We expect equity returns to be muted in next 12 months: CIO, HDFC Life

We are taking a balanced approach towards sectors and hence there is no big call on any particular sector, says Prasun Gajri, Chief Investment Officer, HDFC Life

Markets are building in a sharp recovery in GDP growth and earnings in FY22. Unless these expectations fructify, it will be difficult to justify valuations says Prasun Gajri, Chief Investment Officer, HDFC Life. In an interview to Business Standard, Gajri says a better sense of the FY22 earnings traction will be available over the next 6 months. He believes liquidity alone cannot be the sole driver of markets. Excerpts:

Q. Global and Indian markets saw a sell-off due to concerns about rising Covid-19 cases and news reports on suspicious transactions involving international banks. How far could this problem and sell-off extend, or is it temporary?

I will not like to comment on the short term movements of the market. We believe that the current move in the market is in line with expectations. While correction can continue, we believe that as long as the economic activity continues to recover at the margin and optimism on recovery for FY22 continues and also the possibility that a vaccine is quite likely within the current financial year exists, the correction is unlikely to be long lasting.

Q. Given the hit to economy and its patchy restart coupled with rising Covid-19 cases, many economists now say that India's GDP in FY22 will be lower than FY20 levels. In this backdrop, do you believe markets are expensive and have run ahead of fundamentals?

Markets are clearly building in a sharp recovery in GDP growth as well as corporate earnings in FY22. We have seen a good recovery in the economic activity and hence this assumption of a good recovery in FY22 is not entirely unjustified. If the FY22 numbers come as per expectations, then the valuations of the market can be justified. We will get a better sense of the FY22 earnings traction over the next 6 months. The direction of the market will therefore depend on how the expectations for FY22 change going forward.

Q. Many also say that there is a lot of liquidity to keep equities elevated. How long can liquidity alone keep the rally going?

Liquidity alone is never sufficient for long term market returns. While the liquidity can provide sustenance to the market for some time, ultimately it is the earnings that matter.

Q. Given the stronger hit to the informal sector and economic outlook, what is your view on the prospects of discretionary consumption sectors like auto, multiplexes, tourism, hospitality? When do you expect these to return to pre-Covid-19 levels?

Some of the discretionary sectors like auto have shown a smart recovery. Sectors like hotels have improved but have some way to go. Multiplexes are yet to open. So it is a different story for each of these sectors. For hotels and multiplexes to fully get back to pre-Covid-19 levels it will take some time and a medical solution is a pre-requisite for the same. For auto, it is difficult to ascertain on whether the demand pick is on account of pent up demand or if there is a structural pick up. We will get clarity post November, once the festive season ends.

Q. Sebi's move to change classification of multi-cap MF schemes has seen a rally in mid and small cap stocks. Can it lead to re-rating of quality names in this space like the way liquidity is chasing certain large caps, or is there a need to worry?

While Sebi has suggested the change in the way multi-cap schemes are run and we have seen a positive move in mid and small caps, it remains to be seen on how MFs respond to the change and what the final regulations are. If the response from MFs is to combine multi-cap schemes with some of their other schemes, it is unlikely to lead to any incremental buying in mid-caps or small caps. Also, we also are not sure of how the existing investors of these funds respond to the changes in regulation. Therefore it is difficult to say currently as to how this change will impact the market once these regulations come into effect.

Q. How are you playing your cards and what investment strategy are you following or in favour of over the next 6-12 months? How much returns can one expect from equities over the next 12 months?

We believe that over the next 12 months the returns are likely to be muted from current levels unless we see a sharper recovery in earnings and GDP than currently expected. As far as our strategy is concerned, we are focussing more on individual stocks instead of taking a big call on any particular sector. Performance has been switching from one sector to the next over the last 6 months. We are maintaining a balanced portfolio with a focus on stocks where we are more certain of earnings growth and we find relative valuations reasonable. We are looking to avoid stocks where the business will not be able to absorb the effect of a slowdown especially if the current pandemic lasts longer.

Q. Sectors and themes that you expect to do well and avoid?

As I stated earlier, we are taking a balanced approach towards sectors and hence there is no big call on any particular sector. While we like the defensive sectors like IT and pharma, we also believe that the market is being over cautious on financials especially large banks and believe that financials offer good upside. While we do not want to avoid a specific sector, we are clearly trying to avoid specific stocks where there are concerns on the ability of the business to absorb the effects of the slowdown or where we believe managements have not adequately responded to the crisis.

Q. The Centre and states are short of revenues and inflation is rising. How do you see this playing out on the equities and debt markets?

We believe that rise in inflation is not going to be long lasting as it has been driven largely by supply side issues driven by the lockdown. As the economy is opening up we expect the supply side concerns to ebb and with a relatively muted demand and excess capacity in the system, we expect inflation to come down. However, the fiscal concerns are for real and that has been impacting the debt markets. The fear of large supply has meant that G-Sec yields are not coming down further despite excess liquidity and RBI rate cuts.

Q. So, what's your strategy and risk/return expectations from debt markets?

We expect a range bound debt market with the returns coming more from interest accruals rather than from interest rate movements. While inflation is expected to come down and RBI has room to cut rates further, the supply fear on account of fiscal concerns is likely to keep the rates within a range.