Domestic Inflows Unsustainable In Near Term, Says Jefferies' Mahesh Nandurkar

Mahesh Nandurkar: Absolutely, I think there are a lot of macro events that have happened recently, and could be a few more later parts of this calendar year and clearly, in the context of where we have come in terms of the market movement over the last one and a half years, last two years or so, which have been very strong for Indian markets, and rightly so, in my view, given the pace of the economic growth, the relative strength of the economy, and on top of that, the strong domestic inflows that we are seeing into the markets.

In fact, the pace of the domestic flows is really the key driving factor that we've seen that has kept the markets at a higher level. If you look at the current calendar year, we are looking at almost $7-8 billion a month. That's the extent of inflows that we're seeing from various domestic sources. Clearly, you know, a very, very high number in my view.

So keeping all these things in the context of high valuation, very, very strong domestic flows that we've seen in the last seven, eight months of this current calendar year, and the expected changes, you know, in the global macro so to speak, I would say that the risk reward, at least from a short-term perspective, for say, from the next two to three quarter perspective, doesn't appear that attractive. The long term is obviously looking quite good.

Mahesh Nandurkar: See, we've seen what has happened to the global markets and Indian markets over the last two years, during which the Fed has increased the interest rate by almost 500 basis points. If you, you know, go by the traditional, sort of models, a 500-basis-point increase in the risk-free rate in the US would have impacted the US equity and the global equity quite negatively. That did not happen. So, I'm not so sure that we can really take a leaf out of the history book and say that if the Fed is going to cut rates, that will be benign for the markets.

I don't think we are clearly following the copy-book style response from the equity markets to the potential actions on the interest rate side that have been taken by policymakers. So, I would therefore say that from the next two to three quarters point of view. Yes, the Fed is definitely one. But then we also saw just a few weeks back, you know, what happened to the Japanese market. Although it was a one-day phenomenon, and a large part of the fall has already been recovered, that just goes to show the vulnerability of equity markets to some of the macro developments and you know, therefore we should not be ignoring those.

Mahesh Nandurkar: Absolutely, the markets have, you know, been moving very, very rapidly, as you rightly mentioned, there is hardly any time gap between an event happening, between a company surprising and the stock prices reacting in a very meaningful way. So from that point of view, I would say that the market is really kind of price to perfection, and several sectors and several stocks are priced for that perfection. So that's my whole point.

So one of the earliest statistics that I mentioned of around $7–8 billion per month of domestic inflows and when I say this number, I'm including not just the flows coming in from the equity mutual fund, which includes SIP and non-SIP portion, but also the single stock purchases by individuals, also by the insurance companies. Mind you, this number of $7–8 billion a month, annualises to almost $90 billion a year. That's roughly 25% of the annual financial savings of households on a gross basis, one-third you know, on a net basis.

Now these numbers are actually comparable to what we see in the developed world. 25-30% of savings going into equities is something that we see in developed markets, and to that extent, I believe at least a part of the domestic inflow that we've been seeing appears unsustainable to me. Now what can bring it down to more sustainable levels? I mean, you know, there can be sort of various events that one can think about, whether it is the U.S. recession, whether it is a possibility of some shocks coming, maybe from Japan, or maybe some geopolitical events, you know, there could be some tax related changes and so on.

So, as I said, it's very difficult to pinpoint what exactly might happen. But I would say that, you know, from a near-term perspective, I see the risk that the domestic inflows might calm down, and might slow down from the current levels and while there will probably be some compensating factors coming in from the foreign flows, because those have been very weak, you know, in general, the last sort of like seven, eight months, or even last 12 months or so, so that can be some compensating factor.

But net is that, you know, maybe we have to undergo some kind of a time correction, if not actually some kind of a market correction. But yes, you know, after we go through that near-term adjustments, I think the long term appears to be quite attractive. 

Mahesh Nandurkar: True. So, as we discussed, you know earlier, the results coming in from the IT services companies for the June quarter were maybe a tad better, not a whole lot, and that kind of, you know, that level of positive excitement got priced in, into the stocks very, very quickly, maybe, you know, just like a few days' time. But you know, if one takes a step back and move away from these recent upmoves that we have seen in the stocks and the results, but by and large, when you what we're clearly looking at is the scenario where the possibility of a US economic slowdown is now more today as compared to what it was three months back or six months back.

That's why there is this chatter about the rate cuts in the US. So, you know, I see that there is some element of excitement around the IT services sector due to rate cuts. But what I would say is that one needs to go one level deeper and see what is the reason why these rate cuts are being talked about with much more higher probability today and the reason is that as an economic slowdown, or a possibility of or a higher possibility of US recession, and those things are definitely not, you know, that positive a thing from the demand perspective. So that is clearly, you know one thing to keep in mind.

Secondly, when we talk about the rate cuts, it usually impacts the financials and the banks, you know, in the US . in a negative way because of the margin pressure and the BFSI segment is one of the large sectors in terms of the demand contribution to Indian IT services. So from both these standpoints, we don't really see any big reason to be too excited about. Yes, the IT services sector looks like a defensive sector. It is one of the sectors that hasn't really done that well in the last, say, eight to 12 months or so. There is that element of sector rotation that will probably be playing out and to our mind, it has already played out to some extent. So, beyond that, we don't really see any big fundamental reason to be too bullish on IT services here.

Mahesh Nandurkar: That is true. But you know, we clearly, like some of the stocks in this space, this e-commerce, this tech-enabled sectors, even what you spoke about in the food delivery, quick commerce-related businesses, because these are ultimately the new segments, relative new segments, on the markets and in general, what I would say is that from the broader market perspective, the sectors that have done well over the last 10 years or so need not be the ones that would do better over the next five to 10 years.

Some of these new emerging sectors, be it these tech-enabled, the e-commerce sectors that you spoke about, or even some of the green energy or energy-related sectors, which haven't really done that well in the last 10 years, but I think some of those stocks have done pretty well in the last one or two years or so. I'm going to come back to, you know, our favourite theme that we have spoken about, which is the investment cycle, which is not just real estate, but other capital goods, infra and so on. So these are some of the sectors that have already done well, you know, on the markets in the last, say, one to two years or so and maybe they are in for a breather.

But if you were to ignore that near term, say, six months to 12 months kind of a period, and just focus on, let's say, three to five-year period, I still believe that these e-commerce related, this energy-related, real-estate and investment cycle-related stocks and sectors that will probably do much better than the market from a longer-term perspective. From a near-term perspective, yes, I do see a headwind and a risk of underperformance there.

Mahesh Nandurkar: Insurance is definitely a sector that we quite like, the non-lending financial overall space looks attractive. But even within that, insurance definitely looks attractive. The other part of the NLF, or the non-lending financials, is the capital market-related plays. Once again, the capital market-related plays have done quite well in the last 12 months or so, and I do see some risk of underperformance going ahead into the next six to 12 months.

But beyond that, the capital market plays should pick up once again. But in the interim, we definitely believe that life insurance, particularly as a sector, should do well over the next six to 12 months. I believe the sector rotation, which is also playing out to some extent, should play out in favour of the insurance sector. So, yes, we are overweight in the insurance sector.

Mahesh Nandurkar: I think both general insurance and life insurance appear to be attractive. Long-term theory for sure. You know, there is no doubt in my mind and in terms of the penetration levels, both sectors are at a low level at this point in time.

And clearly the financialization of savings slowly, the households are moving away from the attraction of gold and looking at the other financial investments. And clearly, especially after Covid, the life and the general insurance segments have, you know, become a greater part of an average individual's portfolio. I definitely see a much, much better long term potential for both these sub sectors within insurance.