While inflation does seem to have peaked out, central bankers are not letting their guard down. While increase in policy rates have slowed down, central bankers are now expected to keep rates high for longer and the peak rate could be a tad higher, vs earlier expectations.
Equity markets which had been buoyant in November, on hopes of a policy pivot, gave away some of their gains and consolidated. Covid fears resurfaced on case spike in China.
We had looked at valuations and pointed out that while market levels are sustainable, one should expect the market to consolidate in a range for some time given that the bond yield to earnings yield indicator was not favourably placed. Equity markets are sustainable, given that markets are trading at near 10-year average valuations. Investors must note the changes in the indices in favour of higher quality businesses. Lower commodity prices help the India outlook. We have seen FPI outflows turning into inflows, coinciding with drop in commodity prices.
Key worry was sharply falling forex reserves. We see this as key to sustaining business as usual in the country. Here, over the past 3 weeks we have seen a strong up-move. Trade deficit has dropped on a sequential basis. This has helped to address the issue while we would keep it under watch. The improvement may prove temporary as FED is increasing the pace of taper.
The other key worry is of slowing global growth. However, today when oil production is constrained, slower global growth related slowdown in Indian economy gets compensated by the savings the country makes on lower oil prices.
The third worry is any resurgence in Covid in the country. Experts are indicating that Indian population has developed a good immunity and we should not be impacted much, while China where population has not been exposed to Covid may get impacted. This may work in India’s favour as global supply chains work harder on sourcing diversification.
Reversal in Japanese carry trade is another concern as Yen appreciates. However, impact on India should not be high given that most of incremental money into the market is of Indian origin.
Margins should improve from Q3 onwards
Q3 result season would start from middle of January. After two quarters, when Indian manufacturing witnessed a margin squeeze on account of severe input price volatility and inventory bought at higher prices, Q3 should see margins expand sequentially. Amongst the growth sectors, Cement, consumers, specialty chemicals, and Autos should see margin expansion. The period ahead may see even commodity margins expand as their inputs have also seen reduction and government windfall taxation has reduced. H1FY23 margin squeeze was led by commodities and some reversal would be witnessed going forward. Ex-commodities, EBIDTA margins are expected to fall by just 1% in FY23 and expand again in FY24. EBIDTA margin expansion would provide a tailwind to the earnings in FY24.
Banks dominated profit delivery in Q2FY23. There was a concern that these profits are peak profits and NIMs would decline going forward. Also, credit growth may not be sustainable in the face of falling deposit growth. However, now with deposit growth picking up, and with system liquidity improving, a higher growth rate can sustain for longer aided by money multiplier. Most banks are comfortable on provisions and hence the NPAs should not hurt. PSU banks should see a sharper increase in NIMs given their lending is linked to MCLR. NBFCs, where the share of fixed rate loans is higher would benefit as the loan book gets re-priced.
Amongst other spaces, tyre companies and auto ancillaries should see margin expansion. In an economy facing the heat of global slowdown, margin expansion would prove to be a big driver of profit growth. If commodity price fall trend continues, this lever could strengthen going forward. Since margins are to be realized by just sustaining prices and benefitting from the fall in commodities, they should prove to be more readily obtainable in the face of slowing sales growth vs in a scenario of increasing input prices.
Lower commodity prices, better EBIDTA margins going forward and pre-election spends should help more than negate the negative influence of a global slowdown on profits.
It is time for alpha ideas
Better margins would sustain earnings breadth. Margin bump up is mainly in the manufacturing part of value chain vs branding or distribution while lower distribution costs would also provide support. Midcap and smaller companies derive most of their value from distribution and manufacturing and should benefit strongly. This implies continued strength in earnings breadth and consequently with continued inflow of domestic money into markets, directly or through funds, the chances of alpha seekers should improve.
We are focussed on quality fast growing businesses amongst Lenders, Chemicals, companies benefitting from domestic manufacturing renaissance, tech companies who may be on the verge of EBIDTA breakeven, retailers, Hospital chains, and PLI beneficiaries looking at compounding of profits to deliver most of our returns.
Sustaining performance is a highly desired objective in money management. We released our 27th Wealth Creation Study last month. The study pointed out that the consistent businesses have delivered much better risk adjusted returns over the past 15 years, and for sub-periods, as compared to volatile businesses. Only the consistent businesses are investible for longer term and that too till consistency remains. Other businesses must be looked upon as a trade. Our QGLP framework helps us identify such businesses. Going forward we would incorporate the findings of this study in our risk framework. This should help sustain performance. Over and above the quality focus, we have laid out profit taking frameworks, portfolio and stock sizing framework, Sector weightages and stop loss processes to sustain performance once it is achieved.
Source: Motilal Oswal 27th Wealth Creation Study
Outlook going forward
The year is coming to an end. Next calendar year brings with it a lot of hope while there are risks as well. Margin improvement is the key theme going forward and should work well in combination with other themes of CY22. We expect a growth oriented budget, the last full budget of the current government. Sustained growth and margin improvement in the country, should keep the breadth of the market good. Valuations are sustainable and investors should expect returns approximating earnings growth going forward while the journey should be expected to be more volatile.
Wish You all a very Happy New Year
Executive Director – Motilal Oswal Asset Management Company Limited
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