ETMarkets Smart Talk: Commodity markets should be the next one to correct: Dhananjay Sinha, JM Financial

After a flat April, volatility is likely to continue in May. What is worrying the Street and what is the way ahead?
The markets have been fairly volatile since the beginning of 2022, characterised by two upswings in January and March interspersed with a sharp correction in Feb’22 triggered by the Ukraine-Russia war.

Amid all these, market views have swung between risk-on, and risk-off sentiments as reflected in the volatility indices.

We are of the view that there are two central themes that will concern the market. One, the trajectory of future corporate earnings and path of global liquidity dictated by monetary policy normalisation by major central banks, primarily the US Fed.

The market is adjusting to the possibility of a faster-than-expected rise in the US rates and rapid downsizing of the balance sheet than earlier thought.

These are pivoted on the fact that inflationary trends are getting entrenched across the world, which would also call for a wider level of monetary policy normalisation.

It is also getting evident that corporate earnings will see downgrades due to rising cost pressures. The expectation on future earnings for Nifty 50 at 16-18% over FY23 and FY24 after nearly 40% gains in FY22 looks very optimistic.

We see back to back double digit fall in Netflix shares. Is there a learning lesson for India Inc. here? What are your views?
Major themes based on the digital explosion following the Covid lockdown had resulted in an exponential rise in such names. Low risk-free rate and collapse of market risk premium due to the liquidity overdose resulted in a significant rise in valuations.

Thus, recent disappointments on subscription additions amid rising risk-free rates and rise in the market risk premium are correcting the euphoria.

It, therefore, appears that valuation expansion embedded in the post-pandemic digitisation theme is in for some sharp correction; this will also be relevant for the Indian market as well.

Inflation seems to be the biggest risk that the equity market faces not just in India but across the globe. How can investors make an inflation-proof portfolio?
Elevated inflation is expected to be responded to by speedier-than-expected monetary policy normalisation across most economies.

The channels through which monetary policy actions would tame inflation would involve correction in asset prices. Thus, what we are experiencing since 4Q 2021 is price erosion in both bond and equity markets.

Contrastingly, commodity markets have remained extremely buoyant, sustaining the synchronous upsurge seen in 2021.

We believe this is increasing the probability of aggressive monetary policy response and a hard landing. Hence, commodity markets should be the next one to correct.

Therefore, it is unlikely to be an easy market for investors. A portfolio should be a balanced one, a mix of reasonable components of fixed income, credit, and non-cyclical equities. Eventually, as the volatility settles, consumption themes with a strong market presence should do well.

FII exodus is a bit worrying, especially for the 7th month in a row (cash segment of India equity markets). Are global portfolio managers adjusting their portfolio? What seems to be causing the panic.
The retrenchment of FIIs from the Indian market has been substantial, $17 billion in FY22, and it continues to drain even in the current fiscal. The intensity of FII retrenchment has been particularly severe over the past 5 months.

The surprising part is that it has occurred in anticipation of monetary policy normalisation by the US Fed while a substantial portion of normalisation has yet to take place.

The other contributing factor has been the overvalued situation of Indian markets on a global comparison basis.

Now that we are talking about FIIs – we also have a famous adage “sell in May and go away”. By the looks of it, we might see another month of selling at least in the cash market of India equity markets. What are your views?
I expect FII flows into the Indian market to remain modest. Domestic flows, particularly in mutual funds oriented towards sectoral, thematic, and flexicap themes have counterbalanced the FII outflows.

We need to watch what happens when domestic liquidity also narrows due to the gaining pace of policy normalisation by the RBI.

Where are you finding value in this market?
Rural themes particularly select autos, and we also like consumption themes that can benefit from the near-term pick-up in urban employment.

If not HDFC Bank – where is the smart money moving?
We have been underweight the BFSI sector where we see valuation risks from volatile global variables and margin compression from rising interest rate scenarios and intense competition.

We also believe that the best of NPA cycle enabled by the post-Covid regulatory forbearance may be behind us. The future trajectory will be guided by gains in market share and leverage capital profitably. Thus, we expect greater investor interest in names like ICICI Bank.

What is your view on the IT sector?
The IT sector continues to see good business traction given a strong order book and hiring plans. But, the concerns on margins are visible now. The sector has been an outperformer since the Covid lows and there are valuation concerns.

Investors are also considering a scenario of a US recession due to elevated inflation and aggressive tightening by the Fed. So, what we are seeing is a correction in valuations for the sector.

Amid the increasing interest rate environment and rise in commodity prices — do you think small & midcaps could be under stress in FY23? What should be the strategy of investors?
Earnings and valuation risks are particularly high for the small & mid-caps segments as the illiquidity premium has been significantly underpriced.

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