Stocks: 'Third wave will bring near-term challenges'

'Companies with a strong business case and healthy balance-sheet should sail through and emerge more robust in the future.'

It has been a choppy ride for the markets in the past fortnight as they took cues from the global developments.

Sachin Trivedi, senior vice-president, head of research and equity fund manager at UTI AMC, tells Puneet Wadhwa that in the absence of a positive earnings surprise, the market may witness time-wise correction.

Are the markets now ripe for a time-wise and/or price-wise correction?

In terms of valuation matrix like price-to-earning (P/E) or Price-to-Book value (P/BV), many stocks forming part of the broad index would be in the expensive zone compared to long-term averages.

However, expected profit growth has supported this performance/valuation, and it is also the key.

Positive surprises on the earnings growth, which has been the case for the last two-three quarters, will keep the momentum and can push markets higher.

In the absence of a positive earnings surprise, the market may witness time correction.

Any unexpected and sharp movement in bond yield, be it global or domestic markets and strengthening US dollar, may impact the sentiment and trigger some correction in the near-term.

Are the Indian markets factoring in the possibility of a third wave of the Covid pandemic?

Hard to say that markets have factored in the impact of the third wave.

But going by the experience of the second wave, markets have been resilient, and all along, investor focus has been on earnings growth potential.

Yes, the third wave as large as the second wave will bring near-term challenges, but companies with a strong business case and healthy balance-sheet should sail through and emerge more robust in the future.

What is the road ahead for flows into equity as an asset class?

India may get a higher share of allocation to emerging markets given the regulatory uncertainty in some markets like China.

Further, stable governance in India and a double-digit earnings growth outlook (based on Bloomberg consensus) make India attractive.

Even mutual fund flows have turned positive from March 2021, after remaining in negative territory in fiscal 2020-2021.

If past trends are to repeat, we may witness positive flows in the coming months.

How are markets reading into the inflation data?

Section of the market believes that this inflation print is transitory and led by a sudden increase in demand, but the supply side is taking time to respond.

Consumer facing companies like auto and fast moving consumer goods are already finding it difficult to pass on this sharp increase in raw materials to end consumers, hurting their gross profit margin.

Companies have adopted a gradual approach in terms of the price increase, which will correct the situation over time.

Your overweight and underweight sectors?

Our portfolio construction is driven by bottom-up stock selection depending on scheme mandate and fund manager style.

However, some of our larger schemes would be overweight in automobile, consumer services, industrial manufacturing and pharma.

The underlying expectation is strong earnings recovery in a normalised environment.

Funds would have underweighted in metals, oil & gas, and financial services.

However, within financial services, we like private sector banks and services like insurance.

In the case of metals, valuations have factored in near term potential, and many companies are trading above their fair value.

In oil and gas, we like gas distribution companies.

However, underweight names in oil and gas will have uncertainty around earnings with limited growth potential.

How are investors evaluating the prospects of new-age food/tech companies?

Long-term investors always try to estimate potential cash flows.

The challenge with some new-age business/young companies is that it is hard to forecast potential cash flow, and some of them have no earnings or have a weak business model.

Therefore, the most common matrix used for valuations is difficult to apply.

Or even if you apply them, the business may look expensive.

The key is to rightfully judge whether the product/ services offered by the company have a long growth path and whether the company has already developed a moat around its product/service offering.

Companies meeting these criteria and run by capable management should be a good investment for the long-term.

And such businesses may appear expensive when evaluated on near-term earnings.

Is the banking sector truly reflecting the NPA pain in the system as a result of the two waves of the pandemic?

Numbers reported by a couple of banks and NBFCs suggest that there is pressure in the system, resulting in higher slippages.

Unlike the first wave, there was no moratorium this time, so we expect most of this pressure should reflect in the near term.

But as economic activities started to normalise, they are also witnessing improvement in collection efficiency.

Most large private banks have created excess provision for such contingencies, and provision coverage ratios are also reasonable after accounting for slippage in the last quarter.

As life returns to normalcy, we expect credit growth to pick up, slippage to taper down and improve return ratios.

This improvement will act as a driver for banking stocks.

Feature Presentation: Aslam Hunani/Rediff.com