Global funds remain more overweight on India than APAC: Amish Shah

Amish Shah, India equity strategist at BofA Securities says that his firm expects the markets to consolidate in the near term

It has been an eventful week for the markets that negotiated the weak economic data and developments in the telecom and banking sectors. Amish Shah, India equity strategist at BofA Securities, tells Puneet Wadhwa that his firm expects the markets to consolidate in the near term as stocks of large sectors now offer limited room for further valuation re-rating after the recent rally. Edited excerpts:

Are the markets factoring in a possible further deterioration in the economy?
 

Despite the impact on macro/fiscal deficit, given the massive liquidity globally, the markets are unlikely to correct meaningfully, especially given that valuations for the Indian markets are still largely in-sync with other emerging markets (EMs), as well as with markets globally. However, we do think the markets may take a breather and see consolidation in the near term. The financial sector does have the potential to drive the market rally further, if loan restructuring and NPAs are not excessive. That said, global shocks or negative events are a key risk to the markets.

What’s your view on foreign flows into Indian equities going ahead?

Institutional flows (net) may slow down, as we expect the markets to consolidate in the near term. This is because stocks of large sectors now offer limited room for further valuation re-rating after the recent rally. Also, flows in most financials sector stocks may await clarity on the quantum of non-performing assets (NPAs)/loan restructuring, which may take a few months. That said, we do expect FII flows for the industrials and materials sectors to turn positive, especially given FIIs underweight positioning on the one hand and the improving traction for Make in India/government’s capex push on the other. Domestic institutional investors (DIIs) are already overweight on the industrials sector, but can see increase in allocation towards the materials sector.

What is your market positioning and sector preferences?

According to our Global Quantitative Strategy team, global funds continue to be overweight on India versus other APAC (Asia-Pacific) countries. This also reflected in the fact that FII flows have been positive for India since May 2020, as compared to outflows seen by many other EMs, such as Malaysia, Brazil, South Africa, and Thailand. Given this, the MSCI India's valuation premium to other emerging markets (EMs) is now at over 50 per cent, versus the long-term average at 36 per cent. We expect the market to consolidate in the near term, but see private sector financials having the scope to drive a rally, thereafter, once clarity on NPAs emerges. We prefer select well-run financials, staples, utilities, industrials, and materials sectors. We are cautious on a few discretionary stocks across the consumer, auto, media, and real estate sectors. We see limited scope for further upside for IT, telecom and pharma stocks.

Which sectors should benefit the most from government policies?

We do see targeted efforts from the government this time to improve industrial factors of production. To attract large FDI, India will also have to make legislative changes to reform issues linked to labour markets and the power distribution sector, simplify processes for regulatory approvals, fast-track land acquisition, increase FDI limits, and offer production-linked incentive schemes or capex subsidy schemes in a few more sectors. Our checks with industry stakeholders suggest most of these are in the works. If the implementation of these measures is fast-tracked, it will help re-affirm our view on India benefitting from shifting supply chains and this can be a positive India story, in general, over the long term. This can benefit industrials, materials and logistics stocks in the near term.

With more global economies now open for business and severe contraction in the Indian economy in Q1, should investors focus more on export-oriented firms?
 

Slowing retail credit growth, falling income, job cuts, and efforts by companies across sectors to curtail costs will certainly impact demand for products linked to discretionary consumption for a few years within India. This partly explains our cautious views on discretionary stocks. We believe volumes registered by most discretionary firms in FY19 may return only by FY23.

Your interpretation of Q1 results of India Inc and the ensuing guidance?

Most companies are trying to get back to pre-Covid-19 levels rapidly and have made commendable efforts to address issues linked to labour migration, logistical bottlenecks, and working capital stress. Besides, we are positively surprised by the response of companies to curtail costs. Our analysis of the top 240 firms suggests they cut overhead costs by 25 per cent YoY during Q1.

Going ahead, most firms aim to transition to variable versus fixed costs, and step-up contract labour, etc, to reduce operating leverage. Structurally, supply chain digitisation and its optimisation (logistics costs) and dis-intermediation that started post goods and services tax (GST) are accelerating. Firms with high operating leverage and an aim to curtail costs should benefit as businesses normalise and consolidation accelerates.

Your earnings estimates in this backdrop?

Our earnings estimates for Nifty stocks are 4 per cent/6 per cent below consensus for FY21/FY22. We see most risk to consensus FY22 earnings per share (EPS) within the financials, discretionary and materials sectors, and see the potential for upgrades within the telecom and industrials sectors.