Most global investors cautious of equities after sharp rally: Raychaudhuri

Manishi Raychaudhuri, head of Asia Pacific equity research, BNP Paribas, tells Puneet Wadhwa the reason for India being such an FII favourite is the breadth of stocks and sectors that market offers

The market rally since March 2020 lows has been led mostly by foreign institutional investors. MANISHI RAYCHAUDHURI, head of Asia Pacific equity research, BNP Paribas, tells Puneet Wadhwa the reason for India being such an FII favourite is the breadth of stocks and sectors that the market offers. Edited excerpts:

Are the global and Indian markets heading for a correction?

Since early September, the global equity markets first corrected and then entered a phase of sideways movement. Such a drift in the market engenders a ‘time correction’ in valuations and is a healthy phenomenon. The sharp rally since late March 2020, despite earnings downgrades, had rendered valuations expensive, especially in certain sectors. That said, global central banks shall maintain accommodative policy stances in the foreseeable time horizon.

Is market valuation out of your comfort zone?

The equity rally in the absence of earnings support was worrying, no doubt. However, we must keep in mind that the rally in most markets, including India, was extremely narrow — driven by a handful of stocks. Apart from these superlative performers, valuations in other sectors — largely global and domestic cyclicals — aren’t egregiously expensive. That said, headline forward price-to-earnings (P/E) multiples in most Asian markets are well above their long-term averages, and in some markets like India and Thailand, are three standard deviations higher than the mean. Only Greater China valuations — one standard deviation higher and benefitting from upward earnings revisions — appear less risky.

Can 2020 belong to mid- and small-caps?

The Sebi’s recent mandate, if implemented fully, could result in Rs 390-410 billion of equity assets under management (AUM) moving from large-cap to mid- and small-cap stocks. Ceteris paribus, about 65 per cent of that transfer could be in favour of small-caps and the rest in favour of mid-caps. Some outcomes — like mutual funds changing funds labelling or the Sebi’s directive getting altered — are difficult to predict at this stage. Quality small- and mid-caps may see higher investor interest.

What are your estimates for corporate earnings growth?

For India, consensus earnings growth estimates for FY21 and FY22 — at 30 per cent and 25 per cent — appear overstated. From the low base of FY20, there could be an earnings growth recovery in FY21, but we believe it will settle around the late teens.

Which sectors will lead the recovery?

We expect growth to be led by consumer discretionary, private banks, materials, and telecommunications. A silver lining in the earnings environment is the broad-based earnings recovery — from the early beneficiaries like technology, telecom, and consumer staples, positive earnings inflexions are now beginning to show up in cyclical sectors.

Are risks to the market over the next few months more from global issues than domestic factors?

Major risks to the market arise from the potential resurgence in Covid-19 infections, and the impact on economic activity, US election outcome, continuing geopolitical tensions, and protectionism. In India, employment destruction could delay consumption recovery, worsening of banks’ asset quality could delay lending activity, and the government’s fiscal stress could prevent large demand-supporting stimulus. These factors add risks to Indian equities. While risks in the north Asian markets arise largely from global issues, in India and pockets of Southeast Asia, domestic risk factors are equally crucial.

How’s the mood among your clients/ foreign investors regarding equities as an asset class?

Most global investors appear to be cautious about equities after the sharp rally. Some are looking at rotating away from the sectors that have hitherto driven the markets into sectors that have underperformed, particularly if the latter are beginning to experience upward earnings revisions. India has benefited from large FII flows in the past four months at the expense of most other Asian markets. The reason for India being such an ‘FII favourite’ is the breadth of stocks and sectors it offers. Apart from China, such breadth of investible sectors is difficult to find. Over the medium-term, we expect FIIs’ enthusiasm for Indian equities to continue, though near-term risks could dampen their interest.

What has been your investing strategy since March 2020?

We have been overweight on private banks, insurance, IT, telecom, and select consumers. IT holds the biggest promise in the medium term. Our channel checks reveal large frontline IT firms are winning deals and implementing new cost-saving measures as remote working catches on. 

Selective consumer stocks, particularly those with secular growth and excess return generation, can continue to outperform. We believe cyclicals selectively make sense, especially particularly private banks and some segments of materials. The latter is beginning to see upward earnings inflexions.