Dear Investors,
In this monthly update, we would focus on China re-opening, Indian macro strength, budget expectations in brief, investing themes, and valuations.
China reopens up and FPIs realign their portfolios
In the recent past, despite Covid flare-up concerns, China continued to open up. The Covid scare also receded. With China opening up, commodity prices such as steel and oil, which were soft earlier, have again strengthened. Stocks of commodity-producing businesses have performed better.
During the past year, India had seen strong FPI outflows at the beginning of the year but as Russia-Ukraine conflict grew and China cracked down on its tech companies, the investors shunned these markets. India benefitted at the margin. Now, as China opens up and its markets perform better, investors are realigning their portfolios and in the middle of another commodity up-move, India is seeing some FPI outflows.
The realignment-led FPI selling seen in the country can prove to be a good entry point for domestic investors whose flows are structural and would benefit once FPI selling subsides.
Indian macros are strong
After a sharp dip seen in the levels of forex, India’s forex reserves have seen an uptick. This has improved the outlook on stability in a scenario where the world is seeing a contraction in narrow money. Higher forex reserves provide policymakers a higher degree of freedom to focus on growth initiatives even in the face of a slowing world economy. With oil prices down sharply from the peak and with cheaper Russian oil mix in India’s basket sustaining at a high level, in combination with buoyant remittances and FDI, there is a chance that we see an accretion to USD reserves rather than a depletion over the year.
Quick indicators such as electricity demand, GST collections, etc are all buoyant. Some discretionary categories such as QSR are reporting a slowdown but this should mostly be on account of more spending avenues opening up as the economy normalizes after Covid. The past period has seen economic growth being led by the more affluent sections of society. Adding to this, sales of high-end goods and services have grown much better (SUV vs small car, expensive houses vs mass market houses). Housing prices are sustaining and their sales volumes are also high. In the coming period, as the migrants to cities rebuild their incomes, their consumption should broaden the overall pie and drive Indian growth forward.
IIP numbers for November were buoyant. While petroleum and textiles pulled it down, metals, pharma, machinery, cement, and railways pulled it up. At the same time, inflation is easing both in India and the globe which raises hopes of a slowdown in the pace of increasing interest rates as we move forward into the new year.
At this juncture, we cannot have a combination of low fuel prices and high global growth, given production constraints for oil. Lower oil prices sharply reduce our import bill and negates the effect of a global slowdown thus leading to a sustainable combination which we have now.
Themes that we are focused on
We are a process-driven house focused on the Q(Quality) GL (Growth and its Longevity) P (Valuation) framework. Themes are a great way to think about spaces that are experiencing tailwinds. We, as a team, have shortlisted a few themes that we believe may do well this year. Amongst lenders, we continue to believe that Banks would have an edge over NBFCs. Life Insurance company’s stocks have not performed for some time. They could get their mojo back as embedded value (EV) increases in line with new business with interest rate up-move stopping and then the EV shall increase further as interest rates start to decline. Health insurance companies may see strong profits going forward as Covid related expenses decline.
The other theme we are clued on is health care where hospitals and pharmacy chains seem a better way to build portfolios vs generic pharma companies. In Urbanization, we believe that consumer discretionary categories are better placed than builders, autos, or staples. New-age companies have shared their intent to focus on profitability and if they stay on their projected path, they could be interesting but also volatile as old shareholders exit and shareholdings change. On the margin, these new-age companies could prove to be better than service companies over the long term. Chemical space has the tailwind of China +1. We continue to be focused on Make in India theme and engineering & defense companies continue to be the focus. One should expect to see margins improve from H1FY23 lows as commodity prices have declined and within the above themes, the spaces where margins improve, can have further tailwinds.
Budget outlook
The budget should continue to be growth-focused and focused on nation-building and infrastructure. Globally, countries are focussed on improving domestic manufacturing and defense capabilities and this could help our resolve towards the same. We expect to see stability in the tax regime and expect government to attempt fiscal consolidation. Also, FY23 numbers could be better than budget estimates on fiscal deficit percentage. On market-related taxation, we may see rationalization of holding periods for the purpose of classification as long term capital gains across asset classes for simplicity in tax structure. Also, gains and losses from various asset classes could be made fungible. In a period of global fiscal consolidation, India would have to put its best foot forward to continue to attract foreign flows in both debt and equity.
Valuations
At the current juncture, on pre-tax valuations, debt seems to be more attractive than equity as interest rates peak out and then decline. Having said that, Indian equity index compounding has been in line with profit compounding from 1997 till date at around 12%. This suggests that going forward, one should again expect index compounding to be in lines with earnings compounding.
Source: MOIE
Over the past two years, we have seen Indian markets being influenced more by domestic flows of money compared to the global flows. As per capita income increases in the country, this trend would only strengthen. Domestic investors can invest limited sums of money abroad and offshore investors are investing only small amount of corpus in the country. In such a scenario, the relative movement of various markets is of less importance. India should be expected to trade in line with its fundamentals and be reflective of its earnings growth over some time.
Since the Indian economy is expected to grow faster than most economies and profitability has seen an improvement, there is a great chance that over the coming few years, our market outperforms other global markets. In smaller timeframes, however, other issues would need to be digested. For example, in the current period, there may be portfolio rebalancing happening on China reopening which is causing our markets to be a tad depressed. This kind of FPI selling-induced fall is a good opportunity for domestic investors because when it stabilizes, the markets are expected to bounce back.
It continues to be a time for alpha generation for managers as broad earnings growth and alpha-seeking domestic money makes it possible in combination with better valuation outside of the index. Our portfolios have had this tailwind and we expect this trend to continue going ahead.
Best Regards,
Prateek Agrawal
Executive Director – Motilal Oswal Asset Management Company Limited
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