Risk can play out rapidly on any sign of inflation: Fidelity's Nitin Sharma

In a Q&A, the Director-Research, Fidelity International says while earnings have been supported by margin expansion in the last few quarters, they will be more revenue-linked going ahead

Abundant global liquidity has meant valuations are getting anchored on earnings three to four years out, which clearly raises the investment risk profile, says Nitin Sharma, Director-Research, Fidelity International. In an interview with Ashley Coutinho, he says that while earnings have been supported by margin expansion in the last couple of quarters, they will be more revenue-linked in the coming period. Edited excerpts:

What is your outlook for 2021 and what are the key triggers to watch out for in the near to medium term?

If you look from an economic performance perspective, we will see a sharp rebound in India, on account of the increase in government and private consumption spending. We expect this to be driven by a broad mobility pick-up as the pandemic wanes, in turn reviving the services sector in urban India. The real trigger over the longer term obviously will be signs of a sustained revival in the credit and investment cycle that would boost our potential growth rate.

What is your take on valuations? 
 

One should expect some excesses in valuations given the duration and the pace of the current market rally.  Abundant global liquidity has meant valuations are getting anchored on earnings three to four years out, which clearly raises the investment risk profile. This risk can begin to play out rapidly on any signs of higher inflation.

So, one must be careful in looking at valuations at a time when near-term earnings are suppressed owing to an extraordinary event. Nifty is trading at 22x on 12-month forward earnings versus a 10-year average of 15x, so is apparently expensive. However, it is at 2.9x 12-month forward book value versus a 10-year average of 2.4x. On the latter metric, the extent of overvaluation is not that steep depending on the evolving expectations around earnings recovery.

One should expect higher volatility from here as also greater stock return dispersion. Times like these are ideal for stock picking as the gap between winners and losers becomes even more apparent.

What are your views on the Union Budget 2021? 
 

It is a growth-oriented budget in every sense. Not only is there a visible push on pump-priming the economy, a lot of effort has been made around creating a solid long-term growth platform. Capital allocation is quite positive with emphasis on capital spending (plus 35 per cent), and a sizeable boost for both physical and social infra build in both urban and rural areas. A fillip to housing and construction in general will lead to a quicker multiplier effect on the economic activity, while incentives under the PLI scheme will also provide a runway to manufacturing investment.

Managing to support it all without raising taxes and relying instead on attracting private capital in various forms is clearly progressive. Not only will the measures help banks in managing their asset quality challenges better, the ensuing growth can notably ease their burden in this regard. This positions the economy better in terms of resuming the credit cycle. 

Analysts expect emerging markets to do better this year. How is India placed in the EM pack?
 

Historically, emerging markets have done well during times of cyclical recovery that has supported primary input prices, and during phases of US dollar weakness. As such India is placed well within this group with an above-average growth profile and a favourable external account and inflation outlook (which have historically been a drag for us). However, at Fidelity, we’d always recommend a stock-specific investment approach rather than looking to time a category of markets. One should also note that while EMs may often directionally move together, there is invariably considerable performance difference across them. In 2020, for instance, China and Korea went up over 40 per cent, India 15 per cent, Russia 7 per cent and Indonesia -2 per cent --- that’s a very broad range.  

Investors worldwide are pricing in a return to normalcy. Are there good reasons to be optimistic? With improving vaccine availability in the most impacted countries and potentially approaching herd immunity levels in various regions globally, there are reasons to be cautiously optimistic. Substantial stimulus programmes lined up across the economies is also leading to a positive undertone to growth and earnings expectations. Among risks, foremost are potential delay to the global vaccination efforts or emergence of a nasty mutation of the virus. From markets’ perspective, how do central banks manage the liquidity they have injected in response to the pandemic will be key. They will need to balance inflation concerns upon recovery with the need to have accommodative monetary policies owing to a high debt burden globally. Another potential risk would be the nature of potential US-China decoupling impacting global capital flows and production.  

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

I would say rather than using only a broad market cap brush for assessing stocks, a more reliable approach would be to focus on the quality of the underlying businesses. One must appreciate the several structural changes leading to an emergence of globally competitive and scaled businesses in India across multiple sectors. A vibrant venture and private equity investing in India over the last several years and a more business-friendly posture by the government, along with incentives in the form of lower taxes and PLI, have been among the key drivers for the same. Many of these names are long-term structural stories and have rightly attracted investors’ attention. Having said that, any business trading rich despite poor cash generation, lack of quality growth avenues and having a high leverage should clearly be avoided in this space.

What are your views on corporate earnings? 

The corporate earnings have been strong thus far this quarter, and have a good runway ahead of them for the rest of the year. For 2021, we expect consumer discretionary and industrials sector to show the sharpest rebound in aggregate. Key uncertainly would be for banks given the quantum of restructured loan book for many of them. While earnings have been supported by margin expansion in the last couple of quarters, they will be more revenue-linked in the coming period.  

What is your view on banking and NBFC stocks? Is the worst behind us?

The overall economic recovery from the pandemic will take two-three years at least and the true credit costs for banks and NBFCs will not be truly known till then. While lending entities have created adequate provisions, several businesses have potentially seen a permanent change in their income potential. The resultant capital reallocation will take a while. Till that time, investors should be cautious of banks and NBFCs with historically high non-performing loans or ones that could need more capital to grow out of this crisis.