Covid 2nd wave severity will determine pace of growth: FT's Radhakrishnan

The renewed surge in Covid-19 infections and possible tapering by the US Federal Reserve are the two risks to the market says Anand Radhakrishnan, managing director & chief investment officer – Emerging Markets Equity - India, Franklin Templeton. In an interview with Samie Modak, Radhakrishnan says equities continue to be the most lucrative investment avenue. Edited excerpts:

What are the biggest tail risks for the market at present?

The length and severity of the second wave of the Coronavirus (Covid-19) pandemic will be the key determinants of the pace of recovery for the Indian economy. Faster-than-expected recovery in the US economy and the resultant tapering of stimulus by the US Federal Reserve could potentially affect risk sentiment and impact flows to emerging markets like India.

Do you think markets will struggle to top their February highs?

Markets rallied ahead of the economic recovery in India over the past few months. Presently, investor sentiment has been impacted by the sharp resurgence in Covid-19 cases in the country. It is generally seen that whenever there is a very sharp rally within a short period of time, investors tend to redeem. Behaviourally, investors are more comfortable holding on to gradual compounding names rather than momentum driven stocks. With structural improvement in economic growth and improving quality of earnings growth, the market should hopefully mirror the same going forward.

India has underperformed major global markets in the past one month. What has led to this underperformance? Will this continue?

The second wave of the pandemic hit India later than that experienced by other countries. The severity of this phase being higher than the first wave has led to localised lockdowns which in turn has marred market sentiment. However, the current phase has not seen a complete lockdown or a halt in economic activities. Positive effects of policy measures taken in 2020, low interest rates and accommodative fiscal policy are expected to support medium-term growth and could likely offset any short-term impact of lockdown on the economy. Following a general broad-based recovery in the economy, corporate earnings growth has also begun to improve.

The rupee has been weakening against the dollar. How will this play out on the market? Will it impact foreign flows?

For India, adverse terms of trade due to rising energy prices, inflationary pressures and RBI’s bond purchase programmes to infuse liquidity continue to weigh on the rupee. FPI outflows thus far, led by multiple domestic and global factors, have additionally exerted pressure on the domestic currency. A variety of factors are impacting foreign flows to domestic markets and the rupee depreciation will need to be viewed in conjunction with those moving parts.

What kind of returns shpuld investors expect from here on?

Corporate earnings growth consensus for frontline Indian equity indices stands at around 21 per cent and 25 per cent for FY22 and FY23. Risk-on sentiment improved in the last few months following news on vaccination and opening up of the economy and the market began to re-rate businesses based on the renewed growth assessment. Risks to the continuity of the market uptrend could emanate from key factors including prolonged prevalence and severity of the second wave of pandemic and global market liquidity levels.

In March we saw positive flows into equity schemes. Is this sustainable? Are investors looking to invest at this juncture?

Real rates have turned negative, making traditional fixed income instruments less attractive. Equities offer one of the most lucrative investment avenues supported by robust long term growth prospects for the economy. As investors increasingly recognise the potential of disciplined long-term investing and staying invested through volatile markets, flows into equity funds should stay positive.

Has the turmoil on the debt side, impacted flows and performance on the equity side at FT?

Flows mostly tend to follow performance. Most of our equity funds have staged a strong turnaround in performance since the past few quarters supported by broad-based recovery in the market. Our equity funds have always maintained a diversified portfolio despite the extreme market polarisation seen in the past few years. And now, as the domestic economic growth recovery has begun and the skewed market rally seen earlier is normalising to become more broad-based, the diversified portfolio of FT funds is contributing positively.

Which are the sectors or themes you like?

The financial sector remains attractive from the prospective growth point of view. While the auto sector went through multiple disruptions including the BS-VI transition and some stocks staged a rally, most of the sector is yet to re-rate. Growth potential could also emerge from the electric vehicles segment going forward. All the value chains for housing related sectors, including mortgage, finance, cement, local steel manufacturers, consumer housing construction materials, consumer durables, real estate could perform well. IT stocks are not into a structural overvalued zone and remain attractive.

Banking and IT stocks are trading at a premium to their historical valuations. What’s the outlook there?

After a prolonged period of de-rating in banks, the broad-based recovery in the economy, strong policy measures undertaken to clean up asset quality of banks, recapitalisation and credit guarantee schemes for lending to SME/ MSMEs are jointly yielding positive results and adding to fundamental strength of the banks. The re-rating in the sector stands supported by stronger balance sheets of the banks. Revival in the commodity cycle is a positive for the recovery of bad loans, demand for working capital loans and new capex cycle, which is further supported by the government's infrastructure push. Relatively less-volatile retail profit pool is expected to make up for a third of total profitability over next few years. Furthermore, move towards digitisation, formalisation of broader economy, potential pick up in corporate credit growth offer additional leverage for banks. These factors support valuation levels.

In the case of Indian technology companies, growth opportunities exist for not just technology service providers but also some of the local e-commerce enabled companies. Listing of such companies in the coming years could likely keep the sector extremely dynamic, active and much sought after. Traditional IT companies have demonstrated to their clients that they can continue to provide service irrespective of the disruption. Demand and margins growth are expected to stay positive for the sector both for existing set of companies and emerging opportunities.

Do you think metal stocks will continue to outperform?

The start of a decarbonisation movement in China targeting carbon neutrality by 2060 and move towards cleaner energy consumption is a structural shift. The move could impact the global metal sector in the short-run, constricting supply and increasing prices. Domestically speaking, a rise in steel prices could improve profitability for base metal companies. There has been deleveraging in these companies in the past three quarters and the possibility of further expansion exists. Other key issues to monitor include the impact of high prices on demand and the FY22 capex/leverage trajectory.