Risk-reward not favourable in near to mid term: Nomura India's Mukherjee

He says that the market valuation premium over emerging market (EM) peers is around 70% versus the long-term average of nearly 40%

The equity markets have started the second half of 2022-23 (FY23) on a cautious note amid rising inflation and aggressive central bank policies. Saion Mukherjee, managing director and head of India equity research at Nomura, tells Puneet Wadhwa in an interview that given the existing sentiment, there are more downside risks than triggers for an upside from here on. Edited excerpts:

Are the markets completely out of the woods or do you see panic selling every time global central bankers, especially the US Fed, meet to review their monetary policy?

Macro uncertainties remain high. Inflation and rate concerns are acknowledged by the market. However, there are uncertainties around growth and the stickiness of inflation in the medium term. We, therefore, expect the markets to react excessively based on the outlook on these parameters. The US Fed and central banks, in general, have inflation as their key concern. The markets will also react to inflation data as that will set the tone for central bank actions. Over time, growth will emerge as a key concern, which will particularly be a bigger issue for India, than inflation/rates.

Are you in the ‘sell on a rally’ camp or ‘buy on dips’ as regards Indian equities? To what extent have the Indian markets and economy ‘decoupled’ from the worries and performance of their global peers?

We are cautious as macro headwinds are far from subsiding and equity valuations, in general, are elevated. The Indian markets have significantly outperformed global peers as inflation/rates are bigger concerns for global economies and markets, than it is for India. To that extent, India appears to be decoupled. However, we are increasingly concerned about global and India’s growth. The Indian markets will be more sensitive to the growth outlook than to the inflation/rate dynamics. Typically, the markets tend to factor in growth concerns as it plays out rather than pre-empting a slowdown.

How do you see the next year/Samvat play out for the Indian equity markets? Are there more headwinds than triggers for an upside?

The Indian markets have, thus far, held up well. The macro headwinds are less for India than for other economies. Corporate earnings, too, have held the fort. Bank, corporate, and household balance sheets are in a good shape. The market is supported by domestic flows, and even foreign flows have now come back. Given the existing sentiment, there are more downside risks than triggers for an upside from here on. The rise in interest rates and weak absolute market performance will result in lower flows into the equity markets. Further, a slowdown in growth can be a material disappointment and lead to a reduction in corporate earnings and growth expectations.

Would you prefer large-, mid-, or small-cap stocks from a 12-month perspective?

The risk-reward is not very favorable for equities in the near-to-medium term. It will remain a bottom-up market. Across market caps, we prefer stocks where growth expectations are not high as reflected in high valuation multiples. 

How comfortable are you with the market valuation at this stage? Do you see the pace of foreign investor flows pick up over the next few months, or will economic indicators trigger an outflow yet again?

The Indian equity markets have outperformed global markets. The market valuation premium over emerging market (EM) peers is around 70 per cent versus the long-term average of nearly 40 per cent. The valuation premium of Indian equities to a large extent factors in the relative strength of India. Against the backdrop of rising rates and a likely slowdown, outflows remain a risk.

What has been your investment strategy against this rising interest rate and inflationary backdrop? Where do you see the Sensex/Nifty50 by March 2023?

Our December 2022 Nifty target is 16,900. We have followed a bottom-up approach and prefer companies with valuation comfort and where growth expectations are not elevated. We are overweight on banks, pharma, and industrial/construction, and are relatively cautious about consumers.

What are your expectations from the September quarter earnings season? Will the impact of inflation and the rise in input cost be fully baked into the numbers?

The earnings season will largely be in line with expectations. The impact of higher commodity prices is factored into Street estimates, in our view. That said, we may see a positive impact of lower costs in the subsequent quarters. We expect growth and asset quality for banks that is the largest contributor to aggregate earnings to remain strong.