Equity markets have been going through an extremely volatile phase of late with both the impending rate hikes by the US Federal Reserve as well as the Russia-Ukraine conflict playing havoc with investor sentiments. Vetri Subramaniam, CIO, UTI AMC, a veteran investor with over three decades of experience in Indian equity markets, shares his views on the impact of the war, market valuations and much more in this insightful discussion with BusinessLine. Excerpts:
What will be impact of the Russia-Ukraine war on corporate profitability, especially with crude oil prices nearing all-time high recently?
Both Russia and Ukraine are an important part of the global supply chain for many commodities -- crude oil, base metals, agri commodities etc. Courtesy this conflict, there is once again an exogenous shock to the global supply chain, prices of most commodities have gone through the roof. If you try to convert that into impact on corporate profitability, these are early days.
The impact will be more pronounced if the prices of crude oil and other commodities stay elevated for a year or longer. But if the conflict is resolved in a few weeks and sanctions are also withdrawn, impact on profitability may be restricted to one quarter or so. But then, when you buy a stock, you buy it for the cash flow and earnings that are likely to accrue over 10, 20 or 30 years. So, earnings of one quarter getting impacted may not matter much.
Of concern is the fact that we have a huge import bill for crude oil and other goods. If the cost is $40 higher per barrel compared to the previous year, that is straight away $50 billion of additional bill for crude oil. Similarly, if you add the incremental cost of other imports, the bill could be $50 billion to $100 billion higher. This will have a significant impact on the economy, consumer income, and companies will also have to decide how much of inflationary impact they decide to absorb and how much they pass on to consumers.
What is the Nifty 50 earnings growth you have penciled in for FY23? Does this undergo any change based on recent events?
We are dealing with probabilities here and not certainties. We do not know if the war will last for 6 weeks or 12 weeks or 52 weeks and earnings can be adjusted accordingly. But we are in a state of flux and adjusting earnings based on what we know now may not be relevant.
We usually go with Bloomberg consensus earnings forecast for Nifty 50, which is ₹750 for March 2022 and ₹888 for March 2023. But nobody has started adjusting their earnings estimates yet. The harsh reality is that even if the estimate of ₹888 was accurate and the war had not started, this market was still expensive, factoring in 18 per cent growth in FY23 earnings. It was anyway a very high bar.
If the market valuations are expensive, then their reaction to negative news flow could be severe whereas when valuations are cheap, the ability to absorb negative news flow is much better since the embedded expectations in these valuations is quite low. Equity investors console themselves with the thought that ‘this too shall pass’ when things are difficult. But this phrase is true when you think that the future is brilliant as well.
The Nifty 50 is down almost 10 per cent since its peak value in January. Valuations of most stocks have also corrected. Is value beginning to emerge in some pockets at least?
10 to 15 per cent fall in the market is par for the course. War might be playing on our minds right now but the maximum drawdown from the peak in October 2021 was just 15 to 16 per cent, which is not unusual for equities.
When we look at the valuation at this point in time, there is no metric that gives us the full answer. The biggest comfort we get in terms of price damage and correction in valuation is in the large-cap space. After a long time, valuation of Nifty 50 has pulled back into fair value territory. We are taking fair value as long-term average plus or minus one standard deviation which will explain 66 per cent of observations. Trailing multiples are slightly above average while forward multiples have just dipped into fair value.
On Price to Book, it has barely dipped its toe in fair value. If you look at bonds, we are not in neutral territory yet. Net-net, two indicators are indicating that we are somewhere close to fair value, so we have some comfort with Nifty 50.
However in mid and small-caps, the same metrics suggest that we are not yet in fair value territory.
Many of the foreign brokerages have been going underweight on India and overweight on China citing higher valuations here. Is this going to impact the liquidity from foreign funds?
I think the global funds are too sophisticated and smart to get influenced by what one brokerage tells them. They have the smartest people working for them, they know what valuation of each country is. They don’t need a broker to publish a report and tell them what the valuation of a country is. It is just one input in the overall decision-making process. I think we are dramatically underestimating the intelligence of the people investing in to India.
What we need to recognise is that there are all kinds of foreign investors – long-only funds, index funds, hedge funds. Hedge fund money is volatile, they trade based on their views. Investment fund money is also sensitive to allocation decisions and index funds are passive investors who don’t take any decisions. So, there are all kinds of foreign portfolio investors with different thought processes and it is wrong to paint them all with the same brush.
What is your view on Fed’s impending rate hike? Will that have an impact on market?
Monetary policies in 2020 were set at a level to save the economies in an emergency situation. Now, given that all economies have recouped and come back to pre-pandemic level of output, there is a case for monetary policy normalisation across the world. Normalisation is a given and you cannot keep economy on steroids long after it has recovered.
The reason why this evokes unpleasant memories is because of what happened in 2013 when the Fed began tapering and India was badly affected. But what we are forgetting is India was in a far more precarious position then with trade deficit at 10 per cent, import cover at 6 to 7 months, CAD at 4 to 4.5 per cent and inflation in double digit. Our inflation in 2013 was far higher than in US then and real bond yields were negative.
Today, the situation is quite different. We have stable set of macro numbers – CAD at 1.5 per cent, reserves at $650-660 billion equalling to 12 months of import cover and inflation within RBI’s comfort zone and real yield of 10-year bonds are positive. They are virulently negative in the US. Also, CPI in the US is now much higher than Indian CPI.
So pre-Russia Ukraine conflict, the conditions in India were far better compared to the US which means that there will be ripples from the Fed normalisation but far lower when compared to 2013. This will allow the MPC to decide on the monetary policy for India largely by looking at our own dashboard.
What is your outlook on new-age IPOs, do you think appetite for them will remain?
It’s going to be challenging because of the way the initial set of IPO listed and performed thereafter. The appetite for these is remarkably weaker is the sense we are getting. But it is a global phenomenon. We know for a fact that there were at least 3 to 4 new age consumer tech companies getting ready to list, but post-December they seem to be on hold. It will be much harder for future offerings. They will have to reset their price expectations.
But at the end of the day, it is important for a market economy to have entrepreneurs and they should be able to access capital markets. But investors should participate in these only if the price is right.
In 2021, our team evaluated 48 to 50 IPOs and we invested in 12 of them. In consumer tech companies, we invested in a small way in companies with decent track record.
What is your view on consumption, especially rural consumption? What are you hearing from the ground?
I think there are issues. The commentary from companies shows that the rural side has been troubled. One of the unexpected consequences of the Russia-Ukraine conflict is that agri produce prices have shot up. I am therefore a little hopeful that this may be good for farm income, though it is inflationary. That may be a silver lining in this conflict.
There has been a two-speed recovery in consumption. The top-end of the market with premium or luxury goods has not suffered much while the lower end has suffered. If the current inflationary trend persists, it will have significant impact on consumption.
But if there are a set of companies which have demonstrated their ability to ride out the challenge, we have to decide at which price we would be comfortable buying them rather than worry about the short-term increase in input costs.
What would be your advice to investors on the best way to ride out the volatility?
Volatility is inherent in equities and investors should have a strategy to deal with such volatility instead of trying to decide how to deal with each event. Stick to your asset allocation which is, in turn, based on your financial goals. The allocation should have some overlay of valuation.
Most importantly, continue your SIPs and STPs. The biggest mistake investors make is to halt SIPs due to adverse news. Your asset allocation should enable you to deal with shocks that are inevitable in equity investing.
There is a belief that return from equity should be able to beat fixed income returns. What, in your view, is the return that investors can expect from equities for a 5 to 10-year investment?
Conceptually you are right. Investors who take a higher risk with equity should get higher returns. And if a company is able to earn a higher return than the cost of debt, then that benefit accrues to investors who own the stock. The challenge here is valuation, which needs to be part of the equation.
In any market, over the longer term, there should a reasonable risk premium that equities are able to deliver relative to fixed income. But that curve keeps shifting. If you remember, in 1995-96, IDBI, ICICI, TISCO, etc, issued bonds at 15 to 18 per cent interest. Return expectations from equities, back then, started at 20-25 per cent.
What we need to remember is that the government and RBI are committed to CPI at 4 per cent with 2 per cent leeway on either side, which means that the risk free rate of return could be 6.5 to 7.5 per cent If we add risk premium of 5 to 6 per cent, we get around 12 per cent return expectation from equities. If inflation moves lower to 2 per cent over long term, the returns from equities too will move lower, but the attractiveness of equities will remain.
But if you are extremely savvy and buy at very low valuation, your returns could improve and vice versa. Or if a person sticks to a SIP through market cycles, he gets average index returns, thus taking care of the valuation risk in equities.