Markets May Turn Volatile As Earnings Estimates See Revision, Says Ambit's Dhiraj Agarwal
The Fed commentary at the latest policy meeting was dovish in nature, especially when compared to the slightly hawkish tone of the previous statements, says Agarwal.
The markets may turn volatile through the fourth-quarter earnings season as optimistic FY25 estimates face downward revisions, according to Dhiraj Agarwal, managing director at Ambit Investment Managers.
Earnings performance will keep the market dynamics non-liner this year, marked by significant volatility throughout 2024, he told NDTV Profit. He anticipates a potentially choppy earnings season in the upcoming quarter, leading to fluctuating market conditions.
Views On Recent Fed Meet
The Fed commentary at the latest policy meeting was dovish in nature, especially when compared to the slightly hawkish tone of the previous statements, Agarwal said. The latest announcement was notably specific, indicating that markets can anticipate three rate cuts in the second half of the year, he said.
This represents a departure from previous ambiguity, as Agarwal noted that this is the first time there has been such certainty regarding future rate cuts.
Outlook On BSFI And IT Space
The BFSI sector is currently performing well, and there are no significant challenges anticipated in the coming years, said Agarwal.
While large banks are not performing poorly, the improvement in other sectors has shifted the focus, he said. The banking sector's recent trends mirror those observed from 2015 to 2020, with previously underperforming banks now showing signs of improvement, he said.
There has been a reversal in the valuation of large banks as stocks have not performed well despite rising growth, Agarwal said. Conversely, the banks that faced challenges during 2015–2019 have shown considerable catch-up in performance.
Talking about the IT space, "I think IT might struggle a bit this year in terms of growth."
Watch The Full Interview Here:
Edited excerpts from the interview:
Can't talk about what the U.S. Federal Reserve said, leaving the case for three rate cuts unchanged which was a bit of a surprise to many, and Jerome Powell also talking about slowing down at some point of time in the year. What did you make of the commentary and what would it mean for emerging markets like India?
Dhiraj Agarwal: It's really a dovish pivot in this particular commentary compared to the last few commentaries coming in by the Fed which is maybe slightly on the hawkish side, I would say and I’ll add slightly because it's not that the Fed has ever indicated that they’ll not be going into a rate cut cycle, but they've always maintained that they wanted to see inflation sustained at the target rate of roughly 2% before they actually go in for any rate cuts. This was a little bit more specific guidance that markets can expect two to three rate cuts in the second half of this year. So certainly it’s dovish, the impact of that we're seeing on the emerging markets all across this morning, including India. This certainly removes one uncertainty because 2023 we started with the markets expecting rate cuts in the second half of ‘23. That did not happen. In ‘24 we started with expectations of rate cuts as early as March and got pushed out to June or July. So this is the first time there's a little bit more certainty. So more than the cut itself, I’d say it's a certainty of this event happening rather than risk of it getting postponed yet again, is what the market is happy about.
What do you think the stance of a foreign portfolio investor might be because hitherto we missed FPI flows into India in a meaningful way in the last six months or so, give or take a few sporadic instances. Does the US economy performance, does Japan's policy normalisation and does a potential troika of rate cuts from the Fed alter the FPI stance in any fashion into India?
Dhiraj Agarwal: I don't think so honestly. The FPIs have been struggling with one basic variable in India, which is the macro looks outstanding and the micros a little mixed and second, within the whole micro sphere, wherever there is high confidence in terms of earnings delivery, the evaluations are a little bit of a concern. So I don't think any of these factors go away. So some of these macro variables are very good to move the markets on a short term near-term basis.
But once you zoom out, and then once again, you start focusing on what the earnings delivery of the economy is. On that front. I've maintained that for this year, the markets will be non-linear and when I say markets will be non-linear, I basically try to imply that markets will be very volatile through 2024 and the primary reason for that is earnings performance of the markets. So in the last three quarters Nifty earnings have grown by 23-24% and sales growth is only 5% and most of the earnings expansion is coming through margins. The positive impact of the falling WPI will start to fade away very very soon and if sales growth doesn’t doesn't pick up, we have a slightly choppy earnings season into the coming quarters and hence a choppy market on our cards.
So is that the base case that the optimistic numbers of FY25 on the EPS growth front might actually come under question?
Dhiraj Agarwal: Yes, that's my base view that optimistic earnings estimates of FY25 will keep seeing cuts, 5% sales growth is far too weak and remember this 5% sales growth of the previous nine months is despite a 9%-odd nominal GDP growth. So the Nifty sales growth is lagging the nominal GDP growth by 400 basis points which is not a good sign.
Why would that be happening, just trying to understand it?
Dhiraj Agarwal: Two possible explanations for that. One is if you listen to most of the consumer companies commentary in the previous results season, almost everybody said that the smaller regional players have bounced back very very strongly and (have) taken market share away and I'm extrapolating that a possible reason is the fillip to the smaller regional players bouncing back is in the last six to eight quarters of cost benefit for listed companies, instead of passing the benefit on to the consumers, the company's chose to increase margins.
So just to give you an example of (Hindustan) Unilever, just for an illustration point because Unilever is the largest consumer company in the country. Over four quarters, the gross margins have gone up by 900 plus basis points. Now and those kinds of margins, regional companies are viable once again. So the smaller regional companies went through this whole pain of winding down a little bit because of formalisation in GST. But now they've got their act together in terms of getting more formal and with this additional booster margins are profitable again.
So some amount of the market share has been lost to unlisted players. That's possibly, reason number one. The possible reason number two is the K-shape of our economy. So luxury is going fantastic. Mid and bottom is probably still struggling to some extent, which basically means that a large section of unlisted space which will expose the mid and lower segments are still struggling.
Could there a case be made for mean reversion for this as well. I mean, you are right, I mean base consumption has struggled. Staples has struggled, some kind of segue into consumption, if you will, but do you think a mean reversion case could be made or predicted or would you rather wait for evidence to show up on the screen?
Dhiraj Agarwal: Honestly, I would rather wait for some evidence to show on the screen because it is easy to make a mean reversion call of the valuations have reached a level where they're clearly in the cheap territory and then you can say at these valuations even if I have to wait for a few quarters for a mean reversion trend to restart it's fine. But that's not the case yet. So I would rather wait for some signals.
The other one that I want to talk to you about and there's this Morgan Stanley note to the Asia EM note, which speaks about how they seem (to think) that it's India’s decade, and India and Japan still remain the preferred markets, etc. I'm trying to understand the argument that there is a good domestic alpha opportunity because private capex finally seems to have entered a clear upcycle. We've been missing private capex for a long time now. I’d love to understand your thoughts, I mean, yours and Ambit’s thoughts when it comes to private capex. Has it taken off to your mind or is the proof still missing?
Dhiraj Agarwal: No, it's picking up. So on this whole capex front, I’d like to put two things on the table. One is it has been picking up, this has been a capex-driven market. But at the same time, one should take cognizance of the fact that the capex growth or the private capex growth is not as strong as what the headlines make it out to be.
So there is the off-setting impact. So even though the government capex in the last few years, while the government budgeted capex has gone up very, very strongly, the PSU capex has been a little bit under pressure. So if you consider public capex as PSU capex and government combined, the growth is in single digits. But it sounds a lot more because the on-budget government capex growth has been almost 23- 24% in the last three years, 17% budget for FY25. So capex will undoubtedly pick up. The capacity utilisation ratio for India as a country as a whole is reaching 77-78%. At that point of time, we have no choice but to start reinvesting. So we are optimistic on private capex.
I was looking at a note by Pranjul Bhandari of HSBC, who said that in select cases, I wonder if your view is the same or similar, in that some of the capex that is happening is happening in sectors where in the initial spurt isn’t as high as what will come about in the next two or three years. So both FDI will come into some of these sectors and the resultant up move in capex over the next 24 months on the private side will be thick and fast. Could that be possible and could that have a multiplier effect?
Dhiraj Agarwal: Yes, the capex will certainly pick up both in terms of capacity utilisation number which I gave as well as some of the new sectors that are building, like semiconductors, EVs, etc. where new money is coming into the ground. So the capex will certainly pick up. We will continue to be sort of a capex-driven environment for the next few years. And I will just link it back to the consumption driven economy for the next few years and I would just link it back to the consumption discussion that we had a while ago.
So, you know, mathematically and we've seen that in the 2003 to 2008 cycle as well, when the capex growth is picking up, the consumption growth tends to take a backseat. Anecdotally, why does it happen and because a lot of consumption and capex in the Indian context is the way our national accounts is defined: the household savings and household consumption, a lot of it actually goes into businesses as well.
So when there is a tendency or when there is a positive bias towards the economy about reinvesting more in your own business, many people just tend to postpone consumption, whichever areas it can be postponed, to be able to free more capital for investment. So there's, always a little bit of a trade off but in I and C so I would assume, I would say that within the GDP component, I will continue to grow (in) double digits, which is what it has been doing in the past, which will put a little bit of pressure on C for the next few years as well. That's highly likely.
So just a follow up. I'm tempted to ask this to you. So you believe the bottom end of the C will suffer or the premiumisation which has held out for the last three years post Covid will come into question?
Dhiraj Agarwal: I think premiumisation is probably shielded. That segment, even the high-ticket spends, isn’t that large percentage of expenditure of the super rich, so that just continues to go on.
Dhiraj, healthcare is, in some sense, chalk and cheese, isn't it? The U.S. generic makers have had a good 2023 after a long lull, if you will, but as an overall pocket, it kind of has its ebbs and flows with more downsides than upsides. Is there a trend that could be predicted for healthcare per se?
Dhiraj Agarwal: I think there is. I think U.S. generic is on an uptrend and these uptrends don't fizzle out in a short span like one year. So the previous US generic uptrend we saw topped out in 2014 after 11-12-13 years of a very very strong uptrend. It's been in a downtrend since 2014-15 approximately with price erosion, double-digit price erosion, sometimes even high teens, continuously right up till 2021- 21, 22, which is where it started to bottom out. So now a nice eight-nine years of down cycle of those various things, it forces weak players out of the market, it forces consolidation. It forces a little bit of a supply deficit because people aren't going to invest and a time has come where a number of generic drugs are actually going into a little bit of a supply deficit scenario as well as a few specific drugs. Sometimes there's been supply shortages as well.
So I would say this whole US generics uptick, which has happened is not an uptick. It's a reversal of trend. At the very minimum, it should last five to seven years. So I've been very constructive on Pharma from a medium to long-term basis, at least for now.
Is it contained to U.S. generics only, or we believe other facets of healthcare, I mean, people talk about CDMO being this multi-year opportunity that people might miss the forest for the trees if they're looking at only the near-term performance or for that matter, hospitals and diagnostics as well. Anything on those lines?
Dhiraj Agarwal: So positive on that too. CDMO is in some sense, there's no difference as compared to any offshoring sort of a strategy or any offshoring business. There are multiple factors playing into India’s expertise in Chemical Engineering, whether it is Chemicals or Pharmaceuticals high quality production as well as some amount of China plus one shift, which is happening across sectors, will continue to benefit us. CDMO and those businesses by definition will remain slightly more bulky and jumpy and hence, one might see some volatility up and down, going forward as well like we've seen in the past. But structurally in an uptrend for sure and same in hospitals and health care. The incidence of Indians reaching the bucket where they can afford better quality health care is rising. The penetration of health insurance is rising. India is sort of a health tourism destination and is also improving. So that business also seems to be the structure of trends. So the entire sector, I think, should do well over the next five, seven years.
Could we extend that argument to two other large sectors which are BFSI and I.T.? Let's start off with BFSI. Almost everybody on the street, I don't think there is an exception to this rule, is constructive on banks. One doesn't know when that uptick comes but for now, say for select private banks, the larger ones have been sulking. When we can make this case now, we will see them move?
Dhiraj Agarwal: Two things in terms of banks. The larger ones have been sulking because the larger ones have been doing badly. But simply the rest of the sector started doing so well. So what we have seen in the last three years in banking is a mirror image of what happened between 2015 to 2020. In fact, in one of the recent newsletters that I wrote actually published a very interesting chart where I showed that it will get the Bank Nifty constituent performances for between 2015 to 2019 and 2021 to current. It's exactly a mirror image of each other.
So ‘15 to ‘19, Kotak and HDFC were up between 150 and 175%. Amongst the large banks SBI and BOB were right at the bottom with minus 10 minus five plus five etc. 2021 to now BOB is right at the top at 177, SBI is about 150 and HDFC and Kotak are right at the bottom with just 5-10% performance and the reason for that is the other ones which are not doing well in ‘15 to ‘19 started doing well in this horizon. So if you look at FY24 numbers, it'll be very difficult to distinguish between the top five large cap banks whether it's ROE, Growth, NPA ratios, etc., all the metrics look very very similar. So there has been a valuation convergence in the banking system. So the bigger guys' valuations have gone down by stocks, not doing much and the earnings rising and the names which struggled within ‘15 to ‘19, the valuations have caught up by stocks performing. So at some point of time, the whole convergence process gets over sectors doing well. I don't see a big issue in the sector, the growth is intact. No big challenges on the credit risk, at least for the next few years on the horizon. So no reason why the sector as a whole can’t start delivering good performance going forward.
The other one is I.T. Until recently, none of the companies are talking about demand turning the corner at all. No visibility there. Would this be too early for somebody to look at I.T.? Never mind the fact that they are high quality companies...
Dhiraj Agarwal: I think I.T. might struggle a little bit this year in terms of growth pickup. So you know the U.S. is, as we all know, U.S. is a hardcore capitalist country and sometimes I feel a little strangely hardcore capitalist country because once I say it, you will be able to see that in perspective that U.S. companies start dialling down on expenditure even if there is a fear of a slowdown coming in, at some point of time down the line. They don't really wait for a slowdown to come in before they start cutting expenditure. That's what has been happening in the U.S. right now. Every single economist is calling for a growth slowdown.
At some point of time, it hasn't happened yet. Few even calling for a mild recession. Again, no signs of that yet. But those calls by the macro economists are enough for the companies to say ‘Hey, let's just postpone our spending for some more time. There's no hurry and then they'll just do it time and again’ and hence, till such time that whole cloud on whether the US economy slows down or not goes away, whether it actually slows down or not is immaterial. I don't really think the U.S. companies will bump up their budgets in a big hurry and hence I.T. will continue to do their middling sort of a performance. But if the markets were expecting or hoping for a big bump up in spending budgets by the American companies and hence a big pickup in growth this year from I.T. sector, it might be a cause for disappointment.
