of the manufacturing sector over time. Healthcare has been one of our favoured sectors as health has assumed priority globally and Indian companies have a much larger target market to capture due to their presence globally. We believe the consumer sector, both discretionary and non-discretionary, is a good long term play but has rallied ahead of its near term fundamentals. We also like the agri sector due to the long run-way of growth available given the under penetration in the category.

What is your take on banking and NBFC stocks?

We are positive on the banking sector as large banks and select NBFCs have managed the crisis quite well in terms of limiting the losses from asset quality deterioration. Initially, we were a lot more skeptical about the impact the Covid-19 pandemic would have on the asset quality. However, the outcomes have been better than anticipated. The second wave has raised a few concerns again, but we are more confident now of their ability to weather the storm. Some of the mid-sized banks focused on the SME sector may take another year or so to recover from the impact.