Faster withdrawal of global stimulus can impact markets: Vetri Subramaniam

Without a doubt, fiscal and monetary support across geographies have contributed to this outcome, says Subramaniam

Valuations for mid- and small-caps are not as expensive as for large-cap stocks, but not they aren’t cheap either, says Vetri Subramaniam, group president and head of equity, UTI AMC. In an interview with Ashley Coutinho, he says the government should focus on developing urban infrastructure, including housing and health care, to meet the needs of migrants from the hinterland who constitute a large segment of the workforce in urban India. Edited excerpts:

Has the market run ahead of fundamentals?

It is not just the Indian markets that are at all-time highs. Several markets, in developed and developing countries, are trading at either lifetime or multi-year highs. Without a doubt, fiscal and monetary support across geographies have contributed to this outcome. This support has enabled the markets to look beyond Covid-19, considering the loss of output as being temporary. In India, data across a range of indicators points towards a significant normalisation of the economy. Further, profitability outcomes have been far better than expected. Vaccines now provide hope for a continued recovery path.       

What is your take on valuations?

Valuations are certainly expensive for large-cap-based indices. In the mid- and small-cap segments, aggregate valuations are marginally expensive on the price-to-book metric. Dispersion in valuations remains high when we break down the aggregate valuations. Therefore, some pockets remain attractive. The key is where are we in the growth cycle and how will earnings shape up. Past experience is that the markets often get expensive early in the growth cycle. The baton must pass from valuations to earnings progression from here on. 

What are your views on mid- and small-cap stocks?

The cyclical argument for mid- and small-cap stocks is favourable given the upturn in activity and low interests rates. Valuations are neutral, not as expensive as large-cap stocks but not in cheap territory either. Also, there are several firms in this space that count as leaders in their businesses. Our approach in the mid- and small-cap space is focused on buying companies with leadership positions.

What are your views on corporate earnings?

The results for Q2 were a positive surprise, with profits for the Nifty50 rising 17 per cent as against expectations of a decline. We expect the momentum from the rising levels of activity to have carried into Q3. Inflationary pressures increased during that quarter. However, this might not be sufficient to dent the overall trajectory as there was also some degree of operating leverage. A big chunk of corporate earnings is from financials, where recognition of NPAs has been delayed on account of the Supreme Court’s directive. While we expect companies to provide disclosures, this will not be in their reported numbers. 

What’s your view on bank and NBFC stocks? Is the worst behind us?

The financial sector has been an underperformer and stocks have not recovered to their previous levels of valuations. It appears that credit losses will be less than the worst-case estimates in the middle of the year. Several lending institutions have already provided for credit losses and pre-emptively raised equity capital. Given the degree of normalisation in the economy, combined with prudent actions of these institutions, we see a limited possibility of negative surprises.  

What are your expectations from the upcoming Budget?

We think the government should look to provide humanitarian assistance as there are sectors that have not normalised as yet. Further, credit enhancements to such sector may also be needed. Raising taxes on fuel helped raise revenues when activity was weak, but with activity normalising and GST collections rising, it will be appropriate to roll-back some of the taxes on fuel. We also want the government to focus on developing urban infrastructure, including housing and health care, to meet the needs of migrants from the hinterland who constitute a large segment of the workforce in urban India. 

What are the key global cues to watch out for the coming months?

An important variable to watch for will be the trajectory and pace of withdrawal of stimulus and monetary support. As economies around the world normalise, these emergency and extraordinary measures will need to be withdrawn, but if the pace is faster than expected, it will negatively impact the markets. Also, if the inflation surge persists, it will complicate policy choices. The US-China political and trade tensions, as a new administration takes charge in Washington, will be another important variable to watch.

Large-cap funds have underperformed their benchmarks over the past few years. Do you see things improving?

We believe some of the challenges are cyclical and related to a narrow breadth of the market in the recent period. This situation may not persist and funds may do better.

Which are the sectors or pockets of the market that you like in the aftermath of the pandemic? 

We don’t see any specific reason to reshuffle our portfolio from a top-down perspective based on the pandemic. Our portfolio turnover ratio as of December 2020 across strategies is similar to or even lower than the portfolio turnover ratio as of a year back. While not related to the pandemic, the outlook for domestic cyclicals is improving.

What are the key learnings from 2020 for fund managers?

 The lesson of 2020 is that the future is always uncertain. The biggest risks are always outside our peripheral vision. These risks are best navigated by a well-diversified portfolio with fundamentally sound companies. Our investment process emphasises two key factors: Higher return on capital employed over the cost of capital and consistency in operating cash flow.

These parameters and management quality are as important as valuation metrics. It is also important to remember that most valuations metrics ultimately try to understand the value of the cash that the company is expected to generate over its lifetime. Seen in that light, an extreme outcome in one year may not change the underlying value of the enterprise significantly, though its price could prove to be much more volatile.