Ajay Bagga’s top picks for portfolio construction in this market

This week we saw big FIIs selling to the tune of around $1 billion per day come into the markets? Do you think the worst is over now?
We cannot say that at all. There are geopolitical issues and there are economic issues like elevated inflation numbers. Further, commodity demand-supply equations have changed nearly permanently at least for the next couple of years. So there is no supply that can come in and the Russian supply that is going off the market. Geopolitical tensions are much less than they were 15-20 days ago. There is very little chance of the US or NATO getting involved. So that way it is better, but we are not near to a solution right now.

FIIs selling is a bit surprising in a way that out of the 24,000 plus emerging market funds there is actually a net inflow. There is a net inflow for the last two weeks, but India has seen very strong outflows so that could be India focussed funds, India focussed ETFs or Asia focussed ETFs that are seeing outflows or it could be that there are some margin calls elsewhere that are being met by withdrawing money from the Indian market.

It is definitely not any more an issue of the valuation of the Indian market at 19 times one year forward. We are not that expensive anymore in historical context also.

So it is more of a little bit of an enigma of why the FII selling is still continuing at these levels. Maybe it is an issue of us being able to provide an opportunity.

Second, out of the $600-650 billion of FIIs holdings in India, a lot was concentrated in the top 20-30 stocks and especially financials where there is very little impact cost and being able to take out a billion dollars per day.

And thirdly, the DIIs coming in and buying, so offering an exit to the FIIs, I think all that has contributed. I do not see that going down right now. We do not have data to the contrary so I would say we should assume that it continues. It is looking more of a sideways market, more of a caution first, more of a risk off.

What about the defensive sector? They sort of made a comeback this week. We saw pharma which was one of the top index movers this week and apart from that IT also started doing well. Do you think a move into defensives is something which will continue or do you think that is now over and it will start going back to growth stories?

It was also a function of the rupee going down and expectation of high oil prices leading to a worsening of the current account deficit by nearly 75 bps and the rupee continuing to go down I think that was the big trigger.

Second, people are playing a barbell strategy of having defensives in the portfolio and going towards quality, going towards visibility. I would still not be very keen on the pharma space overall. There are a few picks you can look at but overall I would prefer IT. I think IT has a lot more triggers and it will continue to do well in a very secular manner with the kind of drivers that are there and also a strong dollar will help IT as it does the pharma exporters also but valuations have been an issue on pharma and some surprises on compliance that keep coming up regularly.

So on a broad brush, I would still prefer IT. Overall in terms of portfolio construction, I would prefer financials as the top pick that will continue to do well. There will be these blips but we will see financials outperforming. I would look at metals and materials that the commodity super cycle is very much on. There have been corrections in the middle as happens in a commodity cycle but overall if you look at on a gross basis across the world you have more demand than supply and with all the sustainability and issues supply will find it very difficult to get funding and as we are seeing in oil we will see that in metals as well.

The third big thing is the China stimulus, the National People’s Congress just ended. They have reaffirmed that they are looking at economic growth and stimulating economic growth. They have taken a very challenging number of 5% plus of GDP. I am expecting policy accommodation from China which is normally positive for the commodities complex. So both agri commodities as well as metals I would favour in this kind of scenario and in India we cannot really have any players which are energy players because the government producers will get into the subsidy cycle, they will not be paid as much as one would expect, the government will take some profits out of them but globally energy has been an outperformer this year and next year.

Which are the top sectors that you would be watching out for or the big trends in the coming week that will be on your radar?

The Fed review is the most important meeting because it will set the tenure for the rest of the year. Right now the Fed fund rates are showing a probability of seven hikes so the rate goes from zero to 1.75% by end of 2022 that is largely baked into the market. Normalisation of the balance sheet starts around June as per our estimate so if there is any talk about that.

I think these will be the two big factors – one, what is the actual hike – is it 25 or 50, highest probability right now the OIS is showing 25 bps.

Second, seven rate hikes seemed to be baked in, what does the Fed indicate. And third, what does it talk about QT, about normalising its balance sheet that will be the main focus. No other triggers as such.

We are expecting the Russian pressure on Ukraine to really ratchet up over the next few days so the war new, the geopolitical news could get worse next week so that is why I am cautioning again as I have been saying for the last three weeks that still time to be cautious, do not jump into these markets yet.