Daily Voice | This Credit Suisse wealth manager is constructive on 6 sectors with expectation of good festive season

India is in a sweet spot and the equity market P/E premium versus peers should remain elevated given the marked improvement in macroeconomic fundamentals and significant improvement in corporate balance sheets

August 04, 2022 / 10:21 AM IST
Jitendra Gohil of Credit Suisse Wealth Management

Jitendra Gohil of Credit Suisse Wealth Management

Credit Suisse Wealth Management expects the Reserve Bank of India to go for a 35 basis point rate hike, rather than a 50 bps increase, on August 5. This time, too, the Monetary Policy Committee should keep the focus on growth as the economy is not completely out of the woods yet, Jitendra Gohil, Head India Equity Research, said in an interview to Moneycontrol.

In the next two quarters, Gohil, who is responsible for generating investment ideas and proposals for Credit Suisse Wealth Management clients, said one should gear up for a good festive season as the rural economy has shown signs of recovery. Credit Suisse is constructive on cement, credit card companies, multiplexes, media, retail and consumer durables, he said. Edited excerpts:

The key event to focus on would be the RBI policy. Do you expect a 50 bps hike in the repo rate? What do you expect from the RBI commentary?

Certainly, the elbow room for the RBI has increased, given a slightly dovish Federal Reserve policy compared to market expectations, the fall in the US 10-year Treasury yield from the recent peak of close to 3.5 percent to below 2.6 percent currently, and the decline in commodity prices.

The Bloomberg agri-commodity index is down about 20 percent from its peak in May 2022. The US Dollar Index, too, is down from its recent peak in mid-July of ~109 to ~105 currently. Furthermore, the government has reduced excise duty on petrol and diesel, taken some steps to improve imports and restricted exports to improve domestic supplies.

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Hence, we expect the RBI to go for a 35 bp rate hike, rather than a 50 bp increase, in its next meeting. The policies of the central bank have been growth-supportive and this time too, the Monetary Policy Committee should keep the focus on growth as the economy is not completely out of the woods yet.

On the flip side, while the monsoon is now above normal overall, deficient rainfall in the eastern part of the country is a worry on which we are keeping a close watch, especially in light of the higher rice prices in the international market.

Will the Fed soften its stance in the September policy meeting as it has taken note of recent economic growth data?

Our house view that the market has priced in peak hawkishness is playing out. The market expects a 50 bps rate hike in the next meeting, and the Fed could indeed go for it given the substantially high rates of inflation in the developed market. While the US is in a technical recession now as the gross domestic product contracted in the last two quarters, the unemployment rate is low and corporate balance sheets are in good shape.

Hence, the Fed should be able to raise rates despite growth worries surfacing. This should not be a problem for India as slower growth in developed markets as well as in China may push commodity prices, which remain India’s Achilles heel, further lower.

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Can the Fed bring inflation down to its 2% target rate by the end of FY23?

It will be very difficult to say as we currently do not know how the geopolitical situation in Europe will pan out. Structurally though, as the world moves away from hyper-globalisation to localisation or “friend shoring,” the resulting supply-chain disruptions could bring inflationary pressures.

Nevertheless, if commodity prices do not go higher from here and as the base effect catches up, it is possible that the rate of inflation could start to fall. Recession in the developed market and a marked slowdown in the Chinese economy may also help to cool down inflationary forces… inflation should start to fall gradually in the second half of the year.

Are the global markets still worried about inflation and recession?

Yes – however, the worries about recession in the developed market are overtaking the worries about hyperinflation.

Credit Suisse says the Indian market’s elevated valuation premium may persist and India is in a relatively strong position to withstand the global growth slowdown given its low dependence on exports. Can you explain?

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India is in a sweet spot and equity market P/E (price-to-earnings) premium versus peers should remain elevated given the marked improvement in India’s macroeconomic fundamentals as well as significant improvement in corporate balance sheets. India is the fastest-growing major economy in the world. However, what is fascinating is that the growth acceleration, compared to pre-Covid years, is the fastest among peers – we have written about it in our 2022 outlook report.

The market is underestimating India’s growth in the medium term. After a long time, India’s real-estate sector is seeing staggering sales numbers. We do not think this is just pent-up demand that is driving it. It is structural improvement. A sector like real estate can contribute materially to India’s overall GDP as a sizable part of India’s household wealth is linked to this sector.

We are also encouraged by the marked improvement in corporate balance sheets where the average net debt-to-Ebitda for the BSE 500 companies is expected to fall to 1.1 times in FY23 from above 3.0 times in the pre-Covid three years. The government’s capital spending has picked up and we have not seen a slowdown in private capex so far despite the RBI raising interest rates. GST mop-up and growth in the digital economy have led to significant improvement in government finances.

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Hence, despite oil prices surpassing $100 a barrel, India has not seen any major macroeconomic shock. At Credit Suisse Wealth, we focus on slightly longer-term fundamentals and we did speak about financialisation of savings and premiumisation in our urbanisation report back in 2015. The Covid-19 pandemic has actually led to an acceleration of these trends, and despite the record pace of foreign portfolio investor (FPI) selling, India's performance in the year-to-date has been solid.

Currently, the MSCI India Index trades at a record 12-month forward P/E valuation premium of 95 percent versus the MSCI Emerging Markets Index – significantly higher than the average of 45-50 percent premium in the past. India's record-high P/E premium could also be attributed to the substantial decline of Chinese equity valuations as well as the fall in valuations for Asian economies that depend on China.

Given that FPI ownership of Indian equities is at a decade low and there could have been some selling fatigue, valuations of Indian equities may not fall much, in our view, especially as we are expecting a very good festive season that should support domestic earnings.

What are your views on earnings so far? Are earnings and management commentary sending healthy signals about the coming quarters?

Some correction in earnings was priced in by the market. We expect listed companies to gain market share in these unprecedented times and hence the long-term outlook has even strengthened for large companies. Therefore, despite some companies reporting disappointing earnings, the reaction of their share prices was not that sharp in many cases.

While some top-line growth disappointment is possible due to a global growth slowdown in the next few months, we are encouraged by the downtrend in the commodity price environment, which should cushion margins.

Hence, we are just 4-5 percent below consensus for Nifty 50 companies in the next two years. India is coming out of an earnings recession (pre-Covid) already and the corporate balance sheet strength gives us confidence in the companies’ overall earnings delivery.

The market is back in action again. Are we done with the worst and moving toward a better environment or is it just a short-term reversal?

We maintain our strategic allocation to equities in a portfolio context. Hence, we are fully deployed. We are monitoring the progress of the monsoon and the restocking ahead of the festive season that starts in the next couple of months.

The recent bounce was long due as the market was pricing in peak hawkishness and that view has played out. While we remain positive on India’s medium-term outlook, we cannot ignore concerns over geopolitics and a global growth slowdown.

Hence, investors should diversify their portfolio and focus on risk management. We are mindful that a sharp recession in the US and Europe, along with a marked slowdown in China, could bring more pain to global equity markets. In the near term, we expect the market to remain well supported.

What are the pockets you see performing now?

We favoured rotating portfolios away from IT and metals toward auto and fast-moving consumer goods in the past couple of quarters. In the next two quarters, one should position for a good festive season as the rural economy has been showing signs of a recovery. Thus we are constructive on the cement, credit card companies, multiplexes, media, retail and consumer durable segments.

Financials are starting to do well as tier-2 and tier-3 banks along with public sector banks are beginning to re-rate.

From a medium- to long-term perspective, investors should focus on sectors that are gaining market share in global exports and also ones that are likely to benefit from import substitution, e.g. defence, chemicals, and select pharma companies.

We have continued to maintain a positive stance on the Indian chemical sector and this view seems to be materialising. In the event of a further correction, the valuation froth in the IT sector should settle and that may be a good time to bottom-fish, but as of now, we remain underweight on the Indian IT sector in the context of our India portfolio.

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Sunil Shankar Matkar
first published: Aug 4, 2022 10:19 am