New set of winners to lead next round of rally; investors must have a margin of safety: Niraj Kumar

“Stock market is a forward looking animal, having the ability to discount the positives and negatives and move on,” says Niraj Kumar, Chief Investment Officer at Future Generali India Life Insurance. In an interview to ETMarkets.com, Kumar said about 75 per cent of Nifty50 earnings will remain unaffected by the recent events, which would provide downside support to the market. Edited excerpts:


What was the key learning for stock investors in FY22?
FY2022 was indeed an eventful year for financial markets. The year saw the most lethal Covid second wave in April-May 2021, which tested the mettle of the human race and markets. Nonetheless as testified in the past, the economies across the world including India remained resilient and emerged stronger with economic activities rapidly normalizing aided by less stringent restrictions, vaccination drive and coordinated monetary and fiscal impulses by the central bank and government. FY22 witnessed never before buoyant equity markets with record fund raising via IPOs, thus exemplifying the sheer strength and resilience of markets. While the fear psychosis around Fed tapering did impart some bouts of volatility, the markets took this as well effortlessly in its stride.

Thus from investors’ standpoint, the key learning from FY22 is that markets have an inherent nature of being resilient and are a forward looking animal having the ability to discount the positives and negatives and move on. FY22 has glorified the importance of being a patient and disciplined Investor.

Investors who were unfazed by the market volatility and have remained invested despite the Covid mayhem, have seen their wealth growing. On the flip side, those investors that have succumbed to fear and panic and exited their investments have seen sour returns. Thus interim upswings and downswings should not deter investors from their long-term investment strategies and that investors should leverage on the presented opportunities to create long term wealth.

Also, while the new retail investors have seen stupendous returns in the last couple of years, it’s important that investors don’t base their investment decisions based on this performance going forward and get more pragmatic about market cycles.

Furthermore, FY22 has also been an interesting one from the IPO market’s perspective. The fiscal year kicked off with a strong euphoria in the IPO markets aided by ample global liquidity at lower rates and stellar performance of equity markets and the new age companies garnered strong valuations, as investors looked beyond the prism of traditional valuation parameters. However, soon the euphoria dried out post listing and new age stocks have seen sharp corrections.

From investors’ standpoint, one of the key lessons that came out is don’t follow the euphoria and take a balanced approach and the focus should be on ‘Differentiation based on Quality’. Companies with strong structural fundamentals and quality along with justifiable valuations will garner more investor interest and that IPO’s from hereon are likely to come at reasonable valuations.

While Investors should continue to invest in new age technology space where the market size is huge and the opportunity that exists for these companies are unparalleled, it’s imperative that now they would be cognizant of the inherent risks in these segments and be disciplined in their approach and not follow the euphoria.

The investors are likely to assign more weightage to business moats and vision of growth and profitability in the near to medium term. Another key learning for investors in FY22 is that – technology is evolving every day and that it is important to identify companies that are agile in adapting to new technology innovations and back them, as non-adaptability can lead to huge business disruptions.

Any sector that you think did not perform well in FY22 but could be a contra bet in FY23?
As we embark into FY23, we are likely to see a significant shift in sectoral performance than seen hitherto. Sectors such as BFSI will take the centerstage as it is poised for a strong show after an elongated period of underperformance. We believe the financial sector is at the cusp of a significant turnaround as it would benefit from twin tailwinds of pick up in credit growth as well as a benign credit cost environment.

The Bank Nifty index has delivered a modest 6.5% CAGR returns over the past 3 years and is barely 10% above the pre Covid levels. Growth is slated to pick up going ahead aided by increased working capital requirements and some green shoots in capex recovery, and margins would likely see an expansion in a rising interest rate environment as assets reprice faster than liabilities.

Clearly, asset quality woes are a thing of the past and banks are adequately capitalized and most importantly the valuations are still below their historical average. Likewise, we see good opportunities in the telecom space given the material change in the competitive dynamics of the sector and much coveted price hikes being undertaken. This would culminate into strong earnings growth and consequent deleveraging of the balance sheets. We also remain extremely constructive on the Metal stocks, which have been on a weaker footing in the past 6 months or so.

We believe the recent surge in commodity prices would last longer than anticipated by our counterparts and would bode well for operating leverage benefits and cash flow generation. In terms of contra bet, we would like to bet on the Auto sector, which has been reeling for 3 years in a row and the volumes are down 30-50% in 2-wheelers & commercial vehicles. With growth slated to pick up, we would see recovery in volumes and consequent price appreciation.

Besides, the cement sector which is currently grappling with inflationary headwinds and would see margin pressures in the beginning of FY23, is likely to see recovery in the second half from the bottom of the margin cycle, aided by gradual price hikes taken and positive seasonality. In addition, the hospitality sector would be a recovery play as earnings should bounce back in FY23 led by complete opening up of the economy.

RBI in its March bulletin said the government must time LIC IPO correctly and that retail players’ response is critical to success. How would you rate retail mood at present? Many big IPOs in the past did not reward investors.

Retail investors have emerged as the most influencing investor class in the Indian equity markets in the post-Covid era. They have certainly come of age and we need to acknowledge them with the credit for showing an unflinching faith in the Indian growth story. The strong influence exerted by the retail & domestic investors is clearly testified by the fact that despite an unprecedented FII selling of over 2 lakh crore in last 6 months, Nifty was down by mere 7-8% from its peak. The significant structural change in retail flows has cushioned the exodus of FII’s from Indian Equities.

Besides, monthly SIP flows have been unabated and have stayed at over $1.5 billion per month for over 6 months, despite nil returns from the index. This further testifies the retailers’ interest in the Indian equities as an asset class. While a few new age technology stock IPOs have indeed disappointed, we reckon retail investors would be unaffected despite the disappointment in new age IPO investments, as their overall portfolio must have still made significant returns in the last 2 years.

We believe that momentum in retail flows and Indian primary markets is here to stay as Indian markets will continue to see an increase in financialisation of savings led by paradigm shift in the investor’s mindset and thus rise in equity exposure is bound to be a natural progression. Besides, factors such as increased digitization, growing awareness about equities, affordable internet availability and the relatively moderate interest rate environment will continue to aid the retail investor participation in capital markets.

Do you think high earnings growth estimates for next four quarters need a reality check? What sort of cuts do you see in earnings if inflation remains sticky?

At the current juncture, It is tricky to estimate the earnings growth for next few quarters given the kind of uncertain environment we are operating in. While there is no denying that the next two quarters are going to be really tough, we need to be cognizant of the construct of the Nifty Index. We do not expect any meaningful earnings cut on an aggregate basis, as we believe that any cuts in commodity consuming sectors (auto, FMCG, consumer durables and cement) will largely be offset by an upgrade in earnings of commodity companies ( such as oil & gas and metals).

However, there is surely going to be significant sectoral disparity. With commodity inflation running red hot (both agri commodity & metals), end users of commodities such as autos, consumer durables, FMCG and cement are likely to see some demand destruction and resultant weak growth and margin compression which would warrant downward EPS adjustments. On the contrary, sectors such as oil & gas, metals & mining are likely to see significant EPS upgrades, while sectors like BFSI, IT & pharma would remain largely unaffected which would ensure that the overall cuts to Nifty EPS are not very steep.

Our estimate is that ~75% of Nifty EPS is largely unaffected by the recent events which would provide downside support to the market. However, the challenges are more in the mid-cap space where the construct of the index is very different and would likely see wider EPS cuts. For this reason, we are more inclined towards Large caps versus Mid -caps.

What is your return expectation from equity as an asset class over the next 12 months? Do you see pain in the first half and gain in the second half? What should be the strategy for retail stock investors?

Prima facie, equity as an asset class has rendered spectacular returns over the last 2 years (48% CAGR) largely aided by the low base formed during Covid. However, when seen from a 3-year standpoint, Nifty has delivered a modest 15% growth. Thus to put things in context, we believe the period of easy returns as seen in the last 2 years for markets is clearly behind us and from here on return expectations are likely to be moderate and more realistic.

We continue to remain constructive on Indian equity markets and believe that markets have been resilient & have climbed the major wall of worries such as Russia-Ukraine standoff, US Fed rate hike & hawkish commentary, state elections, unprecedented FII selling, with limited price damage. Since a lot of these known risks are already priced in and as we transition from an unknown to known territory, we believe going forward Nifty returns will be a function of earnings growth. Markets might consolidate in a range over next few months until there is clarity on the impact of the Russia Ukraine standoff and likely pace of US Fed balance sheet unwinding emerges.

We are also of the opinion that winners of the next round of up-move are going to be different from the last rally that we have had over the last two years and that would present an opportunity for investors to leverage on. We believe that retail investors should use the current period of consolidation to build equity positions. It is extremely important to identify the risk reward characteristic of the investment opportunity and have margin of safety in an uncertain and volatile environment. Margin of safety will allow the investor the liberty to stay invested during periods of volatility and reap the benefit of compounding over the long term. Such margin of safety is available in several sectors such as banking & financials, telecom, commodities, utilities, autos etc.

Retail inflows have stayed strong, defying skepticism. Do you think the ownership pattern of domestic stocks may change drastically 3-5 years down the line? Or do you see the fad fizzling once fixed income products become attractive amid recovery in interest rate?

With Retail inflows holding fort despite the market correction, an obvious question that comes to anyone’s mind is – whether this is Transient and will revert when the economy recovers or it is earmarking the beginning of a behavioral change? What we are seeing is not a flash in the pan but could turn out to be a secular change. However, the litmus test for these investors will be when they actually see significant drawdowns in their portfolio. Hitherto the portfolios have been extremely resilient and these new investors have not seen any downturn or panic. How they react during these testing times will actually decide their future course and if this is the new equity cult or just a fad.

The key factor that has led to this kind of surge in retail investor participation in markets is lack of other lucrative investment avenues. With SIP holding up at strong levels, we believe retail investor participation will continue and are likely to have a sizable portion of the total investments going forward. While we concur with the view, the overall ownership of the domestic stocks is bound to undergo some change over the next 3-5 years. We also need to be cognizant of the fact that DII flows are not just from the retail investors, but are also from institutions such as Provident Fund, NPS etc. which are investing significant amounts of money in markets. As their corpus grows over next few years, their equity investments will also grow and will bode well for the equity markets. Nonetheless, we believe it’s important that retail investors focus on asset allocation and build a balanced and diversified portfolio by capitalizing on attractive alternative investment avenues.