Margin gains limited; earnings to align with top line: Anish Tawakley

In an interview, Tawakley advises investors entering equities now to maintain a long-term horizon

Earnings growth should be robust in domestic cyclical sectors like automotive (auto), cement, capital goods, real estate, and financials. However, investors should be cautious, as these sectors are no longer cheap, says ANISH TAWAKLEY, co-chief investment officer of equity at ICICI Prudential Asset Management Company (ICICI Pru AMC). In an interview with Abhishek Kumar, Tawakley advises investors entering equities now to maintain a long-term horizon. Edited excerpts:

How do you perceive the events in the global markets in recent weeks? Is the volatility here to stay?

Market volatility is high because monetary policy (interest rate movements) is less predictable than it has been for the past 15 years (2007-2022). Paradoxically, this is due to many economies being in better shape than before.

During the 2007-2022 period, there were two major shocks: the global financial crisis and the pandemic. These led to a prolonged slump (the Great Recession) in developed economies. Because these economies were weak, central bank actions — except for brief periods like the 2013 taper tantrum — were very predictable. Central banks maintained low rates and abundant liquidity.

Now, with economies in better shape, central bank actions are more dependent on economic data and therefore less predictable. This healthier economic backdrop may paradoxically result in greater volatility for the markets.

What are your key takeaways from the first-quarter results so far? Is there a change in view in any of the sectors?

Earnings growth has slowed from 2023-24 levels, which is natural after a strong growth phase. In the past two years, growth was higher as demand recovered from a slump and businesses saw improved capacity utilisation. Earnings grew faster than the top line due to improved margins and increased capacity utilisation.

Moving forward, as new capacity is added to meet incremental demand, earnings growth should align more closely with the top line. If markets were expecting continued margin improvement, there might be some disappointment.

Any major upgrades or downgrades for 2024-25 and 2025-26 earnings or sector estimates?

We have seen cuts in estimates for cement, non-banking financial companies, and fast-moving consumer goods. Industrials and banking estimates have remained flat. There have been upgrades in the auto sector and some stabilisation in information technology, where previous cuts had been made.

Do you see valuations sustaining, especially in the smallcap space?

Overall, valuations are considered rich. We have advised against entering equity markets with expectations of short-term returns. Investors should have a long-term perspective, ideally holding positions for at least three years.

Concerns are higher in the small and midcap (SMID) space, where weak business models are being valued as gems — resulting in the market not distinguishing between good and poor investments. Consequently, we have closed our SMID funds to lump-sum investments.

What should be the return expectations for investors coming into equities at these levels? Which schemes should they prefer?

The economy is in good shape, and earnings growth should remain healthy in domestic cyclical sectors like auto, cement, capital goods, real estate, and financials. However, these sectors are no longer cheap. Investors need to be selective, avoiding companies with unreasonably high earnings expectations.

Specifically, among lenders, caution is advised in the unsecured loan space. A rational yet conservative approach is essential, focusing on diversified asset allocation across equities, debt, commodities, and cash. This multi-asset strategy ensures balanced risk and return, making it optimal under current market conditions.

Existing investors should stay invested, as India’s long-term growth story remains intact. Those adding equity should consider largecap, flexicap, business cycle, energy, or hybrid schemes, and focus on asset allocation.

What are the key headwinds and tailwinds at this juncture? Will the US Federal Reserve rate cut be a big factor? How will a hard landing impact the global economy and markets?

I do not foresee a hard landing or massive rate cuts. The US economy remains strong. Although the unemployment rate has gone up, this rise is due to more people entering the workforce (due to immigration or improved job prospects) rather than layoffs. Job growth, while positive, has not kept pace with workforce growth. This suggests the economy is not contracting but could grow faster by creating more jobs.

A hard landing occurs when people are losing their jobs and the economy is contracting, which is not the case currently. Therefore, large rate cuts are unnecessary.

Additionally, multiples are not cheap to begin with, so I would not build an investment case around major rate cuts and consequent multiple expansions. In India, key variables to monitor include domestic factors, particularly ensuring that house-building activity remains strong and house prices do not rise to levels that stifle demand.

So when does this cycle peak in India?

Economic cycles peak when demand exceeds capacity. In developed countries, capacity is defined by the number of workers. When everyone who wants a job has one, the cycle peaks.

In India, capacity is better understood in terms of power, cement, and infrastructure — essential for production and not importable. This cycle will peak when we run out of power capacity.

What are the trends in terms of retail inflows and their deployment in the equity market?

Flows in any asset class tend to be reflexive. If the asset class performs well, it attracts more flows until it becomes overvalued. Conversely, poor performance leads to outflows until the asset class becomes undervalued.

At ICICI Pru AMC, we view flows as a contra indicator. Retail flows are likely to follow a similar pattern. Investing based on the belief that flows will remain strong indefinitely can lead to investing in hopes of finding a greater fool.