“We believe that these valuations are justified given ample monetary/fiscal stimulus, record global liquidity, low interest rates, strong earnings growth momentum, expectation of a cyclical recovery (leading to strong earnings growth & surprise), record deleveraging that many corporates have managed to achieve, rapid vaccination and benign infection rate. India’s earnings story has turned better in FY21 after a decade of stagnant earnings and we are seeing sustained strength in the earnings,” Kumar said to EtMarkets.com. Edited excerpts:Animal spirits definitely seem to have been unleashed as far as the equity market is concerned, indices are hovering around lifetime highs. We have also seen a flurry of IPOs recently, especially in the pharma space. Are you worried about the current valuations or would you say the rally has more legs?Indian equity markets have rallied and are hovering around all-time high levels now. Valuations are elevated, but one has to evaluate valuations in the context of earnings and interest rates. We believe that these valuations are justified given ample monetary/fiscal stimulus, record global liquidity, low interest rates, strong earnings growth momentum, expectation of a cyclical recovery (leading to strong earnings growth & surprise), record deleveraging that many corporates have managed to achieve, rapid vaccination and benign infection rate. India’s earnings story has turned better in FY21 after a decade of stagnant earnings and we are seeing sustained strength in the earnings. We are happy to note that now positive earnings growth contribution is coming from multiple sectors, which is leading to a broad-basing of earnings. Markets should be supported by strong earnings and the global environment of low interest rates; but intermittent corrections are par for the course. In some pockets of mid/small-caps, there definitely is some froth and those valuations need to correct or earnings need to catch up there, leading to possible time correction in stock prices. Overall, it is fair to expect that markets may remain range-bound in the near term (with heightened volatility during the Fed tapering announcement). What is your view on the recent corporate earnings? More and more firms are adjusting to the realities of functioning during the pandemic and showing substantial growth in earnings. With active Covid cases showing signs of declining and the pace of vaccination picking up, is the trend on earnings set to continue?We do expect earnings to continue to pick up as has been seen from H2-FY21. As of now, the key components of earnings drivers are banks & financials, IT services and metals. Some sectors like Banks & financials and metals are giving very large earnings growth contributions. Within banks and financials, large banks (coming out of legacy corporate NPA problems) have seen cleaner balance sheets after years of provisioning hits. In fact, Nifty Banks & Financials’ profits bottomed out in FY18 and since then have tripled already in FY21. Metals and commodities are benefiting from higher commodity prices and sharp deleveraging. The IT Services sector has been a big beneficiary of digital adaption by businesses (accelerated in the post Covid-19 world) and cloud. Thus, it will not be far-fetched to say that India’s earnings can compound at a healthy high-teens rate for the next two years. While we will wait and watch for the structural real growth rate of the Indian economy in the normalized world; we note a few more medium tail-winds for corporate earnings. As vaccinations pick up pace and the load of severe Covid-19 cases remain low, the normalization of economic activities should get a further leg up. Another potential positive is the higher level of inflation aiding nominal earnings in many sectors. We also note global corporates implementing a partial shift of sourcing of manufactured goods from China to other countries is aiding the manufacturing sector in India in certain sectors. What is also aiding it is the continued push by the Indian government towards promoting domestic manufacturing through the PLI schemes and other incentives. If there is a word that sums up the current situation, it is volatility. In such times, what sort of an asset allocation strategy should investors adopt?The environment we live in today is characterized by high volatility, often from unpredictable sources and breakdown of historical patterns. The market moves, both in India and globally, is being led by different assets almost on a quarterly basis – from commodities to quality large caps, small and mid- caps, real estate, crypto currencies to private tech investments. It is challenging several assumptions but also throwing up new opportunities. Opportunities are emerging in new areas which were not in the reckoning earlier – new tech being a prime example. Many of the existing investments, which might have been considered “safe” earlier, are quickly being challenged by various factors, especially technology and ESG mandates. In such an environment, it is imperative to have a balanced asset allocation. This ought to take care of multiple factors like technology disruption, valuations and inflation risks. One can no longer afford to miss out on investing in new emerging technologies which are inherently more risky in nature. On the other hand, one should not be overinvested in any asset class that is being disrupted by new technologies, ESG risks or has gone through a major valuation re-rating. A balanced asset allocation of let’s say 65-75% in equities and 25-35% debt (with the flexibility to change when the need arises) should bode well for long-term investors in this VUCA world. In short, keep your eggs in multiple asset classes to derive superior risk-adjusted returns. Which are the sectors that ICICI Prudential Life is overweight and underweight on and what is the rationale behind the view?One key feature of the current market is the broad-basing of sectoral participation in earnings growth and in contribution to market returns as compared to the past (especially the years before Covid-19). Going forward, we believe that the leaders/laggards will be determined more by the pace of economic recovery. We will continue to have a sector agnostic, bottom-up approach to our portfolios. On the overweight side, we prefer companies with stronger balance sheets, better brands and more evolved digital adoption, which should come out as winners in the post-COVID-19 recovery phase. For example, larger banks will be in a position of strength. Some of them are also benefiting from a tailwind of recovery in the corporate NPA cycle. Digital businesses and there enablers will do well. As the capex cycle restarts, led by domestic manufacturing set-ups, metals and other large industries, certain industrial stocks will benefit. Consumer staples should compound at a healthy rate.We are wary of certain sub-sectors which have seen elevated earnings in the recent past due to pent-up demand, cost cuts etc. Some of them have been trading at elevated valuations too. We are also wary of sectors where demand is weak and input cost inflation is high, thereby impacting margins. We are mindful of disruption risks, like adoption of EVs and Digital business models. We are underweight on certain sub-sectors within Consumer discretionary/Automobiles and Healthcare. There again could be exceptions, where the bottom-up story is attractive. As a large player in the fund management space, how has ICICI Prudential Life navigated the uncertainties of the pandemic? How are growth prospects looking?The recovery since the March lows has been fairly steep and has been characterized by fast sector rotations, and as such has kept investors on their toes. Throughout this period we have maintained a calibrated approach towards our investments. Firstly, we have focused on businesses with strong balance sheets and robust client franchises, which has allowed business operations to bounce back with minimal damage. Also, we have been fairly sector-agnostic, and focused on good stocks with strong bottom-up stories across sectors. This has helped us navigate the rapid rotation in sector leadership as the market has rallied. We have kept an eye out for emergent themes and re-positioned our portfolios accordingly. These themes have included accelerated digitalisation of business processes, technology-shift/ESG-led disruptions, shifting of manufacturing bases to India from China in certain industries, consolidation of market share amongst strong players in some businesses combined with strong pent-up demand, vaccinations led recovery in economies, sustained disruptions in major supply chains, increased retail participation in markets and sharp inflation in commodity prices. The core portfolios have remained focused on long term compounding businesses, with sustainable economic moats and superior long-term growth prospects. An additional level of agility has been maintained to identify emerging themes/threats which affect the investment hypothesis either ways. Additionally, we have shied away from purely speculative theories. From early on in the pandemic period, we have humbly accepted that this is an unprecedented event, the impacts of which could pan out in various ways. From a fund management perspective, has the RBI’s latest policy statement provided a conducive environment? The governor reiterated in no uncertain terms that reviving growth sustainably remains the highest priority.The RBI acknowledged that the outlook for economic activity is improving, but is “still weak and overcast by the pandemic”. Several sectors remain stressed, with sentiments for large ticket spends (investments/ consumption) especially affected by the pandemic. Continued accommodation from the RBI will keep borrowing costs low, which provides a tailwind for consumption and investments to recover. An early hike in interest rates might put brakes on the recovery story too soon, and hence is avoidable. However, keeping rates low for long can be tough for the RBI. Inflationary pressures have risen following sudden pick-up in consumer demand for goods and the disruptions in supply-chains (pandemic-induced, like lockdowns), which are hence struggling to cope with demand surges. As demand patterns normalize, and move more from goods to services and supply side issues are resolved, inflationary pressures should subside. However, prolonged periods of elevated inflation can lead to unnecessary and early interest rate hikes. Hence, the RBI has emphasized more government intervention on the supply side such as tax cuts to cool inflation impulses. Keeping inflation in control will ensure that the central bank does not have to over-correct. The RBI normalizing interest rates gradually just to pre-COVID-19 levels over the next 18 months is still positive. It is a fine balancing act, which can lead to a smoother economic normalization and hopefully a robust growth path thereafter.
Read more: economictimes.indiatimes.com