Earnings expectations can be biggest stumbling block: Anoop Bhaskar

The positive commentary on the Union Budget should spur additional foreign flows, notwithstanding higher valuations, says Bhaskar

Anoop Bhaskar, head-equity at IDFC Asset Management Company, says most global markets are at elevated levels and high valuations are not a ‘local’ issue. In an interview with Chirag Madia, Bhaskar says elevated valuations, monetary tightening, and failure of vaccines are the three biggest risks for the markets. Edited excerpts:

The Indian markets have seen a sharp jump over the past year. What do you think of this rally?

It depends on one’s perspective — either focus on the sharp rally from the lows of March 2020, which may make most investors uncomfortable. Or, view it from the pre-pandemic level — January 2020. While the Nifty is up over 90 per cent from March 2020 lows, it is up by a more ‘reasonable’ 22 per cent from end January levels. Take your pick.

How comfortable are you with market valuations?

At the absolute level, with the Nifty trading at 29x, the markets clearly appear elevated. However, this has to be viewed in the context of depressed earnings of FY21, especially Q1FY21 on account of the lockdown. The equity markets globally appear to be at similar elevated levels; hence valuation is not a ‘local’ issue, it has become a ‘global’ issue for institutional investors.

Foreign inflows continue at a record pace. Do you see the trend continuing?

The positive commentary on the Union Budget should spur additional foreign flows, notwithstanding higher valuations. Several Budget proposals — credible Budget maths, move to privatise at least two PSU banks, strategic sale of BPCL & other PSUs — should remove the final obstacles for those foreign investors who are underweight on India. The Budget can act as a catalyst for such institutions to re-enter and increase exposure to Indian equities.

What risks do you see in the markets?

The market faces three issues — elevated valuations and expectations of robust earnings growth, tightening of monetary policy by central bankers which would be spurred by concerns on commodity-led price inflation, and failure of vaccines to provide long-term immunity from the virus.

With elevated valuations come high expectations of a strong earnings rebound. Notwithstanding the stupendous performance during the December quarter — the highest-ever quarterly profit for the BSE 200 companies — has led to a strong upgrade of earnings for FY22 and FY23. Usually, weigh of earnings expectations acts as the biggest stumbling block for a rally in equities. The strength of earnings will have a significant impact on the gradient of the current market movements.

In addition, a sharp rise in US 10-year bond yields as inflation expectations get heightened with a sustained spurt in commodity prices can be the other factor that will make equity investors twitchy. If 10-year US yields move beyond the 1.7-2 per cent level, investors’ nervousness of ‘easy’ liquidity — a critical ingredient to support high multiple for growth stocks — can start to crumble. 

Finally, the current fiscal crisis has been brought out by a health pandemic. While currently, hopes on the efficacy of various vaccines appear to be high, if the virus returns in any form, it can be a big negative for the global markets.

What is your outlook for mid-caps and small-caps?

Every economic uptrend is positive for mid- and small-caps, as they tend to fall the sharpest during the slowdown. At the end of March 2020, ‘small-cap’ was the cheapest end of the market. Until the RBI does not point towards tightening of liquidity and an interest regime, which focuses on rates hardening, the outperformance of small- and mid-caps should continue. Large-caps regain market leadership when the central banker clearly signals a shift in focus from growth to price stability.

For which are the sectors you are bullish and bearish?

Domestic and corporate-focused sectors, such as banking, retail, automobiles, cement, and construction. These are the pockets of the economy where green shoots are visible or where balance sheet repair has been faster than expected. Consumption-oriented segments can take a bit longer to repair or reach pre-Covid levels.

What challenges were faced over the past year while managing equity funds, given the market condition and continuous outflows in the industry?

On the funds management side, trying to ‘balance’ a portfolio — being overweight sectors least impacted — staples, pharmaceuticals, and IT services. On the other hand, not rushing to exit segments ‘most’ impacted – retail, banks and discretionary. This was achieved with varying degrees of success across funds. The biggest learning: GDP growth staying negative beyond two quarters has a low probability, even after the horrendous Q1FY21 print.

Most large actively managed schemes have underperformed. Why?

After the fall in March 2020, fund performance across peer groups has significantly improved, as the market breadth has broadened. But, when viewed from a one-year lens, the number appears bleak — entirely on account of the steep market fall, especially mid- and small-caps during February and March 2020. 

We expect a larger number of schemes to report outperformance versus their respective benchmark on a one-year basis, as we go forward.

Equity MFs have been continuously selling, even as FPIs have been pumping in a lot of money? Is it due to redemption pressure or a contra strategy?

Investor redemptions have been the primary cause for this selling. Money that came into mutual funds near the previous peaks – the second half of 2017 and 2018 -- has in most cases experienced unflattering returns. A large proportion of redemptions could be such inflows exiting when the market recovered sharply from July 2020 onwards.