Don't get swayed by current optically high valuations: Mahesh Patil

Defensive sectors like information technology (IT) and consumer may lag, says CIO Patil

With the markets hoping for a gradual reopening of the economy after the second Covid wave, MAHESH PATIL, chief investment officer at Aditya Birla Sun Life AMC, tells Puneet Wadhwa in an interview that domestic cyclicals, industrials, financials, and pharma sectors are likely to lead the market recovery. Edited excerpts:

You expected an ‘extended period of a bull market’ earlier this year. Does that view still hold?

We are seeing some demand destruction due to the second Covid wave and India’s economic recovery can be delayed by six months. Hence, market returns can be muted in the near term. But, the Covid wave seems to have peaked and we are seeing a decline in new cases. At the same time, vaccine supply should improve in the next few months and India should attain herd immunity by the end of this year.

With the Indian economy expected to recover and normalise by FY23, the domestic cyclicals, industrials, financials, and pharma sectors are likely to lead the market recovery. Defensive sectors like information technology (IT) and consumer may lag. Multi-cap and flexi-cap funds are ideal for investors looking for equity exposure as they are market-cap agnostic; so, investors can get exposure to large/mid/small-cap stocks in a single fund. At current market levels, we are agnostic to market-cap and are following a more bottom-stock selection approach.

So, will flows into equities continue?

FII flows have been impacted in the past two months due to concerns regarding Covid. However, against the positive global backdrop and with the second wave having peaked out in India, FII flows can come back in the second half of this year. Domestic flows have recovered in the past couple of months and should remain strong this year, in contrast to the outflows seen last year. Retail participation has increased big time and is supporting the market. This is evident from the fact that mid-and small-cap stocks have fared well even amid uncertainty.

How comfortable are you with the market valuation?

The market valuation seems stretched from a near-term perspective. But investors should bear in mind that we are in an environment wherein earnings are not normalised, liquidity is very high, and interest rates are low. So, valuations can sustain above their long-term averages. From a medium-term perspective, valuations seem fair as the economy and earnings will normalise by then. Investors should not get swayed by current optically high valuations. We are positive on the recovery plays, including domestic and global cyclicals, banking and financials, and consumer discretionary and retail.

What’s your view on corporate earnings growth?

The March 2021 quarter result season has been largely in line, so far. Macro cues from Q4 are that export-oriented sectors, such as information technology (IT) and auto, investment-oriented sectors, such as cement and metals, and consumption-oriented sectors, such as staples, have been resilient. At the same time, discretionary consumption is lagging. Fortunately, the health crisis has not spilt over into a widespread financial crisis yet as indicated by the absence of large GNPA shocks in the financial system. Cost pressures are rising across the board but the ability to mitigate this by cost rationalisation, product mix changes, and passing on the cost to the consumer is visible.

For corporates, localised restrictions due to Covid have impacted demand and higher commodity prices will have a short-term impact on margins. After June 2021 quarter results, Nifty FY22 earnings are likely to get downgraded by 5-7 per cent from the current high level of 34 per cent YoY. Earnings estimates for sectors, such as consumer discretionary, retail, auto, oil & gas, and realty, are likely to see downgrades. Also, infra, capital goods, and cement can also be at a greater risk of downgrades, if there is a prolonged impact of Covid.

To what extent can recent lockdowns and the economic slowdown hurt bank credit growth? How are you tackling the financial sector stocks against this backdrop?

As against 5.6 per cent credit growth for the banking system in FY21, we were budgeting 10-11 per cent before the second wave. The current stress has manifested in the self-employed segment and this time round in rural India, as well. Consequently, we think systemic growth for FY22 can settle at around 8-9 per cent, as against 10-11 per cent estimated earlier. Larger private sector banks should still deliver 14-15 per cent growth, mid-sized and regional banks around 8-9 per cent, and PSU banks around 6 per cent. 

Larger banks have also raised capital to strengthen their balance sheets and already taken sufficient provisions which should cover the Covid impact. Given their ears-on-the-ground centric collections and lending models, NBFCs specifically in the vehicle finance/MFI segments and SFBs can witness stiffer growth challenges. Our fundamental call on being overweight banks stands — when the system is flush with liquidity, temporal issues with asset quality can always be easily sorted.