Frothy valuations to take hit as liquidity withdraws: InCred Asset Mgt head

In a Q&A, Mrinal Singh, CEO & CIO of the firm, says Indian markets are better placed than other EMs and there are enough bottom-up opportunities

Monetary tightening by the US Federal Reserve will have an impact on equity valuations, particularly pockets where they are lofty, says Mrinal Singh, CEO & CIO InCred Asset Management. In an interview with Sundar Sethuraman, Singh says Indian markets are better placed than other emerging markets and there are enough bottom-up opportunities. Edited excerpts:

How will Fed's policy tightening play out in the markets?

We have entered 2022, bracing for the US Federal Reserve's tightening regime. With US inflation already at a 40-year high and rising crude prices, the Fed may move to hike rates sooner than expected. Let us be mindful that the Fed's rate hikes may weigh on the equity markets, particularly the emerging markets (EMs). Zones of frothy valuations are likely to be more impacted as liquidity withdrawal occurs. Though India is in a better place than other EMs. Meanwhile, the good news is that despite foreign portfolio investor (FPI) selling, the Nifty has been relatively resilient as domestic investors stepped in and are supporting the market like never before.

What are the other key risks?

We believe the risk of geopolitical development might have the potential to escalate, the developed world growth outlook could moderate, and inflation could remain more resilient than expected, and higher energy prices may cause a concern.

What are the return expectations this year?

We believe this year is expected to be more volatile than in the immediate past. However, it is likely to offer very interesting prices to realign your portfolio towards businesses ahead of the earnings growth curve.

What are earnings expectations for the quarter that went by? How do you see valuations?

The overall earnings trajectory going ahead remains modest. We expect to see an around 15-17 per cent growth in earnings within a few sectors in Q4 FY22, helped by a pickup in credit growth and strong demand visibility in the IT sector. Rising commodity prices will imply good results for metals and oil producers. The growth in corporate earnings may be led by the cyclical sectors such as banking & Finance (BFSI), backed by improving asset quality trends and revival in credit growth. Automobiles, oil, gas & consumable fuels might also account for incremental net profits. For FY23, the earnings momentum that we saw in FY22 may sustain unless new headwinds emerge. Nifty trades at around 23 times FY23 earnings and valuation may not look cheap when we look at the benchmark index. However, a bottom-up approach and prudent stock selection may be key to generating alpha.

Is there enough opportunity to deploy the strong inflows that are coming into equity schemes? How does one generate alpha?

Taking a bottom-up approach, there are enough opportunities available in sectors that are relatively underperformed such as autos, financials, consumer durables and healthcare. Now is the time when asset managers are playing a crucial role. Stock selection and conviction will play a much bigger role than they did in recent times. Prudent money and risk management are essential. At this point, investors should stick to good companies with an excellent moat and strong revenue growth potential. The market does have a lot of opportunities to deploy fresh funds. Sector rotation is a key to portfolio managers, as they plough up the funds into the sectors that are set to benefit from here on.

Which sectors or themes one can look at or stay away from at this juncture?

In the near to medium term, we see significant potential, particularly in segments that are driven by capacity expansion. We like the domestic manufacturing theme and the capacity addition. We are optimistic about sectors that are grabbing the opportunities of China plus one theme. Companies benefitting from the PLI scheme will continue to see good traction in their business, and opportunities are immense going ahead. Metal producers and the likes directly benefit from a rise in commodity prices.  We believe there are pockets in healthcare that are interesting. Domestic formulation and API companies can pass on the price hike to customers, unlike unbranded generics in the US or EU. While the IT space looks well-placed to reap the benefits of a stronger dollar. Considering the hawkish Fed stance, the strengthening US dollar also means one needs to look at exports and closely choose the stocks. An inflationary environment may put commodity producers under pressure as commodity consumers will see margin compression due to rising input costs.