Budget 2022 can enhance sectors with multiplier effect, says Mahesh Patil

Given the rally in the markets in 2021, easy money has already been made, says Patil

The US Federal Reserve’s hawkish turn will lead to moderation in price-to-earnings (P/E) multiples and remove some frothiness, says Mahesh Patil, chief investment officer at  Aditya Birla Sun Life AMC. He tells Chirag Madia in an interview that the impact of the Fed rate increases will be felt more in the short term as after the past rate hike cycles, the market had given positive returns over a 12-month period. Edited excerpts:

What’s the market outlook following the Fed’s hawkish pivot?

Given the rally in the markets in 2021, easy money has already been made. The one-way risk-on rally was driven by high liquidity and low interest rates. CY22 can be looked at as a year of transition as excess liquidity gets withdrawn and interest rates inch up. The Fed chair delivering a hawkish message recently was on expected lines as it is moving towards normalising monetary policy. Given this scenario, the frothiness in the markets should give away. High P/E multiples, which are more sensitive to interest rates, should moderate.

We have seen in the past four rate hike cycles that although stocks typically were sold off immediately following the first Fed rate hike, on average, the S&P 500 was higher by roughly 8 per cent in the 12-months after the first rate hike. But given that the starting point of valuations is much higher in this cycle, the upside is expected to be limited.

From India’s perspective, adjustment by the Fed may lead to short-term volatility. In the past bull markets, corrections of more than 10 per cent have been normal. We may see a slightly higher correction than what we witnessed in the past year. However, as earnings and GDP growth projections are anticipated to be strong, they should neutralise the impact of rate hikes globally. On an overall basis, the trend in equities is likely to be upwards this year but the markets are expected to be more discerning, and stocks will be driven by fundamentals.

What are the key risks this year?

Recent comments by the Fed point to accelerated policy tightening in the coming months. This remains the key risk as it can impact global sentiment and foreign portfolio investors (FPI) flows to emerging markets, including India. The markets are already factoring in four rate hikes this year, along with the Fed starting its balance sheet run-off in a predictable manner following the first-rate hike. Brent crude prices are touching $90 a barrel and if the price goes above $100 per barrel, it can be a risk as it impacts the current account deficit (CAD). Omicron is not being seen as a major risk at this time. It appears to be milder than the previous variants and is projected to peak out soon.

What do you make of the spike in the domestic bond yield? How will it play out on the equity markets?

In India, we are seeing a rise in the domestic bond yield following the rise in yields globally. However, we do not expect the RBI to follow the Fed’s path of aggressive tightening as the situation in India is different. Inflation in India is well under control, giving sufficient room for the RBI to maintain an accommodative policy for supporting growth. We are only expecting two rate hikes by the RBI this year. The market is already factoring in higher yields. So, even if there is a spike in the domestic bond yield, it can lead to short-term volatility but since the yield is not expected to go very high, it should still be supportive for the equity markets.

What are your expectations from the Union Budget?

The government is likely to focus on supporting growth in the upcoming Budget. The Indian economy is already on the road to recovery and thus, the government through its reforms is likely to provide a boost to sectors that have higher multiplier effects on the economy, such as manufacturing, infrastructure, and real estate. These sectors have seen reforms in the recent past that are expected to act as tailwinds for growth. The government is also expected to support the rural economy through schemes, such as MGNREGA and the construction of rural roads. Along with continuing its divestment programme, the government should provide direction to unlock value in brownfield core infrastructure assets under the Rs 6-trillion National Monetization Pipeline (NMP) that was identified in the previous Union Budget.

What’s the outlook for the mid- and small-cap universe?

Mid-and small-caps have given double the returns of large-caps in 2021. And after the rally, valuations of mid- and-small-caps seem high. However, if the Indian economy continues to expand for the next three years, mid- and-small caps can continue to do well as they have higher exposure to the domestic economy than large-caps. That said, we are market-agnostic at this time and are following a bottom-up stock picking approach, irrespective of the market cap. We are focusing on earnings growth visibility and prefer companies that have drivers in place for them to do well.

Will MFs continue to participate in a big way in IPOs? Any view on LIC?

IPO activity was also at an all-time high with more than 100 companies getting listed and raising $16 billion. The public markets have been willing to provide risk capital to businesses with potential but which are not yet profitable. The markets have become more discerning now. We are seeing that while quality companies providing good visibility to earnings and cash flows are holding up, other companies that are unprofitable or where cash flows are back-ended have seen a correction. So, while flows to MFs will likely remain strong, they are likely to be selective in terms of the IPOs they invest in and focus on valuations will be high. We are awaiting details on the LIC IPO.