"We think the trajectory of global monetary policy tightening has not changed. In fact, major central banks have reiterated their commitment towards price stability and hawkish stance," says Dhananjay Sinha, Co-Head of Equities & Head of Research - Strategy & Economics at Systematix Group in an interview with Moneycontrol.
Hence, he expects valuation multiples to remain under pressure.
According to him, a relief rally may be possible after the market prices in the US banking sector debacle.
With more than 22 years of experience related to the capital markets, equity research and economy, Dhananjay advised that it would be pertinent to focus on sectors and companies that have strong pricing power, are less susceptible to interest rates or tightening in financial conditions and have reasonably high liquidity. These are in the areas of domestic consumption, viz autos and consumer staples, he says.
Do you think the banking crisis that emerged in US and Europe can extend further?
The recent episodes of collapse of some banks in the US and Europe reflect the treasury yield curve bear-flattening impact in response to the ramp-up in monetary tightening initiated by the US Federal reserve since mid-2021 in an effort to tame the post-COVID surge in inflation to a 40-year high. Thus, the factors behind the collapse of some banks are not surprising.
Fed’s latest assessment is that dislocations in the banking system following the Silicon Valley Bank and other banks are idiosyncratic occurrences among a poorly managed and reckless small number of banks; it is not a systemic problem. As of now the surplus liquidity in the US banking system is sufficiently large, the banking system is well capitalized and there is a large asset-holding concentration among the large banks. All these factors would limit the scope of an immediate contagion.
With the objective of inflation control being paramount, the central bank appears unrelenting from the need to tighten financial conditions. The problem will arise if the implosion of a small number of banks triggers the acute tightening of credit conditions at the broader level.
Your thoughts on the recent increase in STT on futures & options trades?
The imposition of STT (securities transaction tax) and the removal of tax arbitrage between debt mutual funds and bank deposits are measures that will imply a higher incidence of tax for rich individuals. This is imminent given the slackening in corporate profits in the recent quarters and the impact it would have on the gross tax collections of the centre.
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It is unlikely that the trading volumes in the F&O segment will diminish due to the imposition of higher STT. Likewise, the removal of tax arbitrage for debt mutual funds will likely see some reallocation into other funds like a hybrid or balanced mutual funds.
Overall, while the budget did not contain any measure relating to capital gains, the latest measures relating to STT on F&O and debt mutual funds indicate that more such announcements may get announced in the future.
What is your take on the life insurance sector?
Life insurance sector has seen significant derating due to rising yields on G-Sec and the recently announced tax measures in the Union Budget 2023 that has levied a tax on proceeds received from non-ULIP schemes aggregating annual premiums of over Rs 5 lakh. Also, the removal of exemptions from claims under any other schemes has also impacted the sector. All these factors reflect in significant underperformance of insurance companies since mid-2021 and YTD. At the current levels, the valuations are undemanding.
Do you see any kind of major triggers that can bring relief rally in the market in near future?
Typically, there is a relief rally following a phase of heightened market anxiety, which may be possible after the markets price in the US banking sector debacle. However, we think the trajectory of global monetary policy tightening has not changed. In fact, major central banks have reiterated their commitment to price stability and hawkish stance.
Hence, one would expect valuation multiples to remain under pressure. If the credit conditions in the US and Europe tighten in a significant manner, then global financial conditions can tighten due to rising credit risk. If it doesn’t tighten enough to impact demand and inflation, the central banks will continue their tightening path.
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Either way, the valuations in the risk market will get impacted. What can surprise, however, is if the tight labour market conditions in the US and other advanced economies and the sticky core inflation were to ease suddenly, surprisingly.
Which are the sectors to pick if the correction extends from here on?
In our view, retention of margins and profitability will be the key driver of corporate profitability in the next one and a half years. Hence it will be pertinent to focus on sectors and companies that have strong pricing power, are less susceptible to interest rates, or tightening in financial conditions, and have reasonably high liquidity.
These are in the areas of domestic consumption, viz autos and consumer staples. Utilities are less prone to get impacted by tightening financial conditions or price volatility. Agri-input sectors (fertilizers and farm equipment) can also gain from a sustained rise in terms of trade for the agriculture sector. It will be good to preserve some near-money assets and wait for appropriate valuations to emerge.
Do you think the discretionary theme will underperform for next couple of quarters?
A lot of discretionary spending in the durables space is backed by leveraged consumption. Retail lending of banks is growing at 20 percent YoY capturing the rapid pace of household borrowings under autos, credit cards, loans against fixed deposits and other assets, financials and properties. This has been fuelling urban spending despite very modest gains in compensation in the organized sector beyond the BFSI and IT space.
We think there is a risk of some slowdown emanating from peaking out of the corporate performance. Likewise, the short-term tightening of government spending in rural areas, in line with the curtailments announced in the budget will also impact demand in the non-agri rural space.
At the same time, the electrical durable space is facing pricing erosion due to weak demand conditions, which is impacting profit performance. Discretionary segments, like paints, for instance, can benefit from a potential decline in global crude prices.
Is the rural economy still facing challenges?
Rural sector has been facing challenges in recent quarters due to weak demand conditions, and lack of adequate revival in urban jobs beyond construction. The government's free food distribution and other allocations under other heads had been supporting income and consumption situation in the rural area amid inadequate remittance from urban areas. These have forced higher reliance of the rural workforce on agri economy.
Hence, tapering of government spending and urban slowdown will impact the non-agri rural demand. Lately, there is also a risk of unseasonal rain occurring in significant agricultural areas, following a dry winter, especially in north India. This will provide upside impetus to farm produce prices and agri wages while also impacting farm productivity.
Based on the expected future situation, demand for public spending in the rural will rise and will require appropriate policy responses.
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