Let your investment become boring; time to pare returns expectation
The staggering outflows from FIIs over the past 15 months have left equity investors high & dry in this calendar year. Looking forward, Indian equities still look choppy! The growth outlook will be tempered in the near term as the interest rate cycle is moving high from lows.
As I’d mentioned in my note, a few months back, that “Stagflation” might become reality. The current scenario does indicate an environment of high inflation and a slowdown in the real economy.
Global liquidity taps are closing
The tap of cheap liquidity flows across the world is drying quickly. Most central banks across the world (with exception of the EU), are clearly signaling that controlling inflation is a priority now. The geo-political tension, prevailing high food grains and crude oil prices are signaling more uncertainties. The high inflation, increase in interest rates and weakening global economic environment has made many experts start talking about recession.
Obviously, the Indian economy will not be immune to global slowdown. The correction in equities clearly reflects this scenario. The valuations of equities were at the high end of the curve at the beginning of the year (over 24x forward earnings). Now the valuations are catching up with the fundamentals and PE multiple is down to 18x forwards earnings. Well, this multiple is reasonable but not cheap.
RBI- Inflation over growth?
Although RBI has increased the repo rate by 90 bps in the past 30 days; it might not serve the purpose of taming down the inflationary pressure. The sharp rise in inflation is due to some supply side constraint like; higher crude oil price, strain in commodity supply due to Ukraine- Russia war, China related supply chain issues (pandemic related lockdown)
All these factors are effectively beyond the monetary policy tools of RBI. In fact, a rather rapid rise in interest rate and removing liquidity from the banking system can be counterproductive for the economy.
The estimate for CPI inflation for FY 2022-23 is at 6.7% while the repo rate, after RBI hike, is still at 4.9%. So there is a significant gap between the real interest rates and the inflation. RBI has to walk on a tightrope to ensure that the growth coupled with investments and job creation do not become causality in order to contain inflation. The recent movement in bond yield also indicates that the near term outlook is challenging. The 10 year G-sec bond has now moved to 7.51% which was at 5.7% in June 2020.
India: Domestic scenario
Domestic investors have been lauded as the shock absorber of the equity market. But
unfortunately many investors who were the last to join the rally last year will see a painful exit or
a longer waiting period. In the current global scenario, the Indian economy is still better placed with expected economic growth of around 7%. So eventually liquidity will find its way back into Indian markets. However for that to happen the economy and the equity market has to absorb the cycle of rising interest rates & inflation. We do not expect any V shape recovery as far as equities are concerned. Investors need to be extremely patient during this gestation period of Stagflation. We may or may not see deep point correction but the time correction is very much on the horizon.
The biggest causality during this period will be the PE/ VC investments as “The Greater fool
theory” is being played out. The subscribers to some of the recent IPOs have already witnessed this brutal game. The narrative of growth only from a top line or revenue perspective will not have many takers in the investment community. From a longer term perspective, the focus will be back on profitability and the cash flows.
The rationality is gradually coming back to the valuations now. Investors need to ignore the noise and be patient with their investments. After a strong rally in equity during 2020-21, the time has come now to pare down the returns expectation. Let your investment remain boring. We strongly recommend not to chase returns by taking undue risk. Currently the IT sector which has seen one of the sharp corrections in recent times, offers a very interesting investment opportunity. Also the banking sector offers good opportunities for investors with a long term perspective.
Thanks for your patient reading!
