As a market participant, how did you read the reaction of the market both overseas as well as back home in India to the US inflation numbers. Was it priced in?
Markets are really all over the place. The intraday reaction to the probability of Fed tightening by almost 100 bps because of a really bad inflation number in the US did send the markets into a tailspin, but then in a weird sort of a way, the logic now seems to be because the Fed will tighten very hard in the next meeting, it will create a very fast and sharp recession in the US. And because the recession will be so fast and sharp by the first half of next year, the Fed will be forced to start loosening rates again.
The market is working with that kind of warped logic. I do not think the full implications of a Fed tightening and remaining tight for a long period of time are still digested by the markets either globally or in India. I would be a bit cautious here.
There are some news reports coming in that the government may go back on reviewing the windfall tax which was levied on oil and gas because the oil prices are coming down. What do you make of this because this news came after that crude prices just slipped down?
I think the finance minister was quite clear when she announced these taxes that they will be reviewed every 15 days and I guess since oil prices have come down a bit in the last few days, it could be as per the government’s plan to keep reviewing this situation every 15 days.
Is there a probability that inflation has peaked because if you look at the internals of US CPI also, the shelter component did not fall. It is usually sticky; all other components; food, fuel fell afterwards. Does it indicate that the upcoming reading would capture the fall of all the components of inflation?
I would treat the US situation and the Indian situation differently. The US is very much linked to the huge stimulus and the demand side of the equation as far as inflation is concerned and that has created demand for services, driving house prices higher, driving house rentals higher and that is much stickier.
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For India, the inflation has been more supply side driven because we never really stimulated the economy and so there is no artificial demand to be collapsed in India. It is more on the supply side, especially the oil and food prices. So my guess is that India actually might have less sticky inflation than the US and for India, we may see inflation start tapering out after a quarter or so.
Have you been buyers of commodity user sectors or have you been increasing your weight in commodity user sectors for the last six months?
Yes more so because the user sectors are mostly linked to consumption. We are talking about consumer discretionary, FMCG and then, of course, banking is also linked to it. So to that extent, we are now more bullish on the domestic theme and the domestic consumption recovery which is happening in its own cyclical way.
For India, both goods and services are doing quite well. There is a pent-up demand in a lot of things. Even shopping, services, travel and tourism and automobiles, have some element of pent up demand. In automobiles specifically, while there was demand, there were chip shortages, supply issues and now those shortages are behind us and the pent-up element is showing up.
In general, we are playing the consumer discretionary stocks which are now benefiting from decent demand and easing in commodity price pressures. However, there is a caveat here, I do not think the margins improvement in discretionary, auto, etc, will show up immediately because there is always this element of lag and inventory gains. But structurally, over the next two quarters or so, we should start seeing improvement in margins for most of the consumer sectors which are good users of commodities.
How is the quality of earnings looking right now? Have you scaled back your numbers meaningfully or do you think that for the next two-three years, are you expecting the stocks in your portfolios on a blended basis to still give 18-20% earnings visibility?
The headline number of 17-18% remains for the Nifty components. But in the last six months, there has been a shift in the composition. We have seen upgrades in the commodity producers, energy, metal names and downgrades in IT and the commodity users. So I would say the quality of earnings has deteriorated over the last six months or so, but if commodity prices are coming down, then we probably will see some downgrades in earnings because commodity is a big component, energy, etc. While we might see a little bit of downgrade in earnings, it will be in favour of better quality earnings.
What are your thoughts on the midcap, small cap end of the basket? Do you see value emerging or do you still see some froth over there and would recommend investors to be cautious on that zone?
I think the situation is much better than what it was four-five months ago with the midcap index having corrected by almost 20% from the peak, small cap index almost 30% down from the peak. Some of the froth is gone and good stock picking chances available and one should start nibbling at this segment, picking and choosing the right ones as per your preferences of sector and stocks but certainly that extreme overvaluation is gone and there is some fertile ground available now.
What about technology? The opinion is very divided.
I am still a bit on the negative side even after the correction. There are a couple of reasons – one is on the demand side, we have seen the peak of euphoria as far as IT service demand is concerned. There was a lot of bunching up of demand in 2021 because of work from home, online shopping, people doing a lot of stuff more online, etc. So the bandwidth required, the website up-gradations required, the transaction processing required had to be scaled up and companies invested a lot of money in very accelerated fashion in 2020 and 2021. So there was a huge amount of bunching up. Now, of course, things are coming back to normal and all those things are no longer required so we will be back to probably more moderate demand growth for IT services.
Secondly, if the US goes into a recession, then this is discretionary spending. IT spending is discretionary and we might see cutting back of order books, etc. That, coupled with the fact that a lot of the Indian companies especially the IT companies have actually gone and over corrected a bit on the hiring side over the last two-three quarters and maybe hired a bit extra, may continue to put margin pressure.
So we may see headwinds on demand as well as margins in the next few quarters. If I look at the bigger picture for the next two years, the preference is towards domestic segments and overall earnings growth of say 18% or so. IT overall would grow by 12% to 13%, lower than the market and the domestic segments would grow higher than the market. So growth-wise, relatively speaking, the best is probably over for IT.