Looking at domestic flows, peak pessimism hasn't reached yet: ICICI Sec CIO

The price-to-earnings (P/E) ratio has seen sharp contraction, which warrants investments from a long-term perspective, says Piyush Garg, chief investment officer, ICICI Securities. In conversation with Sundar Sethuraman, Garg says stocks in sectors like consumer discretionary, fast-moving consumer goods (FMCG), automotive (auto), and cement have reached attractive valuations. Edited excerpts:

Are you more inclined to buy now as valuations have come off highs? Or will you await further correction?

Nifty’s one-year forward P/E was 23x when the index made a high of 18,600 in October 2021. While the market fell, earnings continued to revive. This led to a contraction in Nifty P/E to 18x 2022-23. Such contraction in P/E warrants some investment from a long-term perspective.

Have stocks fallen more in the broader markets? Does one buy small-caps that have corrected sharply?

The earnings yield difference between large-caps and mid-caps is hardly 10 basis points (bps), which makes large-caps more attractive. Both large-cap and mid-cap valuations have reached below the last 10-year average. However, on risk-adjusted terms, large-cap valuations look more attractive. 

What are the expectations for the June quarter? Which sectors could miss or beat expectations?

The rise in the dollar and fears of recession have led to a decline in commodity prices, limiting US inflation somewhat. India imports 60 per cent of its palm oil consumption, which has corrected 24 per cent in June itself.

India has also imposed higher duties on wheat and steel exports and on gold imports to reduce the impact on inflation. With monsoon picking up, there is expectation of lower inflation numbers. This has created opportunities for commodity-user sectors like consumer discretionary, FMCG, auto, and cement. All of them have declined sharply. Some have reached attractive valuations. Some recovery can be seen in these sectors.

Retail investor participation has been sluggish since the beginning of the year. What are the trends you are witnessing when it comes to retail behaviour? 

Systematic investment plan inflows have continued. Despite more than $6 billion of foreign outflow in June, almost the same amount is poured into by domestic institutions. Looking at domestic flows, peak pessimism has not been reached yet. That is why there may be more painful consolidation.

How has investor enthusiasm for global stocks evolved since the pandemic?

Significant money has gone into global technology stocks in the midst of the pandemic. This space has significantly corrected since the start of 2022 on account of rise in interest rates, and also, it was an overbought sector. Also, $95 billion per month of balance-sheet reduction is announced by the US Federal Reserve to check runaway inflation.

Investor focus will be on results and future guidance. Better-than-expected results can revive investor interest. The impact of higher interest rates is clearly seen in the demand slowdown in the US and Europe.

The US consumer sentiment index has declined the most in 60 years. India’s exports, particularly in footwear and leather goods, cotton yarn, readymade garments, and handicraft, declined due to higher inventory in US retail chains.

India’s exports in June rose 16.8 per cent year-on-year at $37.9 billion — slower than 20.4 per cent in May.

What’s your advice to investors, given the correction in US markets this year?

Investors have not seen such a high inflation in 40 years. A sharp increase of 75 bps in just one month is also unprecedented, compared to two decades of rate hikes.

Foreign investors across the globe have displayed risk-averse behaviour. This trend may alter, with the Russia-Ukraine stand-off finding some solution. Equity markets are likely to remain volatile in 2022-23.

What are the key global headwinds right now? Will foreign portfolio investment sell-off stem or reverse soon?

Elevated inflation is a major concern, leading to front-loading of the monetary policy. Supply-chain concerns are at the core of sticky inflation, exacerbated by the Russia-Ukraine war. With China opening up, we expect some relief from inflation, along with recent corrections in commodities.

Foreign institutional investment (FII) is expected to reverse when these macro headwinds stabilise for a few months. The Reserve bank of India (RBI) has also taken steps to shore up the rupee, which can restrict some inflationary trends. Efforts by the RBI were required as foreign exchange reserves in India have depleted by $50 billion, from $643 billion to $593 billion, due to FII outflows in the past year.

Also, more than 40 per cent ($267 billion) of external debt of $621 billion is due for repayment in the next nine months, which can further put pressure on the rupee. We expect the rupee to be under pressure till the dollar rally sustains.

Which sectors are you bearish/bullish on?

We like business-to-business businesses in a higher inflationary scenario. We are overweight on production-linked incentives and China Plus One beneficiaries. We prefer large banks and non-banking financial companies.

Our focus is on rising refining margins in the energy space and an increase in average revenue per user in the telecommunications space. Also, beneficiaries of higher government capital expenditure can recover faster in the days to come.