stock market strategy: Taher Badshah on 3 reasons why one should not sell right now

“The whole readjustment process in the last two years is going to be happening over the next six to nine odd months. We are already three or six months into it. That would mean it is best from an investor expectation point of view to assume that “Headline returns for CY2022 will probably not be anything meaningful. But this will also be a period when investors will get enough time to be able to assess what they need to do with regard to investments,” says Taher BadshahCIO, Invesco Mutual Fund.

Are things looking settled now given how markets have come back from the recent lows? Is the market pricing a lot of bad news?
Yes, it looks like the first leg of the impact of inflation and possible slowdown in growth has got priced into various markets both globally as well as in India too. Obviously the market will now try to assess the impact some of the moves undertaken by central banks around the world are likely to have on inflation in the coming weeks and months. That will decide the trajectory from here onwards, but in the meanwhile, downward readjusted earnings valuation seem to be at levels which are reasonably comfortable if not entirely cheap for the markets to probably form some kind of a base here and assess incoming information.

Is 2022 going to be one of those years where it will be difficult to make money?
Yes, I would think so. The whole readjustment process in the last two years is probably going to be happening over the next six to nine odd months. We are already three or six months into it. That would mean it is best from an investor expectation point of view to assume that headline returns for calendar year 2022 or the balance part of this year will probably not be anything meaningful. But this will also be a period when investors will get enough time to be able to assess what they need to do with regard to investments, probably asset allocation as well as use various tools and methods to make sure that during the balance of the year, they get the money in with the possible expectations of returns flowing in CY2023 and beyond.

We have been seeing the velocity and pace with which the FIIs have been selling off. That seems to have come down. Have the FIIs oversold? Do you expect this strength to continue just seeing the behavior of the dollar index?
I tend to look at three or four factors that at some level provide some kind of a framework in terms of FIIs or foreign investor flows. Otherwise, it is always very difficult to figure out as to what they are going to be up to and it is always known in hindsight whether they sold or bought. Three or four things generally can act as good guidepost. One clearly, at least from an India standpoint, is where we are in terms of the growth outlook both globally as well as for India. If that were to get a little better, then that will favor India investments from an FII standpoint.

The second thing is of course where we are in the commodity price cycle and particularly oil, If we see commodity prices getting a little more benign, particularly oil and if it were to retract below $ 100, then it will become favorable for India.

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The third is where we are in the rate cycle and if the rate cycle is upwards, then that is something which is generally perceived to be negative for India.

Lastly, it is basically about where we are in the relative valuation scale of the country versus within the MSCI or other emerging markets. On these four parameters, at least in the more recent past, we can take some heart and the fact that valuations have corrected although we have been at a premium and will probably continue to be at a premium to other markets. But clearly, the valuation premium has come off a little bit for sure.

Second, the metals commodity complex has corrected quite reasonably in the last few weeks. That is something which is heartening from an India standpoint. If we were to see oil potentially come to below three digits then we probably also see the prospects of margin recovery for profitability for Indian corporates or the outlook getting a little better, then that should enthuse foreign investors.

Probably the growth outlook overall for the world at large and the interest rates is still some time away. Out of four factors, at least two could potentially turn relatively favorable and as you rightly said, we could see further slowing of the pace of selling that we have been seeing recently and probably at some stage in the future, even that can convert into a positive inflow.

That is what is going to take for the banking pack to finally perform. It just has not been reflecting in the stock prices?
It continues to confound others as well and we are probably in the same boat but we keep to our conviction. We are aware of the fact that other sectors are also reasonably well owned. Fundamentally, we are all probably in consonance and agreement that fundamentals for the sectors are getting better. Even the last missing bus, which is basically about credit growth in the system, has started to come back and shape up quite well.

We are now trending at about 12% odd year on year and I think all the factors are falling into place but markets can just persist with the certain view for a reasonably long length of time, ignoring fundamentals completely but that is where we continue to build our conviction to moderate some intra sector positions if required, but otherwise, for private sector banks and even the top tier public sector banks, we continue to hold a reasonably favorable view.

The markets tend to price in the future and we are at the cusp of the next earnings cycle. Are we in for further downgrades at the cusp of this earning season?
Probably not as much. I do not really think there will be very severe downgrades and the fact that in the more recent weeks, we have all seen a fair bit of correction in commodity prices – some of the metal commodities have come off quite well. That is going to provide some relief to many of the corporates which have suffered in the recent past. We see some of the sectors to continue to be resilient like banks and technology, at least in terms of IT services, FY23 looks to be quite secure although commentaries could probably change as we get into the third and fourth quarter for this year.

But from purely an earning standpoint, we have seen some downgrades. It does not really look like we are going to have very severe bouts or very severe downgrades going forward. Can it moderate a little bit? I think we are probably now tracking something like 15% to 16% CAGR over the next two years in terms of estimates. Can it moderate down to early teens – 12-13%? That is quite possible. I do not really see a situation where earnings will fall off a cliff.

The rupee has hit a record low 78.93. The big question for IT is not only the earnings growth but given the fact that we are factoring in a possibility that the US might head into recession, but the valuations are still at a bit of a premium against pre-Covid times. Do you expect pressure to continue in IT names?
A good portion of the valuation readjustment is required in order to reflect a possible slowdown in earnings coming out of either the slowdown in the US or recession. We do not really know where we are headed. We will get to know over the next six months or so but bulk of that valuation related correction has come about.

There could be some more, but I do not really think it is a situation where we will get a significant amount of downside. There is a certain amount of premium but it is a lot lesser than what it used to be around the turn of the calendar year in early 2022 or late 2021. Meanwhile, as I said, we do see a possibility of still higher double digit growth of 14-15 odd percent for FY23. It is not a very deep cyclical sector, it is a relatively more shallow cyclical, if it all and even if there were to be a recession, there are certain activities or certain services which probably will continue to find demand.

So it should be a sector which should be able to manage at least somewhere near the double digit mark in terms of growth and that would probably mean that valuations can hold up in and around these levels.

Give me three reasons why one should not sell right now. Three reasons why here from now for those who have not sold they will be happy?
One is clearly the fact where you assess your downside and you have probably lost about 20% on an average from the peak. If you are staring at something like a 7-8% or a maximum of 10% decline, is it worth doing that trade at this stage?

The second thing is that it is always very difficult to come back and so there is an opportunity cost and a transaction cost which comes about. If you add up all these things beyond a particular point, the whole exercise is probably not worth it and especially if you have gone through a good part of it over the last six odd months.

Then, what you hold is a view for the next two years as well. It is not five years and so on and let us not talk about very long term periods, but in terms of the overall economic cycle, at least for India and the Indian market and Indian economy, we are reasonably well placed.

There is a clear and present danger in the form of inflation which is haunting all of us and probably for India a little more, given that many of the components of inflation for India are not within our control and one part which is probably within our control is food inflation. It has also gone out of our control because of the Russia-Ukraine affair.

So by definition, it also implies that India is going to be the immediate beneficiary of any come down in inflation and probably any kind of resolution to the geopolitical conflict. From that standpoint, there is a fair bit to look forward to as well. We do not really see a situation like we are going to fall off a cliff in terms of earnings delivery.

Keeping all these in mind and valuations which are probably already somewhere near the five-year average and within the next 7-8%, we will get closer to the ten-year average. It does not look to me like a very good thing to sell out now.

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