Rotation into large-caps could continue ahead of elections: Ritu Arora

Indian markets have rebounded sharply from their lows in mid-March with the Sensex crossing the 75,000 mark for the first time ever this week. RITU ARORA, chief executive office and chief investment officer for Asia at Allianz Investment Management, tells Puneet Wadhwa in an email interview that the Indian markets will witness periodic corrections and provide better entry opportunities over the next year. Edited excerpts:

The Sensex hit the 75,000 mark earlier this week. Is there more steam left in the Indian markets?

The outperformance in the Indian equity market is not surprising and we remain constructive on Indian equities from a long-term perspective, considering the structural strengths in the Indian economy. Indian equity valuations, though not very expensive, compared to their own history, are not cheap either at 21x 1year forward price-earnings (PE) versus the long-term average of 19x. These PE multiples may not be factoring in growth slowdown in the near-term, driven by the high interest rate environment and developed markets.

India’s market cap to GDP ratio at around 130 per cent, is well above its long-term average of 80 per cent. Equity earnings yield of nearly 5 per cent does not compare favorably with the 10-year yield of around 7 per cent. Indian markets will witness periodic corrections and provide better entry opportunities over the next year.

Which other equity markets in the Asian / EM pack look more attractive than India?

From an Asian perspective, Indonesia and Philippines continue to be attractive markets, considering the favourable domestic demographics and ongoing urbanization. These are well-run economies and equity valuations are also reasonable at 12-14x 1year forward PE multiples. Both countries also continue to offer lucrative opportunities for Foreign Direct Investment (FDI). Singapore and Malaysian markets offer attractive dividend yields (over 4 – 5 per cent) in addition to capital appreciation potential.

China could be another market to watch out for, depending on its domestic economic revival, potential recovery of the property sector, and single digit PE multiples. Japan and Taiwan have been some of the large markets that have done very well over the past year and are attractive from a structural perspective.

Have the Indian equity markets fully discounted the election outcome?
 

Equity markets in India have historically traded well heading into the elections, with the Nifty 50 rallying over 10 per cent in the six months preceding elections in four of the past seven general elections. These past pre-election rallies, which occurred on expectations of a stable government, were led by domestic cyclicals. While earnings will primarily drive the market, domestic inflows amid the rapid financialisation of household savings and foreign inflows will have an impact on the market, in addition to the election results.

Overweight and underweight sectors in the Indian context?

We continue to prefer domestic sectors in India, emphasising on a growth at reasonable valuations approach. Economic growth in India would be manufacturing activity-led and driven by the impending capital expenditure cycle, which may be around the corner. We particularly like financials, industrials, utilities, telcos, autos and insurance. On the other side, we remain cautious on pharma, chemicals and OMCs (oil-marketing companies). Themes of interest include quality large caps; affluent India; home building; Make-in-India, and industrials.

Earnings expectations for the March 2024 quarter?
 

After around 20 per cent earnings growth last year, we expect double-digit earnings CAGR in 2024/25, which will be a significant growth in the region after the tech-driven cyclical recoveries in Korea and Taiwan. After significantly outperforming last year, midcap and smallcap indices are consolidating, are below their peaks and have lagged large-caps. The rotation into large-caps could continue as we head closer to the general elections and valuations there are more reasonable.

How concerned are you regarding the sharp run seen in IT stocks in the US, especially the ‘Magnificent 7’?

Earnings growth expectations and valuations are high and concentrated in AI, particularly in the Top 6 US stocks. But the Q4 earnings season confirmed the AI lead for now. With earnings growth recovering and a strong track record to beat market expectations, we do not expect a widespread sustained price correction in the US in 2024.

That said, it is also pertinent to note that the US equity market remains expensive: forward PE of 22x versus long-term average of 18.5x. This is largely due to the Top 6 tech companies which offer over 25 per cent expected earnings growth in 2024, compared to low single-digit earnings growth for the remaining US stocks. This picture is much more benign than that of the dot-com era in the late '90s.