"The major challenge for equities in FY24 remains interest rate path volatility," Unmesh Sharma, Head of Institutional Equities, HDFC Securities says in an interview with Moneycontrol.
He feels that an emerging risk factor to the Indian equity market is the quality of the upcoming monsoon season. "Considering that it is an election year, a poor monsoon will lead to additional government support to rural India to keep rural incomes afloat. This will raise the risk of putting pressure on the fiscal and take focus away from the government's allocated budget to spend on capital expenditure and other progressive central schemes," he explains.
The government is focusing on “investment” over “consumption” in the GDP equation as its strategy to drive the country’s growth. Therefore, Unmesh with over 18 years of experience in the field of capital markets believes sectors and companies which are beneficiaries of capex should be preferred in the current market.
Do you see a strong possibility of the market breaking the June 2022 lows given the banking crisis in the US and Europe?
The market scenario is playing out in line with our expectations. We continue to remain cautious given many uncertain macroeconomic and geo-political variables. Any incremental negative news can wildly shake investor confidence globally.
While the market correction has brought valuations down closer to long-term averages, there is a possibility of overshooting. In such an environment, we will not be surprised if the market tests the June 2022 lows.
Do you think the terminal rate is expected to go beyond 6 percent in the US?
Our house view at this time is that we will not see a 6 percent+ terminal fed funds rate. The pace of the rate hikes was bound to put some pressure on the overall system, and it was the banking system where the stress emerged. While SVB was relatively idiosyncratic, the fed cannot risk the collapse of another bank and consequently increase the risk of contagion.
That being said, central banks across the globe have reiterated that the fight against inflation is paramount and they will be focused to reduce inflationary pressure on their respective economies. We believe that while the fed funds rate will not cross 6 percent, it will continue to remain at a high level for the majority of this year.
Do you expect the RBI to deliver its last rate hike in April and then will take a pause?
We expect another 25 bps hike from the RBI in the forthcoming meeting; while core inflation has been steadily inching downwards, it is still above the RBI's comfort zone.
Post the hike, we expect the RBI's decisions to be data-driven, making it difficult to take a call on any moves thereafter. Just like the US, we expect the repo rate to be at an elevated level for the majority of this year.
Several PSU stocks have seen a strong rally in the last more than a couple of months, taking CPSE index to record highs. Do you expect a further rally in the space or is it looking overvalued now?
We do not advocate a gung-ho stance on PSUs in the ongoing risk-off environment. The PSU basket is made up of a wide category of companies operating in various industries. Thus, it is important to engage in bottom-up stock picking if one is looking to invest in the space.
We are currently overweight certain PSUs such as SBI, IOCL, ONGC, and NTPC in our model portfolio as we like the fundamentals of the companies and the space they operate in. We advise a similar bottom-up approach as opposed to a broad thematic approach to PSUs, despite the recent price action.
Do you expect the banking crisis to widen in US and Europe in months to come?
The banking crisis in the US should largely be contained. The issues persisting seem to be with relatively smaller regional banks with concentration risk surrounding the deposit base. The bulge bracket banks are well capitalised. Many lessons from the 2008 crisis have been learnt and the regulators and large banks were ahead of the curve on rebalancing their bond portfolios and maintaining buffers. Furthermore, there seems to be ample support from the Fed as well as the US Treasury to ensure banking system stability in the US.
The limitations of government treasury support and the overhang of the Russia-Ukraine war make the European banking system more constrained than the American banking system. While not as strong as their American counterparts, we do believe European banks should also be able to withstand the current environment without any further mishaps.
Post the Global Financial Crisis in 2008, central banks have been very diligent in the monitoring of their respective banking institutions. Increased stress testing and higher capital reserve requirements should ensure timely interventions by the central banks.
Apart from the US banking crisis, do you see any other major challenge for equities in FY24?
The major challenge for equities in FY24 remains interest rate path volatility. Implied fed funds rate and hike probabilities have been swinging almost every day at an unprecedented quantum. Stocks tend to underperform during such an uncertain environment. The base case is currently for the Fed to cut rates to ease the pressure on financial institutions. It will be interesting to see what impact that will have on US inflation, which has proven to be sticky despite aggressive rate hikes. In such a dynamic macroeconomic environment, it is imperative to be quick-footed with your asset allocation.
An emerging risk factor to the Indian equity market is the quality of the upcoming monsoon season. Considering that it is an election year, a poor monsoon will lead to additional government support to rural India to keep rural incomes afloat. This will raise the risk of putting pressure on the fiscal and take focus away from the government's allocated budget to spend on capital expenditure and other progressive central schemes. The impact of such a move will be felt in industries dependent on central investment and can take the wind out of the sails of the government’s capex push.
Most sectors participated in the recent correction. Any three great ideas (sectors) to bet on for FY24?
The government is focusing on “investment” over “consumption” in the GDP equation as its strategy to drive the country’s growth. Therefore, we believe sectors and companies which are beneficiaries of capex should be preferred in the current market. This capex cycle should sustain due to healthy corporate balance sheets, a well-capitalised banking system and mid-cycle capacity utilisation.
Additionally, rising budgetary allocations towards capex and healthy execution by central government agencies bode well for ongoing capex cycle. Against this backdrop, we favour sectors such as capital goods, infrastructure, power, cement, chemicals and select financials- especially large banks. Nevertheless, investors should be mindful of stock valuations ('Value') while doing bottom-up analysis of companies from the abovementioned sectors.
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