UBS is underweight on Indian equities within EM/Asia: Sunil Tirumalai

Valuations in India, he said in this interview, are pricing a lot more 'sentiment' premium than what fundamentals of the stocks can explain

Despite the sharp and swift correction in the mid-and small-caps in the last few weeks, SUNIL TIRUMALAI, emerging markets and India Strategist at UBS Securities tells Puneet Wadhwa in an email interview that there is still a lot of richness in mid/small cap valuations that needs to subside before one can be constructive. Edited excerpts:

As a strategy, are you bullish or bearish on the markets as things stand from a short-term perspective?

UBS is underweight on India equities within the emerging market/Asia context. Given where equity valuations are compared to bond markets, it makes more sense to look at bonds over the near-term. A bit of the distortion in the valuation relationship post COVID is due to strong household flows into equities (both directly into stock markets, and also through mutual funds). This was a result of high savings during the pandemic, low domestic bank deposit rates and the market performance driven by global liquidity flood post pandemic. However, as many of these factors recede, retail flows could soften. This is already visible in retail net buying this year being softer than previous year.

Higher for longer seems to be the mantra now – be it interest rates, crude oil prices or bond yields. Do you think markets accept this as the new normal and eventually move north?

Markets can deviate from fundamental relationships over the short term, but it would be hard to ignore fundamentals over the longer term. Higher bond yields and interest rates do reduce the attractiveness of equities, especially if the higher rates are happening in an environment where inflation is becoming less of concern, but higher due to higher real rates.

Higher oil prices – especially one that is driven by supply constraints (rather than strong global demand) can hurt. This is truer for markets like India, which are dependent on imports. Over the last 12-15 years, the Nifty’s response function to crude oil increase has worsened. This is due to a reduction in index weight of stocks that benefit during periods of surging oil prices (like energy and commodities), and an increase in weight of stocks that more closely represent the negative impact of such inflation on the Indian economy (consumer sector and banks). So, overall, we believe a ‘higher for longer’ situation would result in weak equities outcome.

Are the fundamentals of the economy & markets supportive of the levels where the Sensex, Nifty are right now?

Valuations in India are pricing a lot more ‘sentiment’ premium than what fundamentals of the stocks can explain. Our quantitative model suggests that an average randomly selected EM stock that is listed in India today (all else being the same) gets a straight 75 per cent increase in valuations. This premium was around 30 per cent pre-pandemic, and around 20 per cent pre-2014. Overall, this suggests a lot of the valuations in India are a function of ‘sentiment’ or ‘perception’, rather than hard fundamentals and company growth expectations over the next 3 years.

Two of the biggest stock markets globally – India and the US – head into general elections in 2024. What are the markets expecting?

As far as US elections are concerned, geopolitical rhetoric could rise in the run-up, and that can cause higher volatility overall. For India, elections have become less relevant for markets over the years. Market is likely expecting a continuation of the current regime (that favours infrastructure spending over consumption boosters). It may take note if there are any major setbacks for the ruling party in state elections, or if there is a populist turn in the central government’s policies in the run-up to elections.

Have the valuation excesses been completely removed from the mid-and small-cap spaces after the recent correction?

We do not think so – there is still a lot of richness in mid/small cap valuations that needs to subside before one can be constructive. We would prefer the safety of large-caps in such a richly valued environment

How do you see the earnings come through over the next few quarters in the backdrop of global and domestic headwinds?

We see about 5-6 per cent downside to consensus fiscal 2025 (FY25) earnings. As things stand, over 70 per cent of Nifty stocks are seeing EPS cuts. Aggregate Nifty EPS was holding up largely due to bank net interest margin (NIM) expansions. But, that could be coming to a close too. Key variables to watch for would be US/China economic momentum, oil prices, geopolitics. Also, recovery in demand from rural/low-income categories could be important for some sectors – that has been a bit elusive post pandemic.