Gird up for higher volatility in 2022: Edelweiss MF's Trideep Bhattacharya

'We are constructive on mid- and small-caps stocks over the medium term', said Bhattacharya

Valuations appear optically high on the back of depressed earnings estimates in pockets of the market, says Trideep Bhattacharya, co-chief investment officer, equities, Edelweiss Mutual Fund. He tells Ashley Coutinho that persistent higher inflation, combined with faltering economic growth, would be the biggest risk for Indian equities. Edited excerpts: 

What are the biggest risks for the Indian equity market in the coming year? What are the key triggers to watch out for? 

We think 2022 will likely to be the first year of policy normalisation, post-pandemic. In the first half, I would expect the markets to digest the pace of policy normalisation, along with the Omicron worry and expect it to be volatile.

In the second half, I expect the markets to respond to earnings direction as economic recovery unfolds. Overall, we are constructive on equities in 2022, but prepared for higher volatility ahead. In this context, persistent higher inflation, combined with faltering economic growth, would be the biggest risk for Indian equities. 

What is your take on current valuations?

I think valuations appear optically high on the back of depressed earnings estimates, certainly in pockets of the market. As the incipient economic recovery unfolds over the next two to three years, we would expect valuations to normalise on the back of an earnings upgrade over time. However, we expect an uneven economic recovery. A lot of focus is needed to identify these pockets of earnings upgrades.

What are your views on mid- and small-cap stocks at this juncture? 

We are constructive on mid- and small-caps stocks over the medium term. The valuation differential that existed between large- and mid-/small-cap stocks has normalised over the past 12-18 months. Going forward, we believe the movements will likely be stock-specific and will follow the earnings upgrade/downgrade cycle of stocks closely. They continue to be a strong source of wealth creation for investors with a three- to five-year investing time horizon and deserve a meaningful part of an investor’s asset allocation. 

What are your thoughts on earnings growth in the third quarter (Q3)? 

We expect information technology services companies to kick off the earnings season with resilient earnings. Overall, we expect earnings growth in Q3 to reflect that of an economy coming out of the Covid-19 pandemic. While we expect the dichotomous earnings growth performance between commodity users and commodity-related earners to continue in Q3, we would expect the management commentary to flag off easing commodity-related concerns and increasing optimism of economic recovery over the next two to three years.

Which sectors are you betting on in the coming months? 

Based on our analysis of capital expenditure (capex) intentions of the corporate sector, combined with decade-low interest rates, we believe India could witness a strong capex cycle over the next two to three years - something we haven’t seen since demonetisation.  

Also, the structural reforms by the Indian government over the past two-three years could potentially increase India’s gross domestic product growth by a percentage or two over the medium term. We keep looking out for stock ideas across sectors that are direct or indirect plays on these themes.

In this context, we think the economy-facing sectors like select financial, industrial, and indirect plays on real estate are fertile hunting ground for us. On the other hand, the sectors that are least favourite include consumer staples and utilities.

What is your take on banking and non-banking financial company (NBFC) stocks? 

We are selectively positive on financials. As a consequence of the deleveraging cycle of Indian corporates, banks and NBFCs have broadly emerged strongly on the asset quality front, while credit growth is sluggish overall. However, within the sector, we would expect the key sector leaders to witness stronger growth than peers, reflective of a consolidation within the sector.