Rahul Singh, CIO - Equities, Tata Asset Management, shares his insights on the impact of high interest rates on equities, choosing between large-, mid- and small-cap stocks today and why GARP is a timeless approach to Indian markets.
Rahul has over 27 years of investment experience and is an alumnus of IIT Bombay and IIM Lucknow. He joined Tata Asset Management in October 2018 as CIO - Equities, leading the fund management and equity research teams. In his previous role at Ampersand Capital Investment Advisors LLP, Rahul was the Managing Partner. He has also worked with many reputed financial institutions like Standard Chartered Securities and Citigroup Global Markets India as Head of Equity Research.
In your newsletter in June this year, you said that India could be in a sweet spot, with China’s recovery being slow and the possibility of only a shallow recession in developed markets. How do you see the scenario today?
The situation has gone a bit the other way in the sense that instead of a shallow recession, what we are seeing in the US at least is that there is hardly any recession. This scenario increases the risk in some ways because interest rates are likely to remain higher for longer and it will also it will result in slightly higher input/commodity prices. So, it is not exactly a best situation from an Indian market perspective. However, overall, I think everyone is still of the view that this is temporary – a respite before we see the GDP growth numbers coming down again in the US. China and the European region are anyway on a slower growth trajectory. So, I would say at the margin things have turned very slightly negative from a complete sweet spot scenario.
Bond yields have been rising in the US and you spoke of interest rates remaining higher for longer. This is not-so-good for equities. The Israel-Hamas conflict is also adding to the uncertainty. What is the further downside for the Indian markets from here on?
If the interest rates remain high, it is obviously negative for equity valuations. And it is generally negative for risk assets because you are getting almost a risk-free return of about 5 per cent in the US and so, any risk asset will be evaluated much more stringently — which is one of the reasons why we see FII selling persisting in the Indian market despite the economic fundamentals being much better than other emerging markets. It is difficult to quantify the downside because that is more technical in nature and that will be a result of how much imbalance there is between domestic inflows and global outflows. But I would say the base case scenario for me is that market remains sideways or consolidates at these levels for some time, which I think will be a healthy thing to happen.
By saying that it is a healthy thing to happen, you imply that there is some kind of a slight overvaluation currently which will get corrected?
It is more to do with the fact that if that healthy balance does not remain, we could get into a situation where we have too much money chasing too few stocks. So, a healthy situation is where we are able to buy what we want to buy at the prices at which we want. I think if the current or plus/ minus 3-5 per cent market levels extends to the next six-nine months, it’s a healthy situation. This will provide a better base for the markets to perform for the forthcoming year - FY25. Obviously, the markets are not cheap today. The Nifty at 19 times is about 5-10 per cent more expensive than the average of the last 10 years. But it is not in a bubble either. One must remember that the Nifty valuations are higher because of the good things which are happening in the economy currently, which is the revival of the capex cycle, revival of manufacturing as a sector, revival of real estate, banking sector being strong and corporate deleveraging.
Would you extend this positivity to mid- and small-caps, and say that they are not in bubble zone, or do you agree with the view that it is better to look at large-caps now?
I think I will agree to the view that large-caps are offering better risk reward at this point of time. This is simply because they have not performed, and their growth continues to be pretty decent in a lot of sectors including banks and capital goods; and valuations compared with mid- and small-caps are more reasonable. This is not to say that there are no opportunities in mid- and small-cap space. What you must understand and appreciate is that when the economy moves from just being consumption-oriented to consumption plus investment-oriented one, there are more opportunities which come up in the mid- and small-caps as well because most of the sectors which are doing well now have not done well over the last 10-12 years — infrastructure, capital goods, manufacturing and real estate, for example. And therefore, you will find more companies which are exposed to these sectors in the mid- and small-cap space rather than the large-cap space. We remain constructive on the small- and mid-cap space, and we think that in the next three-five years, mid- and small-cap can still outperform large-caps.
It’s just that we’ve just completed one phase where mid- and small-caps ran very hard and we have reached a point where in the near term the large-caps seem like they’re offering better value.
Is ‘growth at a reasonable price’ or GARP — the philosophy of your fund house — the best approach today? And where do you find opportunities now, applying this principle?
I think it’s a timeless approach. Sometimes, GARP gets overshadowed by growth or quality when the interest rates are low and liquidity is ample. We saw that in the period between 2015 and 2020. But those periods will smoothen out over a seven-/10-year period. And therefore, I don’t see a situation where growth and quality will continuously overshadow valuations or vice-versa. Similarly, we also don’t believe in ‘deep value’ as a philosophy because India is a growth market. We will never buy companies or sectors just for the value part of it or just because they are offering dividend yield unless and until we see growth coming back in the sector or the company. Therefore, GARP is a good mix of finding growth at a reasonable value.
We are seeing opportunities today in the power sector, where we think valuations are reasonable and there are enough changes happening in the sector or in the demand outlook for us to be positive on certain segments of the sector. We also see some signs of recovery and valuations being reasonable in the pharma sector. And, of course, in the two sectors, large-caps are offering relative value compared with small-caps. Besides, large private sector as well as public sector banks are today quite fairly priced or priced less than fair value compared with other sectors.
What is your reading of the Q2 results so far and your earnings expectation for the rest of the year?
Overall, Q2 results are broadly similar to Q1. We have seen recovery in pharma and rural consumption not being great, but companies are still delivering good profit growth because of margin expansion. The only change from Q1 to Q2, or rather a slowdown or a disappointment, has been urban consumption.
The good part is that despite all the minor disappointments or excitements in the earnings season, the overall profit forecast for FY24 and FY25 is not changing much. Typically, when we when we come to the middle of a fiscal year, we have had years when we have had massive downgrades to the profits. This is not happening this year. We are expecting about 14-15 per cent growth in FY24 and a similar number in FY25.
However, it’s obviously something to watch if crude and other commodity prices go up. One of the saviours for the earnings growth for Indian corporates this year has been that the margins supported by lower commodity prices — not just crude. This is not just dependent on the geopolitical situation, but also on China — if starts to grow again. While the risk doesn’t seem to be real at this point of time, that can result in meaningful earnings cuts if it happens.