stock market outlook: India has sustained valuations because of robustness of earnings: Tushar Pradhan

“India has sustained valuations simply because of the robustness in earnings and the future potential which continues to remain robust. While the rest of the world undergoes some growth issues, if earnings have to be downgraded significantly in the rest of the world, markets will also follow. These kinds of differentiated market movements do not survive much in today’s world, says Tushar Pradhan, CIO, HSBC Asset Management India.

On top of everyone’s mind is why this out-of-turn meeting by MPC and what is it that they are going to do?
It should be a more or less routine meeting from my understanding. There is a target which has been announced by the RBI and I am sure that the government would want to take a review in terms of how long it will be before the target has reached or if there is any adjustment to the target that needs to be done etc. I would not read too much into it at this time. There is a time given for the RBI to come back and they have just set up a meeting to do that. I would not read too much into it at this time.

What is the sense you get about the markets, the outperformance of India and the last two-three months, at least since the time this whole Russia issue has happened? What are the markets trying to tell us with the pricing?
Yes, this is a very interesting question and I really would want to address it in two ways; one is that India has outperformed the rest of the world by big margin and so we are up slightly – 1-1.5% to 2% for the year to date – while the S&P500 in the US is down close to 20%. So this is a huge 20% kind of outperformance over the largest market in the world.

The European and the UK markets are also significantly down for the year versus where we are. Even within emerging markets, there are hardly a few which are doing better than India. However, the feeling in India is that we have not really made much money on the equity markets for this year because on an absolute level, we are just where we are but on a relative scale, we have really outperformed. What does this now mean for the future? That is something which is a question which everyone is trying to grapple with.

On the positive side, growth continues to sustain which means that whatever the multiple be, if you forget the multiple of a rerating or a derating, the earnings growth is pretty solid for this year and the estimates for next year also seem pretty rosy. If one has to bet on earnings, India continues to remain pretty robust. However, we have to understand that the global markets may face significant slowdown including the US and that will lead all markets downward because of two pressures – continuing structural inflation and higher interest rates and how long this stays in the economy.

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It is a very complex question to answer at this time. India has sustained valuations simply because of the robustness of earnings and its future potential. While the rest of the world will undergo some growth issues, if earnings have to be downgraded significantly in the rest of the world, markets will also follow.
These kinds of differentiated market movements do not survive much in today’s world. One would want to take it one day at a time to understand where the eventual outcome is likely to be. The only bright spot for world markets, especially equity and asset markets is at some point of time, inflation has captured and discovered to be fought over and won over and either the Federal Reserve or the global central bank starts to pause and eventually combats the slowdown to bring the interest rates down and that is when there is some hope for equity markets all over the world as well.

While India still enjoys the resilience, being ‘decoupled’ from what is going on with the rest of the world, what do you think one is safer investing in? So far, it seems IT clearly is not because IT back home is facing similar headwinds as IT or tech globally. Do you sense that in the near term, the market could see some sectoral rotation?
Yes, one has to make a distinction between where the robustness of the earnings is and the confidence that the companies will continue to grow which means that the valuation will sustain. I am not saying that they will go up from here because one can argue that some of them are already pricing in that kind of robustness in earnings but when we talk about technology, I want to make a distinction between technology in the US and the kind of drawdown that most of these companies have seen last year. Meta, for example, is down around 64% for the year and that is a huge drop in market value.

I think that has been attributed to many other factors rather than what one should look at Indian IT. Indian IT is pretty much robust because it is a BAU sort of expense for most companies in the US and the fact that the multiples that most of the Indian companies trade at nowhere are comparable to FAANGs and the technology companies that we talk about in the US.

So the softness in technology prices in the US is more to do with the looming slowdown and the fact that some of these companies may face headwinds as opposed to India where the sentiment really will drive the valuations because it is not really a difficult proposition to understand that earnings will continue to remain robust.

As for what looks good, consumer discretionary, defence, manufacturing – all of these sectors have seen significant order inflow – where the robustness in earnings estimates is where we are coming from and is likely to be seen. That is more of a domestic phenomenon and that will sustain no matter what happens.

But again as I said the earnings robustness will translate into stock price performance because there is a valuation and a sentiment factor to be talked about and that is where the prediction becomes difficult.

If you were to ask which are the companies which will have robust fundamentals, we can clearly point them out but which are the ones which are likely to do well or whether there will be a rotation will all depend on the global sentiments and how the next few months start to go around. Just to give an example of what I am trying to say, if suppose overnight the geopolitical situation gets diffused, then there is going to be some major readjustment valuations depending on which part of the market you are sitting in.

On the other hand, if you think that this is going to last for a lot longer than what most people expect, then the markets are headed in a very different direction altogether. That is the range of predictability that we have here which is very low and that is why investing in markets like these is very challenging and best.

The general wisdom is buy cheap and sell high but what do you make of this recent phase where we had these listings where companies were just compared to sales and nobody bothered about profits? Can you tell us about the valuation change a lot of these companies have seen? Have you changed your thoughts regarding investing into them?
Tushar Pradhan: I would like to bring a little bit of context and the fact that experience will help here. The last time that we have seen technology companies fly off from fundamentals and valuations based on clicks per minute or whatever you want to do – those valuation metrics clearly did not stand the test of time.

I think there was a miscalculation in terms of the expectation of what these companies were likely to do and that has not changed. So going forward throughout this period, there have been companies which have really rewarded shareholders and of course they may have corrected at some point of time. But if they remain robust businesses and deliver on the longer term earnings promise, then investing in these businesses continue to remain an attractive proposition which means that one has to be ready for a rocky ride.

To last it out and find out who eventually succeeds because the winner takes all is basically a strategy which e-commerce as well as some of the technology businesses really point to, which means that we really do not know who the winner is but can we stay out of it? Probably not.

So as an investor, one should try to hedge one’s bets, take a little bit of exposure, find out the companies that you think are likely to sustain and here is where the distinction becomes a little difficult because one never knows what sort of popularity, any sort of technology or ecommerce stream or a segment of the market starts to give and as a result tremendously benefits that one single company.

So it is difficult to say whether one should stay out or not. Definitely, one should take judicious steps to understand the business potential and even if there are no earnings and only sentiment drove these stocks up because at that time, capital was cheap and there was a lot of sentiment in terms of longer term growth in front of them. Now the sentiment has changed and the capital has become a lot more expensive.

So that has an impact on valuations but does that change the future of the company? No. The future of the company is largely just going to sustain. The valuations that we see in the markets are really driven by the sentiment of that time and if one is a patient investor, one needs to understand that these drawdowns and volatilities are part of the game and if one has a longer term outlook, then some of the winners will come through.

But if one is an institutional investor looking over the shoulder every quarter, this is a very tough business to remain in and only very large diversification will sustain over the long run.

So diversification is needed when you invest in such companies because the winner takes it all. One or two companies may actually give a lot of returns but the remaining five, six companies may actually be a pain point – that is what you are trying to say?

How would you look at the traditional businesses especially the metals pack? Metal prices are high, inflation was high and they have taken the best but at the same time, look at , JSW, – they have substantially reduced their debt, focussed on expansion and made their cost structure very lean. How would you look at that scenario?
I think one has to rely on the fact that they are what are known largely as cyclicals which means that they move in an economic cycle; there is a demand increase and there is a demand squeeze over time and then supply also makes a huge difference to how these companies perform. When there is a lot of demand, these companies invest in a lot of capacity and that capacity does not come cheap.

So, if they have to borrow to get there, if they have to raise equity and dilute other investors to get there, it has a big impact on how companies are viewed at that time. When the surge of demand starts to come off, they are saddled with debt and find it very difficult to return on investor capital and then all of their valuations take a severe hit over this period of time.

Again the cycle starts to turn around at some point of time and the demand goes up. So this is the nature of these companies. Clearly on the very long run, if you look at the compounded average returns of these companies, they are very poor compared to say some of the FMCG companies or more sustainable cash flow generating businesses but when the excitement starts to hit you, when the economy starts to boom, then the returns that you get in these companies are far higher than any of the other cash flow generating businesses as we know.

So it is a little bit of a contrast to say what is the timing that you need to get right on these companies rather than to say whether these companies deserve a better multiple or not. The multiples are really outcomes of the situation that I spoke about and a judicious investor will try to sense the cycle here and just at about the time when everything is looking bad and everybody gives up on them, it is probably the right time to invest and then buy them cheap but sell them high.

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