Domestic Flows May Help Counter Market Decline, Says Demeter Advisors' Ashwini Agarwal
Defence and railways, may witness substantial corrections, he said, 'The stories are good in the long run' for these sectors.
Indian markets have already factored in a lot of positive news, and the constant influx of domestic fund may act as a deterrent to substantial market decline, according to Demeter Advisors Founder Ashwini Agarwal.
The ongoing inflows of domestic money continue, and that may prevent the market from tumbling too much, Agarwal said.
"If you look at the local flows that are coming into mutual funds and the direct money that's coming into the market, that may not allow the market to sink a lot," Agarwal told NDTV Profit's Niraj Shah.
He further emphasised that specific market segments exhibiting elevated valuations, such as defence and railways, may witness substantial corrections. "The stories are good in the long run" for these sectors, he said.
Drawing parallels to the scenario witnessed in internet-based companies during the middle of 2021, Agarwal suggests that these sectors could undergo a noteworthy correction despite their positive underlying narratives.
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Consumer staples and information & technology services in India were identified by Agarwal as sectors where potential losses may be comparatively limited in the event of a market correction.
Despite not being the favored areas for investment due to obvious reasons, Agarwal said that these sectors boast reasonable valuations, strong management, and robust cash flows. Consequently, he suggests that, on a relative basis, these sectors present prudent investment opportunities.
Additionally, Agarwal remain optimistic about the revival of rural consumer demand. He attributes the previous decline in demand over the past 12 to 18 months to an inflationary shock, which he believes is now dissipating. As a result, he anticipates a resurgence in rural consumer demand in the foreseeable future.
Watch The Full Interview Here:
Edited Excerpts From The Interview:
There has been a lot of chatter around how the Indian valuations defy, in some sense, what's happening across the world on the growth front, even if India were to be growing well. Are you okay with the kind of moves that we've made index-wise, though, in the last two months, we've been largely flatlining? What's the way ahead therefore? Would we continue to flatline? Could we see an ascent in the run-up to the elections and would that be something that will make you uncomfortable?
Ashwini Agarwal: Two important points. Like you said, the growth globally has been slowing down, and the second macro reality is that the expectations of very sharp interest rate cuts that we had, let's say around September, October last year, have now been pushed out.
Even in the Indian context, I mean, there's been no cut in rates and if you read through the RBI policy, it appears that there may be no development on this front for at least the next 3-4 months or even post elections. We might not see something right away. And it's a similar trajectory for rates, at least in the U.S. So the question I'm asking myself is that if you look at growth, is the growth accelerating and I'm talking about real GDP growth here, or is it stable, or is it slowing down?
In the Indian context, I think, we saw very strong growth in the first half of the current fiscal year, which is the April-September 2023 period and now we are starting to see the base period catch up. I think, you know, growth should be stable around 6-6.5% over the next one financial year or so. There is no acceleration visible yet, despite significant push by the government on infrastructure spending, especially in the areas of defence, railways, and so on.
So my sense is that, you know, with earnings growth of the order of may be about 14-15%, slightly ahead of nominal GDP growth, the market is already pricing in a significant amount of near-term earnings upside. So to answer your question, you know, do we see a continued move upward from here, on an index-wise basis, I think that's a tall order.
Within the emerging market space, if you would look at it, I know several people keep saying that the asset classes there are a really expensive outlier. So notwithstanding the diversity of the Indian market, notwithstanding the growth, I think a lot of good news is priced in. That's what I see from a global perspective, looking into India. However, if you look from within India, for savers in India, what's happening is that, we are hostages to our own markets, because it's capital controls, and there is, of course, a home bias that every country has with its own investors. These investors have done very well in the last four years notwithstanding corrections that we saw between September 2021, to about March of 2023. So that was the 18-month period, where we saw the markets go down and despite that, over the last few years since Covid, investors have done well. So the domestic money continues to flow in and that may prevent the market from going down a lot. So, you know, flatlining is what we've seen over the last two or three months and that might continue, notwithstanding my concern on valuation.
In some sense, you're saying that there seems to be so much of interest that despite the higher valuations, we may still flatline and not correct because there is an appetite at every dip?
Ashwini Agarwal: That's correct. So, you know, if you look at the local flows that are coming into mutual funds and direct money that's coming into the market, that may not allow the market to sink a lot. But you know, valuations have their own way of imposing themselves on the market. If you go back to September 2021 and we saw a plethora of IPOs in the new-age internet-based companies—where valuations were very expensive for traditional investors like me, who've been around for a while and have value as a constant discipline that we are trying to adhere to—we were amazed at the kind of response that these issues got, but lo and behold, over the next 18 months you did see a significant correction. So pockets of market where valuations are expensive today, be that defence, be that railways, there you can see a lot of correction because I think while the stories are good in the long run, just as they were in the internet-based companies in the middle of 2021, you may still see a significant price correction because the valuations are completely absurd.
Viewers, I must bring out this point and with a couple of charts may be, before I go back to Ashwini, because the point that he's making is very important. A lot of us and a lot of people who are coming to the markets in the last four or five years—which is a large percentage of my viewing population—at times forget this.
So look at say may be a two-year or five-year chart of Zomato or whatever time it’s listed. The stock, while it has rallied from Rs 50 all the way to Rs 130-140, it has corrected initially from Rs 160-170 or whatever it is, all the way to Rs 45. So in some sense, Zomato's 12-month chart looks really impressive. Now, expand this to five years. And you will see, how the stock corrected quite viciously before coming up again. And may be an even better example shows you that over three years or something like that, you have got virtually no returns. That's part one, if you had invested right at the peak, at the expensive valuations.
Similarly, for a behemoth like DMart, just look at what the stock has done. A brilliant stock, everybody shops from there. But it's virtually flatlined, in a meaningful way for so much of a long period of time.
Private banks are performing fundamentally. The issue has been that the supply from the FPIs has been large. What would it take to turn the fortunes of these banks around? Would it need to come from FII flows, for these stocks to start performing?
Ashwini Agarwal: The simple answer is yes. I mean, it's a little bit of circular logic. But what happens is that the domestic investors—the behemoth, the large body of retail investors—tend to take price momentum into account. And I am not looking down upon price momentum as a study. I mean, one of the best explanatory factors for a single stock performance is actually momentum, if you do factor analysis over a long period of time. So, momentum is the way a lot of people invest and that's fine.
For the momentum to change in private sector banks, you will need foreign investors to come back because these are very significantly owned by foreign investors. These are very large, free float companies.
So unless there is a significant shift in institutional buying, for private sector banks, it's difficult to see how the price momentum will change. Having said that, I had like to draw parallels between what you just spoke about on Zomato and DMart. I don't own those stocks.
I don't usually talk about specific names, but here I will take the liberty of using a few names. HDFC Bank, a position that I own and Kotak Mahindra Bank, a position I don't own. If you look at these names, they were very expensive towards the end of let's say 2019 because we were coming out of a decade of highly stressed bank balance sheets and these two banks managed to keep their balance sheets very, very clean. As Mr. Kotak has often said that there was a cleaner shirt in the dirty laundry basket. So you know, the valuations for them were very high.
And why I'm linking this to your Zomato comment or your DMart comment is that, valuations are very important at the point of investing. You may buy a great company but if you just pay too much for it, at the time of going in, you might be stuck with no returns for a period of three to five years. And that's exactly what has happened to some of the private sector banks.
You spoke about private sector banks as a body, but I don't think that's true for all the private sector banks. So if you look at some of the other names within the private sector, they've done very well over the last three years or even five years dare I say. It's the two or three names, that had become ridiculously expensive, that have failed to perform for the reasons that valuations have finally caught up with them.
I think, in the case of HDFC Bank—again, to reiterate, it's a position that I own—it is facing the merger related challenges and might take some time to sort itself out. But I think, if we were to look at a three or five-year picture, I think, this might actually not be such a bad time to invest into them. But of course, the momentum has to return.
Okay, fair point. And yes, I stand corrected. It's not that the whole body has not done well. There are some exceptions to the rule as well. It is just that everybody gets caught up in the commentary around HDFC Bank, Kotak Bank and the likes, may be even an ICICI Bank in the recent past, if you will.
The other interesting study that was done by Bernstein is that PSU stocks which have again, for the month of February, kind of gone completely quiet after a breakneck rally for the last few months. Their ownership analysis seems to suggest that FPIs have largely avoided this pocket. It's largely been retail, DII investors, which took this space higher. Now it's flatlining because of expensive valuations, save for may be PSU banks. And difficult to assess as to what happens there, but the ownership analysis was interesting.
As domestic flows continue to remain strong, but the flows are managed by very smart mutual fund managers, if you will, do PSUs as a body, because of the valuations largely stay flatline for the next few months until earnings catch up?
Ashwini Agarwal: I would think so, selectively, because some of the PSU stocks if you were to draw long-term price-to-earnings or price-to-book charts for several of these PSU names, they're now trading pretty much at the upper end of the valuation range, and this includes the period of 2006 to 2008 which is when the stocks and done phenomenally well. So I think valuations are now pretty full. But these companies are doing well, because the way the administration has kind of turned around in the sense that from what we hear there is not that much interference from the government in the independent running of these PSUs and some of them are pretty well run.
But I think the valuations are now expensive in several pockets and they might take some time to catch up. I think, among the PSU banks, there are still some selective pockets where valuations are not very expensive. But again, in the historical context, they've always traded at a discount to private sector banks. I think there is a good reason why that's the case and I don't see that going away. So yes, my sense is that PSU stocks are also pretty fully priced at this point.
In such a scenario, what looks attractive enough to invest in, aside of may be select private banks wherein there might be opportunity? What is it that is looking attractive?
Ashwini Agarwal: If you look at a lot of the chemicals space, it was hugely in favour immediately post Covid. Prices for a lot of base chemicals went up a lot and they made humongous margin gains. And over the last 12 months, all those margins have been given up, even though stock prices haven't given up all the gains, but they've given a substantial part of their gains.
But the core story hasn't changed. In the sense, that China Plus One is still a reality. I think globally, outsourcing is moving to India. We are getting a lot of attention for being in the space that we are, as a stable country and so on and so forth, and in addition to the fact that China also wants to vacate the space, where value-addition is lower from their perspective. They're focusing more on electronics and cars and EVs and battery technologies and so on. So I think, in base chemicals, I think where prices were down significantly because of excess inventory built up immediately post Covid, I think, you're finally starting to see an end to that inventory cycle. And I think margins will normalise, growth will come back. So that's one space that I'm quite excited about.
Pharmaceuticals I continue to be fairly excited about. I think here again, the generic pricing environment is a lot better today than it has been in the last three or four years. And demand is also pretty decent, both in India as well as overseas. So I think that's another space that I'm looking at, quite favourably, specially the generics space. I think in several exporters, smaller companies, the China Plus One narrative is real. There's a huge opportunity for them to win market share on a global basis. And if you have companies which are well-managed, with good balance sheets, new capacities in place, I think you'll be surprised by the kind of earnings growth that will come through over the next two to three years. And the Indian market always rewards earnings growth. So, if there's a company that's growing at a pretty 20-25% compounded annual for the next two to three years, you should always expect the valuations to go bananas at some point. So I think those are some of the spaces that are looking quite interesting.
I think as a defensive trade, I would say consumer staples in India and IT services are both places where you're likely to lose less in case the market goes into a correction. I mean these are not fancied places to be, for obvious reasons. But I think valuations are reasonable. There is good management in place, cash flows are very, very strong. So I think, on a relative basis these are places to hide.
Are you defensive in your portfolio? Have you added these names for that particular virtue?
Ashwini Agarwal: So, not IT services, but I have added a couple of consumer names because I do think that rural consumer demand should come back because the inflationary shock that has hurt the demand over the last 12-18 months is now beginning to fade. So I am hopeful of that outcome. But I have turned defensive in my portfolio allocation in the sense that I'm sitting on about 15% cash, which is not normally the case. So if that reflects my view on the market, that's something that I'd like to share with your viewers.
So, viewers, the other point is that IT is good, but Ashwini is still sitting on cash as opposed to deploying that money into IT names. So maybe clarity from the companies, at some point of time, around the turn of discretionary demand, may be, that is a factor but certainly a pocket to focus on.
Now, pharmaceuticals for example, if I look at the last 3-6-9-12 months performance, at any point of time you bought into any of the generic names—Sun Pharma, Dr. Reddy's, Lupin, etc., the others too—you made money. So these stocks have rallied. It's not like they've stayed quiet in the last 12 months. Do you still reckon that there is value in investing in them?
Ashwini Agarwal: I mean, the value is less than what it was 12 months ago for sure. But I think they're not expensive. They're reasonably priced and the earnings growth is strong. So you know, if you're looking at the whole market, which is expensive, you go into spaces where valuations are reasonable and earnings are decent.
It's not like 2015-2016. If you remember, in 2016, there was a cover story when Sun Pharma’s market cap had briefly eclipsed that of Reliance Industries. The valuations were nuts back then. So it's nowhere close to the ultimate values. The valuations are okay, they're fine. I mean, they're in their 20s. The earnings growth story is pretty solid. For some of them, larger companies, especially there are differentiated portfolios that they've been able to create. So these are not pure, run-of-the-mill, generic companies anymore. They are also significantly competitive at what they do.
Similarly, in the upstream chemicals and the downstream chemicals space, I think there are niche products that companies have been able to build. I think one of the things that we underestimate is the amount of confidence Indians in general have. So people don't shy away from investing in R&D with uncertain outcomes, as used to be the case 10-15 years ago, and that's starting to pay off.
Well, that's true. I mean, we have seen so many pharma companies even in the CDMO (contract development and manufacturing organization,) space, talk about making large investments, with the returns not necessarily coming in the next 12-24 months, but building out for the longer term.
Your conversation with us on Insights, when we spoke about a particular real estate name, evoked a lot of responses to our social media team and our handle. So, are you constructive on real estate per se as a pocket? We'd spoken back then about Max Estates. Was it a particular bottom-up idea or are you still constructive on Max and the real estate space at large?
Ashwini Agarwal: Okay, so first due disclosure. I am a shareholder in Max Estates. So that's something that your viewers should know. Second is, I am constructive about real estate.
Real estate has long cycles. At least that's what I've experienced. And typically, you know, the real estate cycle starts one or two years after a bull market has set in and they continue for much longer than typical bull market cycles in the equity market. A better home is a universal desire. And when people make money, be it by way of ESOPs, be it by way of investments, smart investments made by the end of the market, be it by way of listing companies and benefiting from them, as has been the case for several promoters both on the SME as well as small and midsize companies on main bourses, the desire to buy a good home is a universal desire. And I think real estate will continue to do very well for the next five, seven years.
Picking stocks in this space is very difficult, because these are long gestation projects. And very often, you know, balance sheets get into trouble, projects get into trouble because of regulatory difficulties they face. So you know, on a bottom-up basis, I have historically found it very difficult to find companies. And Max Estates—about a year-and-a-half or so, may be two years ago, when I first looked at it—looked reasonably appealing from that standpoint, from the kind of governance, checks and balances that they've put into place. And it's a unique company in the sense that it has a large portfolio of rented properties that bring in regular income and a development portfolio as well, with a very strong discipline around the balance sheet. So it's a bit of a unique story, and that's the only real estate play I own. But I'm positive on the space, except that I am wary of investing in individual stocks for the reasons I outlined.
