How Should Investors Navigate Through Mixed Cues? | Talking Point
- Yields inch higher
- Crude prices on the boil
- FIIs continue to buy into Indian equities
What should investors do amidst mixed cues? In conversation with J.P. Morgan's Sanjay Mookim on Talking Point. #BQLive
- Crude prices on the boil
- FIIs continue to buy into Indian equities
What should investors do amidst mixed cues? In conversation with J.P. Morgan's Sanjay Mookim on Talking Point. #BQLive
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00:00 for tuning into today's Talking Point. I'm your host, Neeraj Shah. Our guest today is Sanjay
00:03 Mukhim of JP Morgan. Sanjay, always a pleasure talking to you. Thanks for taking the time out.
00:07 Sanjay Mukhim (00:00:40): Pleasure being on, Neeraj. Good to be here.
00:09 Neeraj Shah (00:00:42): Thank you. Sanjay, good rally,
00:13 no one can complain if you are an equities fan. The last few days, we've seen some turn in that
00:20 yields have inched up a little bit. Crude prices are heading higher for the last two, three weeks.
00:23 FI flows at the margin last three, four days have been slightly wobbly. Have we run up quite a bit
00:30 and relative to the markets, could we therefore see some corrective moves to consolidation?
00:35 What is your view? Sanjay Mukhim (01:01):
00:39 That is just a question like that. Neeraj, you're going to get a macro answer.
00:43 Now, what we think has happened globally is the reinjection of liquidity in the middle of March,
00:50 actually precisely the 13th of March in response to the small bank crisis, the SVB crisis as it's
00:56 called in the US, and this has immediately had an impact on equity prices. All markets have rallied
01:03 other than for China starting the 13th of March. Historically, if you look at the correlation of
01:08 liquidity to market performance, it's very strong from 2008 to now, equity markets, MSCI world,
01:15 has moved almost entirely in line with the size of balance sheets of the big four central banks.
01:20 Now, of course, it's great to say this in hindsight, but on the 13th of March,
01:24 as more liquidity was injected, markets have rallied. Now, what is happening, Neeraj,
01:30 is that you're starting to see central bank balance sheets start to contract again.
01:33 Markets have so far, the last few weeks, defied that contraction and have stayed elevated, which
01:40 is a very significant disconnect that we highlighted in a research note last week,
01:45 arguing that if liquidity continues to now withdraw, which is the plan, then equity prices
01:51 everywhere will come under pressure and that will have an impact on Indian equity markets as well.
01:55 So you reckon that everything else is an entourage to the main event, which is liquidity,
02:04 and liquidity being where it could be, as you're saying, there is a higher probability of a
02:10 corrective move world over and India would participate. Yes, exactly right. And there
02:17 are nuances to it, what we need to correct more, what will correct less. So for example,
02:21 we think the growthy stocks will correct more than the more value stocks and you may get value
02:26 or performance here on. But the starting point is that we've seen this rally in the last few
02:32 months fueled by liquidity, which has led to multiple expansion. So if you see the performance
02:38 of stocks needed, it's not been because we've seen earnings upgrade, the entire rally almost
02:43 entirely, I can say, is being driven by higher valuation, which is a phenomenon of better
02:48 liquidity. So as that liquidity turns, it will put pressure on Indian equity markets as well.
02:53 Okay, there is, I presume, no scientific way of correctly predicting these turns that as they
03:02 happen. I mean, you saw it on 13th of March, I don't know if you were able to predict it.
03:06 And please correct me if I'm wrong here. And part two, is there a way to predict as to
03:10 by and large for how long this withdrawal will stay and for what reasons?
03:14 So that is a challenge for all of us. When you're living through an event,
03:19 it becomes very difficult to anticipate the next part, right? For example, on the 13th of March,
03:24 when the Fed said, okay, look, we're injecting liquidity to bail out or save the small banks,
03:29 we didn't really know how long that might last, what the size of the liquidity injection might
03:33 potentially be, what the uptake from banking system might be. But in hindsight, it's easier
03:37 to comment on it. Now we know that once that rescue package has been absorbed, that the Fed is
03:43 back to its QT, it's back to tapering back to withdrawing 80, 90, $100 billion a month. And
03:49 that is also predictable, at least, we don't see a reason for liquidity to start coming back
03:54 positively to market again. Assuming that Fed sticks to plan on QT, liquidity will continue
03:59 to tighten here on, which like I said, should be a difficult environment for all asset classes.
04:05 Got it. In which case, Sanjay, would this run, correction, stroke, consolidation,
04:15 largely revolve around what the Fed and other central banks do? Or could Indian markets have
04:23 a slight disconnect in that because the domestic flows continue to remain strong?
04:28 Irrespective of the domestic flows, Neeraj, if you look at 25-year history in the country,
04:33 decoupling of Indian equities has happened maybe two or three times, and that has required
04:39 significant events to happen. So let's say big election surprises or the COVID reopening. Those
04:44 are the few instances where India has temporarily disconnected or decoupled, as people use,
04:51 from the global equity sentiment. We don't see such an event in the next six months.
04:57 I mean, yes, we are heading into elections, but that probably increases uncertainty.
05:01 So if you then ask for decoupling, you probably see a downward decoupling if elections become a
05:06 topic of conversation in India to begin with. So we're not saying that India should underperform
05:11 EM. There is no concerns to that extent as well in the next six to nine months, but it is unlikely
05:18 that we'll decouple to the upside as well if global equities were to cover the pressure.
05:23 Got it. The other aspect, Sanjay, is the favor that growth markets like India might have
05:34 had better valuations. Now, my question is, assuming that the scenario that we're talking
05:38 about stays true for the rest of the year, but if the world markets and consequently Indian markets
05:44 slightly sharply, let's say 5%, 10% happen in a period of one, two months, do you reckon that
05:51 even if the liquidity withdrawal scenario stays in place, India specific flows, which some of
05:57 your peers that we've been talking to are saying are starting to come very, very strongly,
06:03 could India centric flows start coming in at those lower valuations and give support?
06:08 This sentiment for India must EM fund managers is super strong. And it is likely to remain that way
06:15 because if you take a dispassionate view of the structural growth of EM economies, let's say for
06:22 the next five, 10 or 15 years, India is probably the only major country where you can argue for
06:28 steady structural growth. Most other economies are either too commodity driven or have headwinds
06:34 to medium term growth. And therefore the bias for investors always in India should remain
06:41 positive, right? To say, look, if I can find something at a good valuation at a good entry
06:45 point, and I have patient capital, then I am positive India and we've also at our end,
06:50 a lot of research demonstrating confidence in that structural growth potential of the economy.
06:55 And the problem here is that we keep arguing that markets don't necessarily always discount
07:03 structural growth. There is cyclicality to market, but if we didn't, then I wouldn't really
07:07 be here. I wouldn't really have a job. Markets are more difficult than that structural element might
07:12 justify. And therefore, we argue both things. Cyclically, you could see a correction,
07:20 and that might create opportunities for people who have patient capital to then add a little bit
07:25 more aggressively to India, but then and wait for the three, five year compounding to play.
07:32 Okay. So before we get to what looks good, I heard you start off this in conversation with
07:37 this thing that within this whole construct is a nuance of what will withstand the pressure,
07:42 what will lead the correction. Can you tell us with your rationale as to
07:46 what both of these sides, if I can use that term would be?
07:51 As a style growth stocks, high duration stocks, companies which are expected to deliver high
07:59 growth for the medium for the next few years, those are the stocks which have related more than
08:04 the market globally and in India. So if you look at, let's say March to now, it's consumer
08:09 discretionary, NBFC, mid cap, which are all considered the growthy basket, which have done
08:16 well, excuse me. And therefore, that correlation with global styles to Indian equities has also
08:22 played through. If this thesis is right, that withdrawal of liquidity with pressure on markets,
08:27 then growth as a style comes under pressure. And the three baskets that come top of mind,
08:31 like I said, discretionary, NBFC, which have done very well in the last few months,
08:35 and mid caps again as a basket, which have all related, they haven't seen the earnings
08:39 expansion yet. This is what comes under pressure to my mind in the coming months.
08:44 Got it. Now, within that, there could be a nuance Sanjay, in that as basket wide, we may not have
08:52 seen too much of an earnings expansion. But within that, there are pockets which are seeing very
08:58 large order flows, strong earnings momentum, even in quarter one or Q4 of last year as well.
09:05 And the commentary around what growth could be is very strong. There's power, there's railways,
09:10 to an extent, the book to build up the defense names, etc. are all looking very, very strong.
09:15 Some of it is B2G, some of it is not. Now, I would love to understand what do you think
09:20 withstands the pressure, despite maybe higher valuations, because the earnings are looking
09:26 strong. And the commentary is not that bad either. Before I answer that question, let me talk about
09:33 the framework of stock picking that we employ, we've employed successfully for the last several
09:39 years, which is not growth. If you're a 12 month investor, and most of people who stay in the
09:46 markets, I mean, when the stock structure will have evaluation periods of 12 months or less.
09:51 So if you're a shorter term investor, then it is earnings revisions, earnings surprises that
09:56 determine stock return, not earnings growth. We've done a lot of quant work running correlation
10:01 statistics to establish this fact. And therefore, and this is where the market has the strange sort
10:08 of outcome, that while we're seeing good outcomes in quarterly numbers, and we're seeing companies
10:13 come out and say, look, growth is strong, we're not getting earnings revisions, positive earnings
10:18 revisions, because expectations are still very elevated. So what I need to do is to figure out
10:24 not just where companies are doing well, but companies which are doing better than what is
10:28 already forecast by analysts or the market in a way. And in that sort of framework, there are
10:35 actually very few stocks that qualify, very few stocks or sectors where we can argue neither that
10:41 you will get significant or notable earnings upgrades in the coming few quarters. In fact,
10:46 like I said, if you look at the nifty mid cap basket, post the March quarter, and March again,
10:53 had this tone of things are recovering and things are doing well from company management.
10:57 Most of them actually had their FY 24 EPS cut after results, even though the numbers were
11:03 supposedly very strong. So there is this dual phase that look, companies are doing better,
11:08 tone is improving, but expectations are already more than pricing it in, which is the problem.
11:13 Okay, so here's my question, Sanjay, if your clients are coming to you after reading this note,
11:20 and asking you where is it that they should get off the train currently, because even if it is
11:25 structurally good story, technically, there might be better opportunities later, or otherwise that,
11:29 you know, it's running sports, and therefore it's bad. What do you think
11:33 fits that bill? What will lead that downside?
11:38 What we've been arguing here is that the financial sector companies, which are very consensus,
11:44 banks, big, large private banks, they have struggled on valuations, multiples for everything
11:48 has come off in the last several quarters, despite steady growth and earnings upgrades. And there
11:54 could be a variety of reasons why those multiples have come under pressure. The more divergence I
11:59 see in the large private banks from growth versus valuation, the more tempted I am to continue my
12:04 recommendation on staying over with private banks. And you can select which ones you want. And
12:09 unfortunately, I can't name stocks on our TV channel. But that is the space that we have
12:16 been very positive saying, look, we're getting growth, low earnings cuts, or actually earnings
12:21 upgrades, and multiples look interesting. What is the trigger for the switch from the growthy
12:27 discretionary NBFC stuff to, let's say, performance of more structural growth companies? I think it
12:33 will have to be pressure on global equities. There is nothing internal, nothing domestic,
12:38 nothing happening in Indian markets that will cause a switch by itself.
12:41 Okay. And since growth stocks, as you mentioned twice in this interaction already,
12:47 are the ones which might actually correct, I'm guessing that would mean most things discretionary,
12:54 because some of them are on a really good run, because of this higher consumer spend theory,
13:00 or new capacities coming on stream theory, etc. So all of those would probably come off. Even the
13:09 platform companies, we have a few of them now in India, have had a good run, you reckon those
13:13 could also come back, so to say. These fit the growth style. And they have seen a very sharp
13:20 rally exactly at the time that this global equity rally has started. And the reversal of the style
13:26 will put pressure on all those stocks as well. Got it. Sanjay, idiosyncratic, there are some
13:33 spaces in which the announcements are looking very strong from the government side, and the
13:39 private companies as well. Power, for example, quite turning the corner, if you will, or maybe
13:45 has turned the corner, I don't know how you're looking at it. But we'd love to understand
13:49 specifically about this particular sector, because we've seen continuous announcements of large CAPEX,
13:55 large order flows and very positive commentaries from the companies.
13:58 We think this will continue. This is the start, I would argue of a multi-year required CAPEX in
14:07 power sector. Now what is happening is because of the reforms and initiatives that have been taken,
14:12 the receivable situation in power of power companies or distributing companies has
14:17 improved significantly. And we get this data in almost real time nowadays, statewide payables
14:23 has fallen almost 50% on a yy basis and will likely remain contained. And therefore, the
14:29 health of cash flows for people in the industry is much more assured than it was previously.
14:35 At the same time, demand growth for electricity is improving. And there could be a variety of
14:40 reasons that demand growth was subdued for a few years and is now simply normalizing.
14:45 So as demand supply in power sector tightens, and you see better cash flow, the ability of
14:51 companies to invest, create more power capacity is much better than before. So we expect that
14:57 over the next two to three years, you should start to see continued power CAPEX in India.
15:02 The challenge that you have, Neeraj, is it too early? Am I jumping the gun a bit? And which
15:08 stocks benefit from power CAPEX? Those are the debates that you have with investors,
15:13 but the underlying theme of a revival of power CAPEX, I think is very convincing.
15:18 Got it. The other aspect which I picked up from a few of your peers is that the incremental news
15:26 flow for the rest of the year for IT might not be as bad because you heard everything that could be
15:34 bad already, and maybe some of it is discounted as well. Do you share the view or is your view
15:40 slightly different on IT? How do you establish that it is
15:44 discounted or not? Is it in the EPS forecasts? Are people priced in any potential weakness?
15:51 For most companies, I would say not, Neeraj, because people are still expecting relatively
15:56 decent growth in top line and bottom line. And so going back to my framework, do I expect those
16:01 expectations to be missed or beaten? The bias is to say they will be missed. If you take the
16:07 results that we have seen in the June quarter, and then you look at what is implied for the
16:11 next nine months, it looks very aggressive. So it is certainly not discounted in earnings
16:16 projections for this sector. Is it part of valuations? Again, you will not be very confident
16:22 in saying that because for most IT companies, the valuations are above where they were in 2019.
16:27 And relative to market also, they appear to be at a slight premium than they used to be.
16:32 So while it may be easy to say, oh, it's discounted because the stocks have fallen,
16:36 it doesn't appear to be part of earnings. The weakness doesn't appear to be part of earnings
16:41 projections, neither in multiples. And therefore, we are convincingly underweight that sector.
16:45 Got it. Sanjay, my last question, because we have that much time.
16:51 But my last question, you've spoken about the overarching factor, which is the withdrawal of
16:56 liquidity as being the key determinant for the next six to nine months, maybe,
16:59 or until the Fed changes its tune, as the case may be. What are the other things that you are
17:05 very keenly watching out for in addition to this, which may enable you to, if not change your
17:13 thesis completely, then at least be less or more sanguine about the reversal in fortunes for the
17:20 Indian indices? If you mean for something to start going up, it will have to be earnings.
17:27 And the hope then is that the consumer steps back to the plate. And what we expect to happen in FY24
17:37 is this handover from COVID-led government stimulus to consumer or corporate spending,
17:43 which sustains growth in the economy. So unless you see that handover happen properly,
17:48 and we know that government capex is going to slow as a percentage of GDP, it has to,
17:53 because deficits have to be brought down. So unless that consumer spending picks up,
17:58 corporate spending picks up, you may get a patch of slight soft activity levels in the economy.
18:04 So the hope is that the consumer steps back. The prima facie conditions are there. So inflation is
18:11 falling, jobs seem to be coming back, consumer confidence is improving. The outcomes in company
18:16 results are still very mixed. So it is still more in the hope territory rather than the actual
18:22 outcome territory for now. But if you started to see signs of a strong consumer revival,
18:28 then you could possibly look for a broader set of ideas within the equity market.
18:32 I just just extend that. Sorry, one last question. And which is, could the decks be set for that in
18:39 that there is G20 as well as the cricket World Cup happening in the current year. There is a very busy
18:46 second half with what I hear in one of the phone calls, a 30 to 40 percent more wedding dates in
18:52 the country this year relative to the second half of the last year. So are the decks set for that to
18:57 happen? If if if we needed enablers, are the enablers there? We'll see, because what you've
19:04 pointed to are very narrow service sector phenomena. What I need to do well is the mass discretionary
19:11 categories where the I think canary in the coal mine will be, which will be, let's say, the footwear,
19:16 the apparel, the electrical, the durables, which have been disappointingly weak for a while.
19:21 That's what needs to turn to my mind, not the hotels and airlines, which have been doing well
19:27 for quite a while. So the health of the consumer, I think, will be assessed by the mass consumer
19:32 categories, mass discretionary categories, in fact, which I think the jury is still out on that.
19:39 Still a hope trade. Let's see if it shapes up. But Sanjay, thanks for, you know, really putting
19:46 it out as to what the macro looks like and how India could participate in that. Really appreciate
19:52 you sharing all those details with us. Pleasure being on, Neeraj.
20:04 Thank you.