Morgan Stanley’s head of India research Ridham Desi. Edited excerpts:
Talking of the multi-year growth in the profit cycle, a lot of commodity prices have gone up massively, a lot of supply chain shocks have come in, semiconductor issues have come in, how does that change that cycle or delay that particular profit cycle ?
It does not change by that much but of course. At the end of last year, I was expecting 20 per cent growth for this fiscal year. Now that expectation has been lowered to around 12 per cent. There will be some deferral of that growth. It spills over into F24, my exit F24 EPS is almost unchanged but there is a shift in terms of where that growth will come – instead of F23 it probably now comes in F24.
Of course, this assumes that the effects of the war will wane in time and that is something that we need to watch. The supply chain outages are not going to be permanent, they will come back and in fact when they come back. I think we will see a significant bounce back in production. The demand for example, and take the auto sector as an example which has been bearing the brunt of the supply chain outages the underlying demand is very strong, it is the companies are not able to supply enough because of the supply chain disruptions so when that goes away there will be a pretty large pent up demand that will need to be serviced.
Coming out of Covid, a lot of sectors that benefitted were the ones that saw pent up demand of the last two years come through whether it is travel, leisure, entertainment, a lot of these sectors have seen a significant return of demand. So I would expect the same for say autos where there has been a supply chain problem. The effects of the war of course it is hard to predict what happens to that. But I hope that they wane going into 2023, if they do not then I think we should be prepared for a pretty environment for stock markets.
It is going to be very difficult to absorb those supply related to an increase in prices of oil, fertilisers, sunflower seed, these are very critical commodities for India. We will be absorbing them for the next six, eight months, it will be harder to absorb them for a longer timeframe, it will call for more interest rate hikes and probably more slowdown in growth which will be kind of a mini external shock, that is the variety of impact that it may have on India.
FIIs really sold a lot when it came to financials, they also merit in the argument that it is financials and banks that could end up being the best performing sector this year, corporate banks balance sheet cleanup that we have seen, credit growth which is picking up. I see you are also overweight on that space. Please explain.
Yes, it is a sweet environment for banks. They have rising rates to help their margins, credit costs have suddenly peaked, they are falling, in fact there could be writing back of provisions as well and they are taking that and investing to growth their businesses and of course credit growth is also recovering.
It is a lag economic performer indicator so we should expect it to do even better in the months ahead. So it is a sweet environment, banks should do well in terms of earnings, valuations look attractive so we are very bullish on this sector, it is our top pick and I think for the rest of this year as well as going into the next year banks should do quite well.
We can talk about various sectors and how things are moving in but let us talk about the bigger theme, whether to play domestics or you play export theme? Yes, we have been focused on that for the past few months. I think domestic cyclicals look better placed. Again, I will put a caveat on this by saying that the effects of the war need to come off by the end of this year, otherwise growth will slow down meaningfully and then things would be a little different in 2023.
But I think for the ensuing months we should see a pretty strong performance from domestic cyclicals which include the banks, it includes consumer discretionary companies and it includes the industrials. So these are the places where we are most bullish on.
On the export front, generally speaking, we do not like the external facing sectors with the exception of technology where we think that there are very strong underlying structural demand trends which are not being affected actually even by what is happening right now.
Of course, if there is a US recession which is not our base case, but if there is one then tech stocks may take a severe beating as we have seen in the past but the underlying trends in software services is very strong. They are going through some margin pressures because of increasing wage costs but I think it is more or less priced in and the stocks have been underperforming quite a lot this year so a lot of that has been priced in.
I was going through a note you had written in April and I quote from it where you write “we are size agnostic, the relative correction in the broader market versus the large caps is likely over.” That was in April have had the brutal month of May, we have seen the underperformance of the broader markets as well, what are your views now?
We have shifted our preference towards the broad market. So we want to own small caps over large caps. We were underweight small caps relative to large caps since October last year, we kind of went neutral in April and then the underperformance in May I think sets up for being bullish on small caps. It is a price related thing and I think small caps look a lot more attractive now than they were looking for the past several months.