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Protect capital for next 2-3 months; expect deflation trade by 2022 end: Andrew Holland

“One could still play the market for inflation by looking for those companies with strong cash flows, high dividend yields and so forth and so on but our view is that by the end of this calendar year, we will see a narrative change from inflation to deflation. One can also play the reopen trade as we are six months behind the world,” says Andrew Holland, CEO, Avendus Capital Public Markets Alternate Strategies LLP.

What do you think about the overall market momentum? Are we in for some sort of a decisive pullback or is there still a bearish undertone before things actually recover?
A number of events are coming up. We already have the inflation figures from the US and they are not as bad as the market expected. So we could have a kind of relief rally and markets generally are looking a bit oversold. So, I would not be surprised if that happens but one cannot walk away from the fact that over the next three months, the Fed is going to continue to increase rates, they want to get aggregate demand down.

China is continuing to close its economy and Europe and the UK are going into a recession. So whichever way I look at it, we are not going to get good news over the next three months and the markets are going to worry more and more about inflation or stagflation or recession. That is going to keep the markets highly volatile.

For the time being, I am not sure one could trade in this market and it is probably best to sit on the sidelines and just let this play out because I do not think the downgrades to earnings have really started to show up apart from maybe the energy sector where oil remains obviously quite strong.

Even one of the favourite sectors of the previous year, the commodity sector, will see downgrades now because demand destruction will happen globally and that will bring commodity prices down. So that is good news but it is not going to happen very quickly. So there is nowhere really to hide.

One could say IT is a good place to hide because of the rupee weakening but of course, the sentiment towards technology overall is very hard to fight, particularly when the Nasdaq is down in bear market territory. It is not coming out of that very quickly and there is a lot of pain in the sector.

I am not saying that there is anything wrong with the IT sector in India, but just sentiment wise, it will find it difficult to fight its way forward in the short term. That is the same for the banking sector and whilst you see a bounce because there has been one of the underperformers, I do not think it is the right time to be buying banks yet.

What about the earnings because we are coming towards the fag end of the earnings season? How would you classify the kind of revenue growth that we have witnessed? Has the volume growth across the board been disappointing or pretty much on expected lines?
From a revenue perspective, it has been fine. Margins though have been under pressure throughout most of the industries and on that basis, a lot of companies over the last six months have been able to pass on some of these input prices. It is going to become more and more difficult to do that going forward.

For example, FMCG companies might not be able to kind of increase prices but then the margin hit that it will take will reduce ad spending and that is probably what will happen. At some point, these companies will have some kind of price war to get market share. All of that will lead to more margin pressure across industries and we know that when that happens, cash flow is important and that is why medium and small businesses come under more pressure. So the earnings downgrades unfortunately are just about to begin.

You mentioned that downgrades are possible when it comes to earnings and you pointed out how it is not the best time to buy into the equity markets. But then what does one do in an inflationary environment? It is not the best idea to sit on cash as well. What works out best for an investor in terms of portfolio allocation?
There are few things in that. I do not think inflation is going to be there for a long period. It is all about timing. If you sit on cash for two-three months, it is really protecting capital and we all think about making money but protecting capital is also equally important because then one has the ability to go back into the markets and make some money.

If you start losing or you get whipsawed by the volatility, it does not give you that ammunition to go back in. So protecting capital is important and that is the key for the next three months with the volatility that we have. One could still play the market for inflation by looking for those companies with strong cash flows, high dividend yields and so forth and so on but our view is that by the end of this calendar year, we will see a narrative change from inflation to deflation.

If all global economies are going to start hurting in terms of growth then demand for commodities will fall and commodity prices are going to go lower. The disposable income in the UK for example is being eaten away by higher fuel prices, higher mortgage payments and higher energy bills. So we have less to spend. At some point, that will come down and start to hurt so much.

The trade I would do at the moment is this; I would look at India because we are still reopening the economy, look at the reopening stocks. Those will continue to do well. I do not think we are travelling overseas so much. I think we are going to continue to travel within India. That is the kind of solid kind of growth there is. I can see energy prices remaining high because of the supply demand imbalance in oil but towards the end of the year, I will be looking at that deflation trade and the deflation trade would mean that interest rates would stop rising and might start falling. Therefore the banking sector would be something that we are looking up and it is not just yet.

What about the FMCG basket? Would you look at , , at this point of time or is it just opening up themes like PVR and the hotel names which you are talking about?
I think FMCG is okay to hide in because we are all going to still need to buy food and eat right so that is going to give them steady cash flows but unfortunately the ability to keep passing on price hikes going to be more difficult therefore they are going to take a margin hit or they are going to start spending less on advertising and reduce prices there.

In the past, the FMCG companies have always used price wars for market share. They always do and so that is going to help them. So I think the reopening trades is probably still where it would be more concentrated because we are all going to keep travelling. We are all going out, we are all spending more wanting to enjoy ourselves and that is the reopening trade that was happening across the world. We are just six months behind everyone else.

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