India's economic activity strengthening, but recovery remains uneven

The third wave driven by Omicron variant is less lethal as compared to previous waves with low mortality, but high transmission. The lockdowns have been partial, impacting limited economic activity. Service sector, which was trailing in terms of recovery specially, travel/ tourism/ entertainment sector remain impacted, while most of the other sectors are expected to see low impact. "Robust GST and direct tax collections, export growth, PMI in 54-55 range suggest economic expansion is gaining traction. However, low credit growth, low cement demand, high unemployment rates is reflecting that economic recovery still remain uneven," says Amit Premchandani, senior vice-president & fund manager (equity), UTI AMC, in an exclusive interview with Bizz Buzz

Valuation of the broader markets is at the upper end of long-term ranges. Nifty-50, post the recent correction, is trading at close to 20x Fwd. PE, which is still expensive, on the positive side, earnings growth has revived and is expected to be over 30 per cent in FY22. A small correction in the markets post the sharp rally over last 18 months is part and parcel of the cycle. Given that the starting point of valuation is high, investors should temper the expectations of return in the short term

Inflation in US has been on multi decade high, it appears some part of it is driven by supply side factors which may be transitory in nature, while some of it is driven by goods demand recovering much faster than expected. As the fed fund rates are now at close to zero, real rates in US as well as large part of the developed world are sharply negative which need to normalise

2022 has started on a cautious note like Omicron cases, rate hikes, liquidity, and partial lockdown. How do you view the situation?

Thankfully, the third wave driven by Omicron variant is less lethal as compared to previous waves with low mortality, but high transmission. Hence the lockdowns have been partial, impacting limited economic activity. Service sector, which was trailing in terms of recovery specially, travel/ tourism/ entertainment sector remain impacted, while most of the other sectors are expected to see low impact.

Monetary policy normalization and fiscal support tempering down across the globe will be the key events for global markets in CY22. Both are likely to act as headwinds, however, normalization of services sector and opening up of restrictions will act as tailwinds.

RBI has been following an accommodative policy and is likely to remain cautious on sharp changes in policy until the recovery gains further ground, however, US fed is likely to follow faster normalization given inflation has been trending significantly above expectations accompanied by low unemployment while real rates still remain significantly negative.

Valuation of the broader markets is at the upper end of long-term ranges. NIFTY50, post the recent correction, is trading at close to 20x Fwd. PE, which is still expensive, on the positive side, earnings growth has revived and is expected to be over 30 per cent in FY22. A small correction in the markets post the sharp rally over last 18 months is part and parcel of the cycle.

Given that the starting point of valuation is high, investors should temper the expectations of return in the short term.

What do you think about the shape of economic recovery? What indicators are you using to make that judgment?

Robust GST and direct tax collections, export growth, PMI in 54-55 range suggest economic expansion is gaining traction. However, low credit growth, low cement demand, high unemployment rates are reflecting that economic recovery still remains uneven.

Power and metals, which include some major PSU brands, were some of the industries that performed significantly in 2021. Do you believe these industries will continue to be a priority in 2022?

Our assessment of sector or companies is largely ownership neutral. Power sector is seeing climate change driven moves towards renewables, thermal power is low growth sector, while distribution may see privatisation driven reforms. Auction-based tariffs for renewable power are low and outsized returns from new capacity addition are unlikely. Ferrous as well as non-ferrous metal prices have seen a dream run in H1CY21 which have led to robust profitability of the sector, with steel sector EBITDA/tonne at all-time highs for some companies, steel price have started correcting over the last few months hence profitability is likely to trend down from all time high levels. Valuations are at higher end of historical ranges.

Are you planning to make any changes in the allocation of UTI banking and financial services fund in view of the recent measures taken by RBI?

As far as Banking, financial services and insurance (BFSI) fund is concerned our views are as follows:

- Corporate credit cycle has peaked

- Slippages run rates in corporate expected to fall sharply

- Corporate credit cost are trending at multi year lows

- NCLT resolution process need to be streamlined

- Credit growth muted, expected to pick up

- Largely driven by retail, which in turn seeing greater penetration of unsecured loans and demand for mortgages.

- Corporate credit will pick up from low base driven by working capital demand

- Private banks and select NBFC likely to gain market share while PSBs may see profitability improving as corporate credit cost are at multi year lows.

- Retail deposit franchise value should go up and lending models will be driven by ability to source stable funding.

- Growth runway for insurance and asset management is long, capital requirement is low, profitability of large players is robust

- Disintermediation of saving as well as lending will continue

- Portfolio allocation will remain tilted to private banks and non-lending business like Insurance.

How is the hike in US inflation likely to impact Indian equity markets?

Inflation in US has been on multi decade high, it appears some part of it is driven by supply side factors which may be transitory in nature, while some of it is driven by goods demand recovering much faster than expected. As the fed fund rates are now at close to zero, real rates in US as well as large part of the developed world are sharply negative which need to normalise.

US fed is now guiding for withdrawal of ultra-loose monetary policy initiated during the pandemic. This will have implication on asset price throughout the world as cost of money is likely to normalise from very low levels currently. This should lead to cost of equity moving up across the world including India which have been beneficiary of Fed monetary policy through FII channel. Some of these flows are likely to reverse and we have already seen that in the form of net FII outflows over last few months. Increasingly we have seen DII flows act as a balancing force to FII outflows specially, if outflows are driven by external factors.

Valuations seem to be rich which has resulted in selloffs by FIIs. At what PE will the Indian markets be interesting to the FIIs

Earnings growth and multiple are interlinked, multiple expansion over last 18 month have been largely driven by sharp increase in earnings growth. Even now earnings are expected to be up 18-20 per cent in FY23 after likely growth of over 30 per cent in FY22. Such sharp earning growth is on the back of almost a decade of muted corporate profitability. As long as earning growth is robust, multiple compression will be limited. On the other hand, as rates move up driven by inflation scare in developed markets, cost of equity moves up which has inverse relation with PE multiple, hence it will act as headwind. Finally current yield difference between 10 year bond and earning yields is 1.9 per cent suggesting equities are much more expensive as compared to bonds. Hence, investors need to adjust the return expectation accordingly.