investment strategy | volatility | inflation: watch out for volatility; invest in installments for the next 3-4 months: Trideep Bhattacharya

“We are positive on domestic cyclicals in the form of industrials, financial lending, direct and indirect real estate plays from a portfolio construction perspective. In contrast, we remain neutral to negative in pharma, IT services, consumer staples and utilities,” says Trideep BhattacharyaCIO, Edelweiss AMC.

How do you think the rest of the calendar year will go?
Overall, we expect this year to be a story of two halves, where the first nine months would be quite volatile and it turns out to be the case. There are two reasons why we thought it would be volatile. First of all, we expected that this change in interest rate regime, going from a falling interest rate to a rising interest rate, would cause a bit of floating.

The second problem is inflation, which has raised its ugly hood over the last two or three months of this earnings season and going forward over the next month and a half we’ll probably see an increasing involvement of the same . We will see an earnings season where on the one hand commodity users will see the impact on their revenue and on the other hand commodity acquirers will see a positive effect on their revenue. This is reflected in the form of volatility in the overall market.

But if one crosses that over to the other side, into the second half of this year and moves into the next two or three years from what we’ve seen in the last 10 years and also India in Against the global backdrop, the investment thesis looks pretty robust. In the medium term, we remain rather positive whereas over the first six to nine months of the year, we are asking investors to take a more graduated view and to invest more in tranches rather than trying to be in urgency.

Lately we have also noticed some contraction in the valuation multiple, but it is now trying to stabilize near the long-term average of around 18-20x. Nevertheless, it is still quoted at higher levels, but at this stage and given the current market structure, would you advocate a further injection of funds and, if so, what strategy would you advise?
The fall in market multiples is more a function of the fact that, overall, thanks to the change in the interest rate regime from falling to rising rates, the cost of capital increases and therefore, from this point of view , the same cash flows are priced down and that’s what we’ve seen over the last three or four months in terms of the impact on valuation multiples and that’s why in some parts more than others, it is more in line with long-term averages.

The impact of inflation on India Inc.’s financials is not yet fully factored in and I believe it will likely start to be factored in by the end of the June quarter. It will be partly taken into account in the current quarter and partly in the next quarter. I would recommend investors from now on, for the next three or four months, to invest in a more gradual way, in installments rather than lump sum, because in the medium term some things in India are looking good.

How would you classify the different sectors into three categories if you had to adopt a positive, negative and neutral position?
In my view, over the next two to three years, three things will happen in the Indian economy that will stand out against the backdrop of the past 10 years. First, over the next two to three years, there is a strong chance of seeing a private sector investment cycle, something we haven’t seen in the last 10 years.

Second, the real estate sector – both direct and indirect – is likely to hit bottom. Real estate generally follows a seven-year cycle and therefore returns would be positive not only for stock markets but also for the economy in general.

Third, for the first time in the past 10 to 15 years, we have seen double-digit salary increases. This may spell trouble for companies trying to maintain their margins, but from a permanent economic power standpoint for the next two to three years, it’s generally a positive. So, based on these three elements, domestic cyclicals are overall the place to be from a medium-term perspective.

In terms of sectors, domestic cyclicals in the form of industrials, financial lending, direct and indirect real estate plays are where we are positive from a portfolio construction perspective. However, we remain neutral to negative on pharma, IT services, consumer staples and utilities. Generally speaking, this would be the sector tilt we have at Edelweiss MF in most long only portfolios. We’re pretty optimistic about them looking two to three years ahead.

What is the current view of the broader markets – the small and mid cap space?
Over the past year, mid and small caps have grown in an annual range of 45-55%, which is quite substantial compared to what we are used to on an annual basis. Against this backdrop, the valuation differential that existed between large, mid and small caps over the past 12-18 months has narrowed overall and as a result, going forward, market movement would be more equity specific. , more specific to the company and more specific to the earnings figure, rather than depending on the market capitalization category to which they belong.

Therefore, if I were to take a one-year view, I would be independent of market capitalization, but from a medium-term perspective – a three- to five-year outlook – given that my view of the Indian economy is constructively, we would think that midcaps and small caps certainly deserve a place in investors’ asset allocation. It’s just that in the short term, they might experience a little more volatility than what we’re used to or seen in the last 12-18 months.

What is the biggest risk this market has right now?
Come Diwali, if we still see oil lingering around $120 and above, then all bets are off. There is academic evidence to prove that if oil stays around $120+ for more than nine months, there is a reasonable chance of demand destruction not only in India but globally and India would not be no slouch in such circumstances. Under these circumstances, there would be demand destruction, a more stagflationary situation, more recessionary conditions overall and we should be concerned about that. This is in my opinion the biggest risk.

Our current view, as opposed to this, is that we believe inflation is more supply driven, more transitory in nature and by the festival season this year should be largely resolved. That’s the balanced view of risk and where we are.

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