Recently downgraded India under Asian Model Portfolio: Manishi Raychaudhuri

The head of Asia-Pacific equity research at BNP Paribas says a renewed slowdown in consumption and some service sectors can lead to consensus downgrades to Indian earnings estimates

The markets will have to navigate through a lot of uncertainty in May, given the rising Covid cases and extension of lockdowns across key cities. Manishi Raychaudhuri, head of Asia-Pacific equity research at BNP Paribas, tells Puneet Wadhwa in an interview that a renewed slowdown in consumption and some service sectors can lead to consensus downgrades to Indian earnings estimates. Edited excerpts:
 
Are the Indian markets poised for more correction?
 
Indian equities are likely to underperform Asian peers in the near term, particularly the north Asian markets like Hong Kong, China, South Korea, and Taiwan. We recently downgraded India in our Asian Model Portfolio from overweight to neutral. A renewed slowdown in consumption and some service sectors can lead to consensus downgrades to Indian earnings estimates, which anyway appear optimistic to us. Potential silver linings could be an acceleration in the pace of vaccination and moderation in commodity prices, particularly oil. The latter can stabilise the rupee and stem outflows from foreign institutional investors (FIIs).
 
How’s the mood among your clients regarding equities as an asset class?
 
Most investors are positive on equities over the medium-term, though some caution persists over the near term. Investors’ caution currently arises from the potential risk of inflation surge, which can lead global central banks to moderate and eventually end their quantitative easing programmes, choking up the source of funds that have benefitted financial assets over the past year.
From a medium-term perspective, most investors believe that equities are the best inflation hedge. Moreover, the present increase in inflationary expectations and bond yields have been caused by growth expectations rising rapidly -- an outcome that’s good for corporate earnings, and therefore for equities
 

Where does India figure in their preference list?
 
Emerging market investors are largely overweight on India, having increased their position in India throughout 2020 and in the first couple of months of 2021. They have recently turned cautious owing to the likelihood of consensus earnings estimate downgrades and India’s valuation premium, which is significantly higher than its usual average valuation premium relative to Asian peers.
 
Your Sensex target by 2021-end…
 
Our Sensex target by the end of 2021 is 52,000. That constitutes an upside just shy of 5 per cent for the remaining part of the year. North Asian markets, which have put the pandemic behind them and have a more visible pathway of corporate earnings revival, are likely to generate more alphas for investors in the same time frame.
 
What about mid- and small-caps?
 
In the near term, mid- and small-caps are expected to underperform their larger peers. During periods of disruption —like the one we are in now —large frontline market leader firms can operate relatively disruption-free, and tend to gain market share. While there could be stock specific attractive stories in small- and mid-caps, broad-based outperformance of small- and mid-caps is unlikely in the medium term.
 
What is the optimum mix of cyclical versus defensives that investors should have now?
 
We follow a “barbell” strategy in our equity asset allocation, with emphasis on cyclicals, defensives and growth plays — the latter often represented by companies benefitting from the tech megatrends. In India, we are playing cyclicals through financials and energy and defensives through consumer staples, telecom and IT services. We also have allocations to select consumer discretionary — particularly autos — which, in India, are long-term growth stories, backed by increasing product penetration. Slightly less than 50 per cent of our India allocations are in cyclicals. We’ve recently trimmed our exposure to Indian financials and increased our allocation to IT.
 
Please elaborate on your views on banks…
 
In our most recent reshuffling of the Asian Model Portfolio, we have reduced exposure to Indian banks and increased exposure to IT. That said, we still maintain exposure to good quality private banks. Our conversations with leading Indian banks reveal that most banks expect the Reserve Bank of India (RBI) to extend the one- time MSME loan dispensation scheme. Besides, in the 2020 Covid episode, recovery was remarkably rapid and such revival can partly occur on this occasion, as well. While we are worried about financials in the near term, we keep our faith in good quality ones over the medium term.
 
Can the second Covid wave derail earnings momentum in the next two quarters?
 
BNP Paribas’ earnings growth estimates for companies in the Nifty are 26 per cent in 2021-22 (FY22) and 21.7 per cent in FY23. These are broadly achievable given the low base in FY21. However, consensus earnings growth estimates for some of the broader indices worry us. The consensus growth estimate for MSCI India, for instance, is 43.4 per cent in CY21 and 21 per cent in CY22.
 
A few sectors like financials and consumer discretionary are forecast to grow at over 90 per cent in CY21. With the Covid spread engendering near-term risk to consumption and banks’ asset quality, we think these forecasts appear a tall order despite the low base.