Market may not find it easy to climb unless earnings growth surprises materially: Invesco MF's CIO Taher Badshah

It was an easy period, in a way, for the markets and valuations in the early part of ’23 and it was easy for investors to put their best foot forward and ride the wave of that opportunity. But over the last 15 odd months, two things have changed. One is that valuations are now not as easy as they were in 2023… not to say that they are blowout expensive, but they are not of the garden variety. Principally, I think the market was relatively less risky and more risk-free in 2023. Investors, therefore, even fund managers like us, were able to focus largely on the growth path ahead, not necessarily having to think a lot about downward volatility or the downside risk. As of 2024 now, the risk is open.

I think we have to approach this year a little more differently compared to the last and you have to take risks along with return, probably risk a little ahead of return, if need be, and then navigate some of these upcoming events; whether it be local elections, US elections, elections in a couple of other developed markets, the whole premise around interest rates and inflation and how it will unfold over the next three to six months, how the monsoon will pan out in India as that will have its own set of repercussions, and geopolitics.

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We are likely to probably see some turbulence, maybe sideways movement, maybe less action. Perhaps the Indian market is kind of dull completely in the second half as we get into policy formulation by the next government. Whether it's going to be significantly different or not, we don’t know. But irrespective of that, we will encounter some new policy objectives. And then, of course, everything that is global is also something which we will have to confront. So, in that situation, the market may not find it very easy to climb unless earnings growth and corporate profitability surprise materially compared to what current expectations are.

Energy prices remain the joker in the pack, but overall, how do you think Indian companies are placed in terms of earnings? What's your outlook?

The last 12 months at least have been a period of reasonably benign commodity prices. We’ve not had to worry too much about that. We may have to worry about that a little more in the near term. I'm talking about the next four quarters, let's say. So that's a negative and that's something that, at the margin, will affect earnings because we as analysts are not necessarily estimating margins for companies to come down on account of raw material prices. They are, as of now, running with stable numbers.

This year, the monsoon will be quite critical. We've not had very good monsoons. Therefore, agriculture and rural segments of the market have been reasonably tough in the last 2-3 years. So we need some spark out there. That's something that will add to the sentiment, add to the numbers. It's not presently woven into the estimates of analysts.

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Thirdly, I think what may matter is basically how strong the investment cycle continues from here on. And that's something which is quite well discovered and well appreciated and well built into market expectations and prices and valuation. So any kind of negative development there, either coming through policy initiatives, being somewhat different post-elections compared to what it has been up until now—though it's a low probability event, but still—or maybe if it is about a lesser capital expenditure support in the budget.

If you look at street or analyst estimates, we are essentially talking about somewhere between 12 to 15 percent CAGR on earnings for, let's say, the narrower universe of the top 100 companies over the next two years. If you take the somewhat broader universe of more than 300, 350 odd companies, if not more, you're talking about CAGR growth of somewhere between 15 to 17 percent for midsize companies and 17-20 percent on the small-cap side for the next two years. We are in that band of, let's say, 12-13 percent at the lowest end for large-size enterprises to somewhere around a 20 percent mark for the mid to small-sized enterprises.

Q. What are some pockets in the market that look attractive at current valuations?

Time and again, people get a little disappointed with a certain sector. You may not see a lot of visibility in terms of growth coming back, but value starts to develop. I think today's banks, private banks, are a space where we feel quite comfortable from a valuation standpoint. We may not necessarily know what the triggers are but we don't have to debate a lot in our minds in terms of the valuations in this space, like the way we have to probably do in a few other parts of the market.

We feel quite okay about pharma and health care as an opportunity. We think they've done well in the recent past, but they're still not very unreasonable in terms of valuations, especially when we compare them by their longer history. There are places like technology also. We don't see immediate triggers or immediate reasons to believe that growth will accelerate, but value pockets are developing there in that sector too.

Fourthly, I think I would say parts of the consumer segment, especially the lower end of the ‘K’ which has not done well in the last two to three years of value retailing… Again, not every part of that value retailing basket, but few pockets where there are competitive advantages or where we feel that the market has been too punishing.

There’s always a bottom-up one-of-kind of companies/ individual cases which may turn out to be value opportunities and that could be across different sectors.

Q. Recently, we have seen RBI clamp down on banks and NBFCs largely to address fears of froth building up in the system. What are your views?

No, we are not in that camp though. We do respect the regulator's moves and try to see how much of our investee companies could be affected by those regulatory changes. But today we don't think that it’s come to a stage where we are to worry. There are some pockets, some small slivers of excesses, but at an aggregate level, it's not too large and it’s at a company-specific level when we see it as part of the book or as part of their exposure… Again, it’s not something that is showing up as very difficult or very alarming. So, we don't have a choice, but to kind of keep monitoring. We don't want to be too pre-emptive either. I mean, yes, it's the regulator's job to be a little more cautious than maybe investors or they have their own, you know, readings or their ways to gauge things… Our screens are not flashing red as yet but we'll have to continue monitoring this situation is all that I can say.

We are taking on more debt, we are participating in riskier asset classes than we were doing before, so that is a bit of a DNA change or maybe driven by the confidence of the younger generation, the changing demographics, the changing economic outlook… Maybe even driven by global experiences and exposures. So there are a couple of notches of higher risk-taking ability in general but also accompanied by decent confidence. It's the regulator's job to look at the smallest of things and make sure that doesn't balloon up in any way.

Q. What’s your view on the mid-and-small cap space? Is there a bubble?

I think this froth-related thing becomes very easy to mention without understanding the circumstances in which we are. I think it's not the first time that we have seen a 60 percent rally in mid-caps, and small-caps in a year. If I recall, the most recent one was in 2017-18. Perhaps it was more like a 40-50 percent rally, but it was still a very strong one. In comparison to that, this rally is a lot more grounded in reality, in terms of fundamentals, in terms of the earnings growth, so it's not entirely unwarranted. We're talking about 18-25 percent earnings growth in various mid-cap and small-cap indices in the last year or so… I don't think those were the kind of numbers and growth that we were seeing in '17-'18, yet we saw a very strong rally. I'm not in that camp where I'm hugely worried. Yeah, you do have to calibrate your return expectations from small caps from what you got in the last 12- 15 months.

Q. The PSU pack has been buzzing but, by and large, earnings in the previous quarter weren’t as robust. How are you looking at PSUs going forward?

We've been running a PSU fund ourselves for more than 15 years and we've generally had to sell that fund as a value proposition most times. We would urge investors to look at it from a value standpoint… They always used to be at a discount to the market but supported by very good, decent dividend yields and cash flows. In the last year, after what PSU stocks have done, they are not as cheap as they used to be.

Now we can't evaluate them as value opportunities, we have to think of them more as growth opportunities because, at this stage of the economic cycle in India, they are in a better place to benefit because many of the companies in the PSU space dominate these (capital goods and industrial manufacturing) businesses. The business tailwinds that they enjoy are stronger, maybe stronger than even some of the private players in that same segment. But we have to now treat them at parity with private enterprises or think of them in the same way as you would think of any other private sector business. After the strong rally, I would like to think that in the next few quarters, the rally may not be as broad-based. Maybe we'll have underperformers as well.