Dear Investors
In this edition let us discuss the following:
· Market outlook after the election process has ended
· Our portfolio positioning for the same
· Inclusion in JPM bond indices
· Themes should remain broadly same after elections while few winners could change with outcomes
Valuations and upside
Election process has ended
The end of the election process to elect the new government is close and the results would be in on 4th June. Once the uncertainties are behind us, focus would come back on the fundamentals.
India has seen a sustained bout of FPI selling and one reason could be election uncertainties while the other seem to be the rebound in the Chinese equities after a sustained slump. HSCEI (China) is up 25% and Hangseng (HK) is up 19% over the past 3 months. China has a larger weight than India in global indices and when that market performs, it would suck in flows. Continuous selling by FPIs in the domestic market and outperformance of China, has made a large correction in the India weight of global managers which should see rebalancing.
Today, India presents a compelling story. It is the highest ROE market in the region, and is the fastest growing large economy. While growth has been happening, leverage of corporate India has come down as a percentage of GDP and banks are in good health. With capacity utilizations now getting better, we are on the cusp of private capex driven growth story, especially in an environment when the policy makers can provide a degree of protection on reverse globalization. Global investors look towards emerging markets for growth and today India offers a compelling multi-year growth story.
A good possibility is that rebalancing of global portfolios coincides with election outcomes. In the event of the election and budgetary outcomes being to markets liking, there is a possibility that we see a spike in FPI inflows as the current uncertainty reduces or at least there is a halt to continuous selling. Something similar happened after the state election results (which also coincided with US 10Y yield drop). Domestic flows continue unabated. We think there is a possibility of Indian markets correcting the underperformance of the last 3 months vs the global peers post elections and post budget if the outcomes are favorable. Reverse could be true as well, but the chances for the same are low
How are our portfolios positioned for post-election scenario?
FPIs are growth focused investors. In the past, IT and Banks used to be the growth leaders in the country and close to 50% of FPI money is invested into these spaces. These are large and liquid spaces also. However, these spaces might no longer be the growth drivers. The earnings growth outlook for large cap IT companies over the next several years is significantly lower vs the index. Outlook for bank earnings is also converging with index earnings growth in the near term. In Dec 23, however, these spaces saw a strong up-move when FPIs last came in strongly. Since we are underweight in these spaces, it is a risk. However, we note that the up-move did not sustain. This points to the possibility that what we saw could have been short covering. We believe that while the possibility of strong performance of these spaces in the event of strong FPI inflows remain, it is lower than before given that growth leadership has passed on to other areas. In any case, over time the flow of money would find its way to the growth spaces in the economy.
We believe that we are well positioned. We are running some of the fastest growth in EPS portfolios in the country with a large earnings growth delta over the index, with a focus on good quality of business and management and well positioned in the growth themes of the country which should sustain given the needs of the country. Domestic investors like these spaces and chances are that FPIs would too. These same spaces benefit from any reduction in interest rates as cost of capital reduce.
Inclusion into JPM bond indices from June24
This is a much awaited event and would start from June 24. We expect incremental demand of around USD2bn per month for government paper and the yield on government paper can reduce. This should reduce re-financing cost for the government. Also, if the yields on government paper reduce, the ability of corporate India to access the domestic savings pool would improve. This again helps the capex theme.
Would growth themes change post elections?
Let us address this in the following manner.
- Some themes are global and every government might focus here. These are
- Defence: globally expenditure here as a percentage of GDP is rising after Russia-Ukraine and Israel-Hamas. This would continue. The names we are exposed to are all PSU names in this theme. This should continue to do well irrespective of election outcomes
- Renewables: With global warming, generating energy from renewable sources has been the focus across the world. India has two wind power generating companies and a few solar names could emerge. This theme should hence continue
- Make in India/ China+1: This includes Chemicals, EMS, garmenting, etc: giving sops to corporate India to set up a manufacturing base is not unique to India. Many countries are doing the same including the US. With China+1 sentiment ruling strong, this theme should also continue. Maybe since this involves government support, the winners of this theme could change in the event of a new face emerging as PM.
2. Indian themes are a result of long period evolution of the economy
- Luxury consumption – We are invested in premium housing, jewellers, food delivery companies. The outlook for none of these change with election outcomes. These are more dependent on the growing per capita incomes of our population which is a long term trend.
- Banks, NBFC, Capital markets: Banks and NBFC are in good health and have seen repayment of loans from corporate India. They should not be impacted much even if we get a government change. However, capital market companies may have to tackle lower volumes and prices on account of policy uncertainty and growth outlook in case of a change.
- Hospitals: Once again low impact space because the need for more is very palpable.
In short, except in close to government spaces such as construction (our portfolios don’t have an exposure here), market volumes and level driven businesses such as brokerages and exchanges, we see continuity post elections and believe we are well positioned. The reform process would move forward and get deeper and we are trying to increase the weight of businesses that benefit from the same.
Valuation and upside
Markets have consolidated for a quarter now. A three-month consolidation corrects valuations by between 4,5,6% for large, mid and small cap spaces respectively, given the strong earnings growth momentum. Markets are valued in line with historical trends for the large cap spaces but the earnings growth outlook is better. Quality of businesses is also better with improvement in return ratios. These are two parameters that are inputs for valuations and both are looking better. Reverse globalization and positive policy making environment is helping India Inc. We had noted in our previous editions that with better growth in earnings outlook, better governance and prospects of interest rate cycle changing direction, current period could see sustained better than average valuations, in the process pulling up long period averages supported by positive policy momentum. This is already true for mid and small cap part of the market. A one percent higher growth in earnings sustained for 10 years, improves the valuation outlook by close to 5%.
Overall, we believe that the markets are at sustainable valuations and could provide better than earnings growth related returns as cost of capital reduces. Cost of capital reduction may increase the competitiveness of growth businesses over value part of the market and this can provide our portfolios further tailwinds.
Thank you
Happy Investing
May the Good Times Continue 😊
Prateek Agrawal
Managing Director and Chief Executive Officer
Motilal Oswal Asset Management Company Limited
Source: Investing.com, CMIE, NSE Indices, Bloomberg, MOAMC Internal Research
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