Start cherry-picking themes that are likely to play out: Andrew Holland

The recent global banking sector crisis caught the markets unawares. Andrew Holland, chief executive officer, Avendus Capital Public Markets Alternate Strategies, in conversation with Puneet Wadhwa, says the developments could have been catastrophic if global central banks had not moved swiftly to bring some kind of stability and avert a contagion. Edited excerpts:

Has the recent banking crisis been averted?

The recent banking sector crisis could have been catastrophic if global central banks had not moved swiftly to bring some kind of stability and avert a contagion. In Europe, too, the crisis was averted as Swiss regulators pledged a $54-billion liquidity lifeline to Credit Suisse.

While the US regulators secured the deposits at Silicon Valley Bank and Signature Bank, there is a looming risk of who is next.

Share prices of US regional banks have continued to take a pounding as investors realise that central banks will help depositors, but not equity holders.

Are headwinds mounting for global financial markets?

The aggressive hike in interest rates over the past 12 months could have unintended consequences. Even though we have now identified some of the problems, the markets continue to remain on edge.

The good news is that bond yields have dropped sharply, with the US two-year falling from 5 per cent to 4 per cent in a matter of days. This indicates that the US Federal Reserve (Fed) will raise rates by 25 basis points (bps) versus expectations of 50 bps a week earlier, and then go on hold.

There are expectations of no rate increase. Alternatively, the fall in bond yields could be heralding a ‘hard landing’ for the US economy.

A 25-bps hike will come through then?

We believe the Fed will shift to a quarter-point rate rise, and then go on hold to monitor any further glitches that may arise from the financial sector.

The risk associated with this strategy is that the narrative may move towards stagflation and ultimately to an earnings downgrade.

The good news is that the Fed’s sentiment seems to be moving towards the end of the tightening cycle.

Are market valuations now in a comfortable zone?

The recent sell-off in the Indian market has brought valuations to nearer long-term averages. However, in the context of emerging markets (EMs), they remain slightly elevated.

We think the first half of 2023 may see earnings come under pressure due to the global slowdown, and the Indian economy taking time to pick up. In the short term, this may lead to pressure on margins and potential downgrades, consequently, keeping valuations elevated. As growth accelerates, we may see certain sectors witnessing an earnings upgrade.

Is it a good time to cherry-pick stocks for the long term?

It makes sense to start cherry-picking themes that are likely to play out, both for the short and long term. In particular, the themes we like are: (i) defence spending and investments in renewable energy continuing apace, (ii) sectors where there is global or local risk in the security of supply, i.e., semiconductor, electronics, and (iii) local travel, hospitality, and aviation. Finally, banking remains a key sector for us, given India’s robust growth story.

What’s the road ahead for foreign flows?

Our long-standing view (which has now become a consensus) has been that once the Fed goes on hold, investors will look for growth and EM will be the asset class of choice. Mainly during the first half of the year, flows into EMs will be towards exporting countries, such as China/Korea/Taiwan, at India’s expense. Regardless, we will see inflows, given our weighting in the Indices.

Most foreign investors have an underweight rating on India at present, given the huge outperformance in 2022 and the current high valuations. The second half may see inflows accelerate as economic growth begins to gather pace and earnings upgrades start to materialise.

Will local flows hold up?

Local investors continue to increase their exposure to equities, mainly through systematic investment plans. Notwithstanding the recent headwinds, the market continues to be strong, with the likelihood of this being maintained.

Debt as an asset class is looking much more attractive, given the higher yields and incremental monies that may be directed here, especially if the Fed tightening cycle is coming to an end.

Can a pick-up in rural demand be the joker in the pack for Indian market sentiment?

Whilst rural demand has been somewhat slower than urban demand, we do see a pick-up towards the second half of the year. If anything, a slowdown in high-end spending may worry markets more. The sentiment towards rural spending slowing more significantly will depend on inflation and a possible El Niño impact.