What are your thoughts on the way commodity collapse is happening right now triggered by a fear of global slowdown? Have markets factored in all of that yet or have we just started to factor in crude and other commodity collapse because that was the biggest worry on the mind of the market in the last couple of months?
Indeed. The biggest concern from the Indian market perspective was the high oil prices. When the Budget was prepared, the oil prices were around $70 and since then it rallied to more than $110-120 meaning that the gross outflow out of India would have been higher by almost $60-70 billion if the oil prices remained at those levels for the rest of the year.
So the correction in the oil prices would definitely be cheered by the Indian markets.
But coming to the point whether the correction happened completely or it is just the beginning. The answer will lie on the geopolitical situation as well because we saw that the prices began to rise only after the geopolitical situation in the European region changed. Those issues have not yet been resolved.
In fact, they have entered a stage of stalemate and as of now, there is no clarity when there would be a conclusion or there will be finality to the geopolitical situation. That is why we still cannot say that this is the end stage, especially for energy prices.
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What has happened in the meantime is that there has been a fear of recession and definitely a slowdown in growth and that is putting pressure on energy prices. The dynamics for the commodity prices were different. They were already very high last year prior to the geopolitical situation in Europe earlier this year. They were bound for a correction and the correction has begun.
But if we look at the long-term charts of the commodity prices, then we realize that they are still at a slightly elevated level as compared to where this will settle down. Our view is that both in the case of energy prices and commodity prices, the sustainable level would be lower than where they are. We are not sure of the timeline in which they would come down even more but in the meantime, the Indian markets would definitely cheer lower oil prices.
What is your own hypothesis for the market at this juncture? We have been through the last 10 difficult months. A lot of foam has been cleaned from the market for various reasons. How do you see the next 12-24 months panning out?
Over the medium to long term, we are definitely very constructive. Now let us see what has happened in the previous 8-10 months. Indian markets have corrected roughly about 14-15% since the peak in October and also the peak in the mid-January level or so.
The decline in the Indian market has been correlated with the decline in the global market. Although India has been a better performer except for a few commodity producing economies, it has been a better producer but nevertheless this decline is painful. What has also happened in this timeframe is that 12 months forward earnings of the Indian corporate has been going up and as we saw that for fiscal year FY22, the earnings growth for Nifty companies were in excess of 40% and for FY23 also three months have passed and if we include this, we are looking at an earnings growth in the mid to high teens for this year.
Given what has happened, almost all the decline in the market has to be explained by the correction in the multiple. So the multiples which were ruling at something like 20% to 30% higher than the five and ten year averages in October, at this point of time the valuation is at a discount to five year average and just slightly above the ten year average which means no longer the valuation should be one of the factors for the market to move.
That leaves only the earnings as the key driver for the market from the medium to long term perspective and that is where we are a lot more constructive. So one of the data points which I gave about is that for FY23, the consensus estimate for Nifty companies earnings is in mid teens, slightly higher than that for FY24, and the drivers of the earnings growth are in place.
In the past eight months, there have been some downgrades in consumer related sectors and slightly in the technology sectors. But they have been more than compensated by upgrades in many other sectors like metals and energy sector and that is why on an overall aggregate basis, the earnings for the Nifty companies have gone up.
Going forward, we might see some correction in downward revision in the energy and the commodity linked stocks and the sectors. At the same time, the benefit will begin to flow into the commodity and the energy consuming sectors. Those stocks and the sectors are benefiting and so there could be an upgrade there. That is why we are not looking for a downgrade in the overall earnings for the Nifty companies at this stage and that makes us constructive in the market from the medium to long term perspective.
How is your portfolio construction looking like right now?
The key driver for our portfolio composition is relative earnings growth. Like I was just now pointing out, from the market perspective, the earnings growth is likely to remain robust. Now within that, there are constituents which are the higher contributors to the overall earnings growth and there are laggards as well.
At the same time, there are upgrades and downgrades. So the key portfolio construct is on account of the relative earnings growth and, of course, at some point of time, the valuations were also a concern. At this point of time, the valuation on an overall basis is not as much as a concern although on a selective basis for some sectors it can be a concern.
Now having said that, like what we have seen in the past three months, there is a tilt in certain cases where the earnings have been downgraded. We were underweight in those consumer related sectors. We have got concerns with respect to the growth in those sectors from the past as well and because of the commodity pressures they were facing greater pressure on their earnings. That led us to reduce our exposure in the consumer space even more.
Where we have increased our position in the last quarter or two is in the auto sector and that is essentially because it is coming on the back of three years of downturn. We are looking at an improved demand scenario for at least two-three years depending upon which segment of car that one is talking about.
Secondly, gradually the chip shortage, which was one of the pain points for this sector last year, is easing. It is still not normalized but the direction is clear and it is easing quite a lot and more recently from last week or maybe 10 days or so, the commodity price decline is going to benefit this sector. But having said that, let me also clarify because this is just one part of the portfolio, what we have not changed and where we have been more positive for a much longer period is the financial sector and the real estate sector as well.
Right now, the financial sector is one of our key overweight sectors. We believe that that is one of the best positions to not only drive the earnings growth even for the Nifty companies for next year and the subsequent year but also to help drive up the market.
We are positive on the large private banks and PSU banks as well, basically the large lenders. That is because a cyclical improvement has been happening in credit growth. The credit cost which was normalizing for the past year and a half or so, should now be better than the previous cycle that we had in the middle of the last decade.