Valuations ease, but there is risk of earnings downgrade in FY24: Taher Badshah of Invesco MF

Regarding the rate cycle, while its approach to peaking may have been accelerated by recent developments around global banking sector stability and tightening credit conditions, for us its unfolding on expected lines given that inflation at the margin had been slowing in much of the world since the start of 2023 and real rates are reaching neutral from deeply negative. The US Fed’s admission that tightening credit markets in themselves imply a 25bps hike, slowing growth indicators and moderation in the US labour market and now the recent pause adopted by the RBI and other central banks around the world , all suggest that rate hikes are now behind us.

The behaviour of the Indian markets and its underperformance of the last 6 months does not entirely surprise us given that India had meaningfully outperformed in much of 2022 due to stronger economic growth helped by a pent-up recovery and healthy base effect. Besides, slowing growth trends especially in the consumption part of the economy were becoming more prominent. The flattening of the earnings upgrade cycle and high relative valuations thus indicated that we could lose some of our outperformance of 2022. Since then, risk to valuations may have somewhat eased from peaking interest rates and our recent relative underperformance, earnings growth will now become the key determinant of market direction hereon. We reckon markets may still have a modest downward bias for rest of 2023 till lagged impact of high interest rates seep through earnings and/or valuations turn more attractive.

With interest rates nearly at highs and fixed income yields still relatively more attractive to equity yield, there clearly is a case for tilt towards fixed income for the near-term. In the event of any steep slowdown in the global economy, fixed income may hold up better too given that increasingly the rhetoric may shift to a possibility of a rate cut sometime in 2024.

Gold may gain favour under current conditions of a slowing global economy and high inflation. It is also finding support from factors such as global central bank buying and acceptance of alternative currencies to the Petro-dollar.

The 4QFY23 result season will offer a lot of cues in this regard. As of now risk to earnings seems to be to the downside and barring the manufacturing and investment-led part of the economy it is difficult to envisage material earnings upgrades from key sectors such as technology, banking, or consumption. Valuations have eased off late but could still be at risk for possible earnings downgrades during FY24.

For risk-conscious investors, flexi-cap funds offer the best option at this stage of the market cycle since they can take a more balanced and flexible approach in this uncertain economic scenario. For investors with higher risk appetite and a medium-term investment horizon, we see opportunity in small cap funds due to its relative underperformance over the past one year.

The cash levels in our fund are more reflective of our fund house philosophy of always being fully invested than of prevailing market conditions. We prefer to manage market risk more through levers such as sector and stock selection compared to asset allocation.

I see good parts of India’s consumption economy facing weakness for some time till either interest rates turn lower, or incomes play catch up. Current set-up of high inflation/rates, corporate/government balance sheets and government policy is supportive for sectors related to the investment cycle of the economy.