Economic Slowdown Cloud Hangs Over Markets Rally, Says Piper Serica's Agarwal

Abhay Agarwal: I don't want to be judgmental about the market moves, you know, because all of us have our own expectations about what the market should do, but markets have their own modes. We have seen a lot of it is driven by liquidity, both domestic and international, and there are times when most of the investors who are bringing in new money into the markets are driven by the near-term returns that their portfolios are generating, and they overlook the risks of a correction.

I think if you look at it from June 4, when the election results were announced, the markets dropped and the dip was bought into, the month ended 15% up and then you had the budget, which had the surprising capital gains tax increase, and there was a very short-term play and again, it was bought into.

So, I think what is happening is that all investors who are chasing momentum are being rewarded by the markets. There's nothing wrong with it. I mean, that's what the markets do. If you do a deeper dive and you look at the fundamental construct of the underlying economy, corporate earnings, clearly there is stress building up. There is some slowdown, short term, medium term building up. I don't think the markets are really taking that into account.

So, markets are going their merry way, not only in India, but even in the US. All dips are getting bought into by the new money that keeps coming into the markets. A lot of it is driven by the expectations of a rate cut globally by all large central banks making money even cheaper. So, I think that is the market construct we are in. It is very difficult to say how long this rally will carry on because a lot of it is just driven by the new money that keeps coming into the markets.

Abhay Agarwal: In pockets of the market, we are already in the bubble by any meaningful valuation standards. You have pockets like PSUs, defence, railway stocks, very good companies. You know, I'm not again taking the call on the quality, but it's just valuations that we worry about as fund managers that it is clearly a case of right now, momentum money, chasing near-term performance.

Again, it is very difficult to, you know, take a call on where and how and when the party will stop. I think that, you know, that sharp spike in the market, driven by liquidity, only stops when there is an unforeseen negative event or there is a sudden drop in the market for whatever reason, I don't know, again, but that breaks the momentum, and then the cycle reverses. I don't know when we will get there.

Right now, you know, the markets are where we are, and we have to deal with them. We still have to find pockets of opportunity that are there. I'm not so worried about, you know, the markets being at an elevated level and the valuations being stretched. I think as long as one can find opportunities there again with a longer-term perspective, you will end up making money in any kind of market.

Abhay Agarwal: I think the data actually, what has come over the last week especially, has been very consistently pointing to a slowdown, and this slowdown started about the time when RBI started squeezing or putting more risk-mitigation measures for banks, they increased risk weight for unsecured lending by banks. They increased risk weights for NBFC lending by banks, even for housing finance companies, the risk weight/rates have gone up, plus a lot of constraints have come up on peer-to-peer lending.

So as a result, what has happened is that the money has become not as easily available as it was last year for any kind of borrowing, especially on personal loans, credit card loans. That has led to that increase in cost of borrowing and led to a slowdown across the board in credit and that number is showing now. Secondly, what that has also done is led to a demand slowdown at the main street level. So, when we recently did our channel checks, we found to our surprise that there is absolutely no inventory built up for discretionary expenses, discretionary purchases for this festive season.

You know, you have auto inventory, which is worrying the retail and retail distributors. There is no inventory built up in paints, in tiles, in other stuff that people would typically spend money on during the festive season. So clearly there is a demand slowdown for discretionary expenses, again driven by the high cost of money, and that is again reflecting in the GST data.

If you saw, the net of refund was only 6.5% whereas the government estimates were much higher. So I think GST data gives you a good idea of what is happening at the underlying consumption level in the economy, and if the GST collection slows down, that is a very solid hint towards a short to mid-term slowdown in consumption in the country. So, I think then you have other issues related to banks.

Since you asked that, our view on lenders, generally banks and NBFCs, is that the peak cycle of margins has been achieved probably six months ago, and now the cost of money, cost of deposits, is going up. Deposits are more scarce to get, cost to income ratio is going up across the board, we see because of higher rental attrition salaries, and then you have higher NPAs kicking in. You know, collection efficiency has gone down from 98% to 94% for the microfinance industry. So there is a struggle on all aspects for lenders, including banks, private banks, public sector banks and NBFCs.

So, in that environment, I don't see how for next six months or a year till the cycle reverses again in the favour of these banks. Investors would expect to make money off lenders. I don't think there is going to be a multiple expansion, because the multiples are still the highest in the world, you know, for our banks. So I think that is why we are negative on banks for the next six months to a year till we see again the margins going up, but right now we don't have any visibility of that. 

Abhay Agarwal: We like the non-lending space. So, I think there are three bets that we already have there. One is which has been with us since post Covid, which is what we call capital market infrastructure players, CDSL, camps, Angel One, you know, because if the capital markets have to grow, which they will grow. These companies make a lot of money, just, you know, because they're basically tech companies that are benefiting from the macro investment theme and CDSL, Angels have already done very well for us, you know, and we continue to hold them as per our modern portfolio allocation.

The second part is, which is more recent about six months ago is the insurance players because we saw a long sideways correction in health, insurance companies, general Insurance companies and in life insurance companies and after doing lot of research, we finally placed our bets and these are not buy recommendations but our model portfolio is known in the market, So we have ICICI Pru, ICICI Lombard and Star Health in our portfolio because we think this is a space that has been ignored by the investors and finally, the regulator is getting more friendly.

There will be launches of more innovative schemes, better risk coverage, and the valuations are quite attractive again by historical standards. So looking at that Insurance is the space we are quite bullish on. There are near-term triggers for reduction in GST. We are hoping it happens, but we are not banking on it. If that happens, I think the whole space will re-rate pretty quickly and the third as you said is the wealth managers. I think that is the space again that will grow pretty rapidly. Valuations are a little unattractive right now, so we probably wait for, you know, better valuation levels to make a bet there.

Abhay Agarwal: We have always liked CGD players. I think this is natural gas is the future, and piped gas it is, you know, from a customer perspective. Even I use gas at home, and there are industries that use gas, and getting it through a pipeline is so much more convenient. So, there is a clear customer move towards having it. The rollout is slower than what people would like to be. But I think there are incumbents, from what we take in the leadership position in their local geographies. I think this is a great business to be in, because over a period of time, gas prices will only continue to trend up. It is a far cleaner fuel than others and easier to transport.

So, we have a very positive view on city gas distributors. Generally, on the oil and energy space, I think this is a space that is already looked at with a lot of interest by the government to make sure that India is not dependent on only oil imports all the time, but to create energy security for the country. So, I think there will be a big rollout in terms of renewable power, in terms of power distribution, as I said earlier, it is better for investors to bet on the big names you know that have the balance sheet strength to carry off these big projects. So definitely very positive on the entire power and energy space.

Abhay Agarwal: I think M&M could be absolutely right. I won't argue with them, they know data better than we see because we do it from our channel checks. When we did the channel checks, we didn't really dive into category wise inventory data. It was more to understand the mood of the distributors, the mood of the showrooms and there seems to be some concern that the inventory that they have right now is the highest over the last four years, since post-Covid and the sales have been slower. The inquiries have been slower than what they are used to in a pre-festive season.

So, there is a worry that if the sales and bookings don't kick in, again, there is an expectation and it may change, you know, post Shraad period, everybody gets into the buying mode, it may change pretty quickly, but what we saw right now is that the distributors are quite cautious about asking the OEMs to send them more inventory. I mean, in fact, the message is clearly, do not send us more inventory. We have enough inventory. I saw a report from one of the automobile financing companies that clearly said that it is 72 days of inventory that the dealers are carrying, which is probably the highest post-Covid environment.

So I think that environment better to wait for the festive season to get over, see the actual dispatch numbers from the OEMs to dealers in November, to get a new sense of you know which way it is going, because if the demand doesn't come back, then the worry is that you will see a pretty conservative guidance and drop in quarterly earnings, which may negatively surprise investors in autos. I would just say that it's a very good long-term theme, but in the short term, maybe better to be cautious, wait out for November and December data 

Abhay Agarwal: We are being very defensive. Let me put a disclaimer here. We are very, very bullish. As bullish as you know, anybody who believes in India's long-term growth thesis. If you take a five-year call, if you take a 10-year call, I don't think any market in the world will create the kind of returns that India would make for long-term investors. Having said that, there are times when the markets get overvalued, there are times when markets are undervalued, and that cycle that the markets go through and as a data you put out, and I think you and I and the fund manager and a few people who's actually looking at P/E multiples right now, everybody's chasing short-term performance.

But what we are doing at the portfolio level is that we are just being more defensive and to become defensive, what we have done is, first of all, we have looked at a portfolio-level valuation, and at portfolio-level valuation, we want to be below 25 times P/E multiple, because if the markets correct, the expensive stocks correct the most. So we have made some changes to the portfolio, taken out some stocks in the portfolio that we like, the companies we like will probably add them back at the right time, but they were trading multiple of more than 100 times, which we find difficult to justify in a slow-growth environment.

Secondly, we have increased cash in the portfolio to about 20%. This is a temporary call. It's not, you know, when we find opportunities we will definitely deploy. Third, we have increased the weight of large caps, just because, you know, the large caps that are not the expensive large caps, but are still growth stocks with attractive valuation for the growth that they are getting into, you know, Hindalco, Grasim, these kinds of companies. So these are the three things we have done, the returns have been very robust over the last couple of years.

So we just want to protect those returns right now. I think the next three to six months will be very choppy for markets globally, with a lot of trigger events, election results, even in India, three states that will go through elections. So I think we just want to wait it out and we have a buy list ready, we will use the cash in the portfolio, you know, as we get opportunities.

Abhay Agarwal: We have been underweight on IT for the last year and a half, from January last year we don't have any IT stock in the portfolio. The reason for that for the IT services exporters in that when the management itself is guiding for 1% or 2% or 3% growth over the next year, I don't know why we should pay a multiple of 25 to 30 times or even more, just because of the optical defensiveness of our earnings.

I mean, investors get rewarded for betting on growth and taking that risk, but if the management itself is guiding for a flat to no growth, I don't want to second guess the management and say this company will actually go faster. So one is from the valuation perspective, the second is from the perspective of the market dynamics and the product offerings. I think lot of these companies are right now under pressure from newer technologies... that is taking away large parts of the fixed cost that they do.

The whole dynamics of pricing is changing even with large customers. If you look at their large banking, financial services customers, JPMorgan, Wells Fargo, Citibank, they have their own cost pressure. So, it's not that if the rate cuts happen, the bank starts spending a lot of money, and all these contracts will come to the companies. There's going to be lot of pricing pressure, lesser very large-value deals, even large revenue deals will have lower margins.

So, I think in that environment. I don't see why we should jump in and add an IT services company to our portfolio. We are looking at IT product companies, which we find to be interesting in case they are focused on a particular vertical or focused on a particular new technology. We are considering them, so maybe we'll add them to the portfolio, but definitely staying away from large cap IT names right now.

Abhay Agarwal: I think some of the IPOs that we have seen are very good IPOs and that gives me a lot of confidence that we are not in that bubble zone, as far as IPOs are concerned. The valuation is interesting, attractive, I would say the business models are attractive, and I think it's good that these IPOs are coming in, giving a lot more breadth and depth to the market, and giving the mutual funds and investors an opportunity to deploy the cash they are sitting on.

On Bajaj Finance, per se. I think it's an interesting one. Very large players are good. Again, investors are getting an opportunity to invest in a large company like this. What happens to Bajaj Finance share price because of this listing will be an interesting one. I don't know how it will react. There could be some holding discount element there. But I think you have this company list itself. I'm happy, because it gives investors a bigger opportunity basket to invest in, in the Housing Finance space.