ETMarkets Smart Talk: Pradeep Gupta highlights 3 ways how US Fed hike and inflation could impact Indian markets

Rising inflation and consequent monetary tightening impact the equity market through three main channels.

• First, it increases the cost of funds for corporates and therefore negatively impact corporate margins.

• Second, for policy rate tightening to be successful in bringing down inflation, it is essential that such measures reduce demand. This, in turn, implies lower corporate earnings.

• Third, an increase in interest and therefore the risk-free rate implies higher discounting factor for future corporate earnings. This results in lower corporate valuation.

Seen from all these perspectives, rising inflation and aggressive monetary tightening by the Federal Reserve have negative implications for the global equity markets.

As indicated earlier, the Indian equity market cannot remain unscathed as the global equity markets correct.

Therefore, rising inflation and aggressive Fed tightening have negative implications for the Indian equity market as well.

However, according to my assessments, a major part of the impact of the high inflation and rising policy rates has already been factored in by the financial markets.

How do you see small & midcaps after the recent fall?

While mid and small-caps have underperformed the large-caps for a couple of years prior to the pandemic, these companies have outperformed since then.

From a medium-term perspective, we are positive about their prospects. Yet, in the near term, the outlook does not look particularly encouraging as investors’ risk aversion to equities continues with a high degree of volatility.

Moody’s Investors Service and now Fitch revised their GDP forecast. Do you think this is a precursor to the recession which is being feared by most?

Currently, there are significant uncertainties, especially on the global front and these factors have negative implications for equity markets.

The Indian market cannot remain unscathed if the global markets correct. Consequently, in the near term, we may look at a certain degree of volatility in the Indian equities too.

At the same time, I feel that the three key drivers of equity markets – fundamentals, liquidity and valuation – are either attractive or neutral for Indian equities.

Therefore, even if the Indian equity market corrects in line with the global market in the near term, I expect the Indian market to bounce back faster and more significantly than most others. The medium to long-term outlook of the Indian market remains positive.

What is your take on consumption as a theme – do you think it could take a hit amid price rise and possible fall in demand?
Indian equities are attractive because of their growth prospects. I prefer growth stocks over others. Some growth stocks such as those in the capital goods sector can also be leveraged.

Which sectors can be safe bets in a rising interest rate scenario as well as a rise in inflation?

Equities as an asset class are highly volatile in the short term. Yet, the risk-adjusted longer-term return on equities are generally much higher than any other asset class.

This simple fact is often ignored by investors resulting in significant losses through speculation and attempts to time the market.

So, I feel that the biggest hidden opportunity is in remaining invested in equities in the face of near-term negative market sentiments and corrections.

We are positive on sectors such as information technology, telecom, cement, capital goods, logistics, infrastructure, power, hospitality, and media.

Foreign Institutional Investors (FIIs) turned away from Indian markets but put money in IPOs. What are your views on when will the tide reverse? What is pushing FIIs away from India and is it the story for other Emerging Markets (EMs) as well?
FIIs have pulled out ~$2.2 billion from the Indian equity market in April, much lower than a net withdrawal of ~$5.4 billion in March. However, the selling was broadly absorbed by domestic institutions being net buyers of ~$3.9 billion in the month of April.

The US central bank has been raising interest rates to control inflation caused by the disruptions in supply chain due to the Russia-Ukraine war, after effects of Omicron, and other factors which resulted in an increase in inflation.

The rise in the US interest rate does result in foreign investors pulling out money from emerging and risky markets and investing in safe and secure markets in the US like debt funds.

What are you factoring in for other forthcoming quarters in terms of earnings? Looks like we could see more earnings downgrade compared to upgrades and the whole theory of earnings revival may take a hit. What are your views?
Indian corporates selectively, too are facing inflation / higher input cost pressures, and this will have near term earnings impact. Some companies/sectors will be selective.

Indian equities are attractive because of their growth prospects. Earnings growth during the last financial year has been close to 100 per cent for Nifty 50. The consensus seems to be expecting a flattish to up to 10 per cent earnings growth in the next 12 months.

We feel that there is a greater possibility of a positive rather than a negative earnings surprise in this time frame. On a trailing basis, Nifty50 is currently trading at 20 times price to earnings.

This is the average that prevailed between 2011 and 2015 and at a considerable discount to what prevailed between 2016 and 2021.

In view of that, I would argue that while the valuation of Indian equities is not cheap, it is not very expensive either.

How should one position their portfolio in terms of equity and debt? Is it time to go slightly underweight on equities or stay neutral?
I believe in strategic portfolio allocation where the key decision is asset allocation among competing asset classes like equities, debt, fixed deposits, real estate, gold, and various other assets.

Equities are one of the most attractive asset classes for long-term investors. However, in the short term, equities are highly volatile. Therefore, equity allocation should be for a longer period spanning over at least three years.

The phase of the interest rate cycle certainly has some impact on returns by various asset classes. In that sense, a rising interest rate cycle should require some tweaking of the portfolio.

However, in the strategic asset allocation approach, much bigger considerations are return expectations, risk tolerance, cash flow situation, and investment horizon of the individual investors.

Once the portfolio is constructed on the basis of these factors, the requirement for tweaking the portfolio based on the business cycle is not substantial. It is generally perceived that in a rising interest rate cycle, the interest-sensitive part of the equity market and bonds underperform.

However, other macros and corporate-specific situations decide the fate of individual securities. I think the ideal framework for asset allocation continues to be the strategic approach that incorporates the key considerations of the individual investors and keeps the portfolio largely unchanged despite short-term volatilities of the market including the phases of the interest rate cycle.

Staying the course of your asset allocation strategy and diversifying can help to preserve your overall investment portfolio against volatility and generate higher alpha in the long term.

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