Cautious on equity markets in near-term due to stretched valuations: Expert

Equity markets have rallied sharply in recent months, on the back of a surge in inflows from foreign institutional investors and a better than expected rebound in corporate earnings and several economic parameters. But now, analysts are turning cautious in the near-term. Rising coronavirus cases in many developed countries is a cause of concern, said Shyamsunder Bhat, chief investment officer at Exide Life Insurance. In an interview with THE WEEK, Bhat shared his views on markets in 2021, sectors he is betting on, interest rate movements and what investors should do at the current juncture among other things. Excerpts:

Equity markets have hit new records even as the global economy may not be out of the woods yet and the virus uncertainty continues. Why?

Equity markets have continued to rally, with an acceleration in the past couple of months. Globally, we witnessed announcements pertaining to the launch of vaccines to address COVID-19 and the results of the US presidential elections. On the domestic front, we are witnessing a moderation of COVID infections, reasonably good trends in festive demand, and better than expected corporate numbers in the second quarter of FY21. However, the largest driving factor for the extent of the rally has been the incessantly large inflows from foreign institutional investors. For calendar 2020, the FII purchases till date are in excess of $19 billion, which is highest after calendar 2013, and this large net positive figure is in spite of the large $8 billion outflows that were witnessed in March. 

The global economy is not yet out of the woods, but the outlook on global recovery is better than what was anticipated earlier. However, the rising COVID cases in some of the western countries are a cause of concern as this can derail the economic recovery witnessed in the last few months, particularly if there is either a slower ramp-up (or the incidence of a higher percentage of side-effects) of the various COVID-19 vaccines, or another wave/newer variants of the virus infections. Other key monitorables would be the US policies on fiscal stimulus and the US-China trade relations.

What's your near-term view and outlook for 2021 on equity markets? 

In terms of outlook, we are cautious on markets from the near-term perspective due to stretched valuations, as recent positive developments appear to have been factored in. It has indeed been difficult to predict the extent of liquidity flowing into the markets over the past few months, which has resulted in the market rally exceeding our expectations. Markets have been having a strong bias towards growth over the past few years. Value-stocks are showing initial signs of recovery, which is encouraging; however, a continuation of the strong inflows may be required to sustain the same.

When markets are trading at these record levels, what is your advice to investors? 

We have witnessed other asset classes, which have done well over the past 5-10 years, particularly fixed income funds. Though the sharp rally in equities in the last few months has closed the gap in returns as compared to fixed income funds for the medium-term, the Crisil Bond Index was outperforming the Nifty-50 for a 10-year period even as of November 2020. With other asset classes like fixed deposits yielding low returns, gold having rallied in 2020 during the initial “flight to safety” and is now giving up some of the gains, and the outlook on real-estate unclear as of now, equities could continue to deserve a percentage in investors’ asset allocation (though the percentage should vary depending upon the age and risk-appetite of investors). Investors with a relatively lesser risk-appetite, or those who require liquidity, could look to book partial profits. However, most other investors can continue to take a longer term perspective, as it is difficult to predict the time and market levels, till which the FII inflows can continue; in recent months, valuations appear to have not been given a due consideration, with the markets already discounting the next two years of earnings.

Based on the quarterly commentary by companies, how do you see the third and fourth quarter panning out as far as corporate performance goes? 

The recently concluded earnings season for the July-September 2020 quarter was better than expected. While analysts were expecting an overall flattish earnings growth, corporate India managed to post an earnings growth in the mid-teens, with most sectors performing well. This better-than-expected performance was a combination of better volumes/sales growth and tighter cost control resulting in better EBITDA (earnings before interest, taxes, depreciation and amortisation) margins. The resultant effect was that we saw earnings upgrades and the ratio of upgrades-to-downgrades improved after many quarters. The COVID-19 infections in India have moderated in the past couple of months, with a decline in the number of confirmed cases and active cases, and economic activity in many sectors has re-attained pre-COVID levels. However, with stocks priced on FY22 (and now on FY23 earnings estimates), a better Q3+Q4 need not necessarily result in further earnings upgrades.

The pandemic has had a huge impact across the board. Are there any green spots visible from an investment perspective? What are your preferred bets?

The financial sector space, in terms of valuations, could see further upsides. This sector had underperformed for most of the post-COVID period (except for the last couple of months when we have seen stocks from this sector recovering). A better economic scenario than was feared earlier should help address some of the concerns for this sector, and despite the upmove witnessed recently, some of the stocks are reasonably valued particularly in the context of where the overall market and the Nifty-50 valuations are standing at presently. The IT sector is another large holding for us, and could continue to do well with the importance of technology spends being reinforced in the post-COVID world. We are also positive on select stocks from the pharma/healthcare sectors, and also on the speciality chemicals and agrochemical space. 

Global investing has picked up in a big way now, with brokerages as well as mutual funds now offering many opportunities. Is diversifying investments across geographies helpful?

Diversifying across geographies is an option that Indian investors have had for several years now. There could be some international companies, like in the technology or e-commerce space, which investors may want to invest in, either directly or indirectly. If the trend of the Indian rupee versus the US dollar continues over the longer-term, this too, is an aspect which investors may be taking into account, while investing overseas. While this diversification could be helpful, it may not be essential.

Interest rates have fallen to their lowest this year. With inflation still trending above RBI's comfort level, where do you see interest rates headed from here on and what kind of impact will it have on debt fund yields? Where would you park your money in this backdrop as far as debt opportunities go? 

Headline inflation has been on the higher side. With the recent sharp rise in commodity prices, domestic inflation could remain a concern for a few more months. The headline rate-easing cycle appears to have ended, for now, and the scope for capital appreciation in fixed income funds could be relatively lesser if one were to compare with the past few years. Higher fiscal supply may continue to be an overhang for the longer end of the yield curve, which could continue to remain on a relatively higher level compared to the shorter-term rates. A strong intent and communication by the RBI to keep rates “lower for longer” is keeping the interest rate curve stable (but steep) at current levels, for the near-term. We generally invest in longer-term government securities and to a smaller extent, in state government securities and AAA corporate bonds.