ETMarkets Smart Talk: Alok Agarwal of Alchemy Capital gives insight on rupee, FIIs selling and Nifty valuations

Markets remained volatile in July but Sensex and Nifty managed to reclaim crucial resistance levels. What is your take on markets?
Ever since hitting the peak in Oct’21, Indian markets have been on a correction mode with a few months of losses being followed by recovery.

5 out of the first 6 months of CY2022 saw a decline in the Nifty, leading to a correction of 9.1 per cent till June 2022 end.

July has brought some respite with the markets staging a recovery.

Commodity prices had been rising for a number of reasons – economic recovery, geopolitical tensions leading to change in effective demand-supply at a country/region level, and under-investment over the years.
While rising demand due to economic recovery is welcome, but a significant rise in commodity prices had a significant impact on inflation globally.

For most countries, inflation is now at multi-decade highs, forcing their respective central banks to hike rates and reduce liquidity.

Over a sixth of the world’s population resides in India, which in turn imports over 80% of its crude requirements. Amongst commodities, crude impacts India at multiple levels – inflation, current account deficit, forex reserves, and import cover.

Crude has corrected ~20% since Jun ‘22 highs. Most other commodities – steel, copper, and aluminium have corrected to 1-year lows, which is expected to soothe the runaway inflation in the coming months.

Markets are a function of earnings and valuations. The bulk of the move in the last couple of years were led by valuation expansion.

Liquidity is one of the key drivers of valuations. Multi-decade high inflation has ensured that major central banks are hiking rates and withdrawing liquidity – a complete opposite of what we saw in the bulk of 2020 and 2021.

As a result, we are seeing valuations reverting towards mean. Nifty one-year forward PE has reduced from all-time highs of 22.8x in Oct’21 to 17.5x now (close to the 10-year average valuation).

The bulk of the excesses in the market has been taken out, significantly improving the risk: reward potential from here on.

In terms of valuations, how do we stand when it comes to historical long-term averages for Nifty as well as for Midcap and Smallcaps?
The Nifty50 is trading at a one-year forward P/E of 17.5x (~3.5% premium to the 10-year average). Similarly, Nifty Midcap 100 Index is trading at 21.4x (~16% premium to the 10-year average) and the Nifty SmallCap 100 Index is trading at 14.4x (~1% discount to the 10-year average).

Also, the Nifty MidCap is trading at 22% premium to Nifty vs 10-year average of 7% premium and the Nifty SmallCap is trading at 17% discount to Nifty vs 10-year average of 15% discount.

While absolute valuations have moved closer to the long-term average, in our view relative valuations currently favour larger companies.

FIIs seem to be on a selling spree, but how long do you think retail investors or DIIs can hold the fort? We have seen at least the trading activity has come down in the last 3-4 months.
FIIs have sold over $33 bn in the last 1 year, with a net sell figure for 10 straight months – we have never witnessed this before. Even during the correction in 2008-09, the highest 1-year net sell figure had reached only $13.5 billion.

However, the last 12-month net sell amounts to ~1.1% of India’s total market cap vs the worst of ~2.3% reached during 2008-09 correction.

With FIIs holding over 35% of India’s free float market cap, their consistent selling is having an impact on the markets. As typically seen in the past, average daily volumes are ~50% lower than the highs seen in October last year.

From 0 in the early 1990s, FIIs have consistently built positions in India, currently owning ~18% of India’s market cap. At the time of the market bottoms in August 2013, FIIs holdings in India were at all-time highs and retail holding was at an all-time low.

However, it is encouraging to note that retail behaviour has started changing – despite record selling by FIIs in the last one year, this time round, India’s retail has ensured that they are building positions.

The number of Demat accounts in India has more than doubled since March 2020 and equity mutual funds continue to see robust inflows. These are indications of improving the maturity of Indian investors.

We believe that a young population (median age ~29 years), per capita income at the inflection point ($2100+), high gross domestic savings rate (~28%), rising financial savings, and tech-enabled penetration, should lead to a long runway of increasing retail participation in the markets.

Some good news from the MF front. A total of 17.92 lakh new SIPs were registered during June. The SIP AUM at the end of June 2022 stood at Rs 5.51 lakh crore. The SIP amount has increased from Rs 10,000 crore to Rs 12000 cr oreevery month. Do you think we could scale past Rs 15000 crore by the end of 2022?
With the rising maturity of Indian retail investors, as evidenced by the consistent inflows despite record FII selling, we expect robust equity flows to continue, albeit interspersed with few dull months.

The Indian mutual fund industry remains highly underpenetrated. India’s AUM-to-GDP ratio is around ~15.5% as against a global average of over ~75%.

The equity AUM-to-GDP ratio is a meagre ~6% vs the global average of ~33%. However, the situation is seemingly changing, with a lot of catch-ups to do.

We are not surprised by the rising SIP numbers. We expect these numbers to continue to remain robust as more domestic household savings get channelled into mutual funds.

What is your take on the rupee? Do you see it crossing 80-81 in the current financial year?
Rupee has depreciated by ~7.1% this year against the dollar – 5th straight year of depreciation and the second highest in the last 9 years. Historically, Rupee has depreciated at an average of ~4% p.a. against the dollar.

In recent times, the Rupee is seeing pressure from record FII selling and rising imports especially due to the rise in crude prices.

As a result, India’s forex reserves have declined ~9% since September last year. India’s import cover (Forex reserves / Last month’s imports) has declined to 9.3 months vs the long-term average of 10.7 months.

The RBI is putting in place a mechanism to settle international trade in rupees, which could be helpful.

With the US economy adding jobs at an impressive pace in June, the odds of a series of aggressive rate hikes have increased further, which is pushing the dollar index on an upwards trajectory – now at a fresh 19th-year high.

It is worth noting that the Rupee has done reasonably well compared to Euro (5% appreciation YTD), and Pound (5.7% appreciation YTD).

The rupee has outperformed 20 out of 32 major economies’ currencies so far this year. The rupee can remain under pressure as long as we see persistent FII outflows, elevated crude prices, and risk aversion in markets.

What is your take on June quarter earnings? Which sectors will be in focus, and which one could be laggards?
June quarter is expected to see another strong growth in corporate profits. Nifty companies are expected to report ~22% YoY growth in net income this quarter. However, on a sequential basis, a decline is expected.

Almost all the incremental aggregate net income is expected to come from Autos, Energy, and Financials.

Materials and Utilities are expected to be laggards.

Autos – After the last three-quarters of a YoY decline in EBITDA margin, we expect improvement in margins and expansion in profit on a low base.

Private Banks are expected to report strong growth, aided by 2-year high system credit growth of over 13% YoY.

How should one approach the markets – bet on defensives or the high beta names?
While a lot of excesses have been taken away from the markets improving the risk and reward considerably, we believe these are not times to be too adventurous. These are great times to buy reasonably good quality franchises, offering growth potential and more importantly now available at reasonable valuations/premiums.

Hence, I am not looking for a defensive or high beta name. I am looking for growth certainty with good capital efficiency, a strong balance sheet, available at reasonable premiums (such combinations are seldom at a deep discount).

Growth as a theme has outperformed in the last one / three months from the oversold zone. However, for a longer duration (1Yr and 2 Yr), the Value theme has been the most dominating theme in the market. Where to put your money?
While the shorter term is difficult (or almost impossible) to predict, we use a combination of growth and value. Our mantra is GARP – Growth at a reasonable price or Growth at a reasonable premium.

However, apart from growth and value, we are interested in superior capital efficiency and a strong balance sheet.

The importance of capital efficiency is often understated. Let’s look at the last 10 years’ data of NSE500 companies. The top decile performers had median ROE of 20.6%, whereas the bottom decile performers had median ROE of 9.3%.

Similarly, higher debt can come to bite during unfavourable times. Again, a look at NSE500 companies (excluding Financials) over the last 10 years reveals that companies with Total Debt to Equity of over 2.5x had an average return of 13.1% vs those below 2.5x returning 23.5%.

There is no doubt that the key attraction of India as an investment destination is the growth opportunity and its diversity. Focus on growth is important, but “growth at any price” can be injurious to “portfolio health”.

It’s critical to weigh the growth opportunity along with valuation, plus the capital efficiency (i.e. ability to earn a higher return on the same capital) and balance sheet strength (debt/equity within reasonable limits).


(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of Economic Times)