shreyash devalkar: Which sectors will perform well in this type of market? Shreyash Devalkar responds

“Among the largecaps and especially Clever, financial services and consumer, which accounts for around 50-55%, were downgraded due to challenges in the consumer segment. This segment’s weightings are higher in large caps and that is why, on the index front as well, large caps underperformed mid caps,” says Shreyash DevalkarSenior Fund Manager – Equities, Axis Mutual Fund.

What are you doing about the quality of the gains that have come so far? Nearly half of Nifty’s earnings by Nifty weighting reported results. This clearly shows that revenue growth is there, but margin pressures are there. How have you analyzed the commentary and quality of earnings so far?
On the results front, as usual, it starts with IT, then finance and other sectors. Margin pressures started a year ago. This is not a recent phenomenon. But normally, it is observed that if revenue growth is in the mid-teens or above, the pressures on margins are absorbed while if they are lower, then it becomes difficult to absorb them.

So when it comes to the earnings season, there have been some concerns about the margin between the segments. It could be IT, in some cases it’s also NIMs that have been under some pressure as well. It has nothing to do with inflation in the case of NIMs, but it’s broadly the same theme so far. Some of these things were probably known in the market and the market started to cut profits for the same reason. However, outside IT, the problem is different, but while in other sectors the problem has been aggravated by the recent war situation and associated with raw material prices in all areas, inflation of costs was actually reflected in some of the cement results and among others. So yes, it remains a short-term concern.

Do you think this is the worst of the pressure on margins and the spike in inflation that would occur between this quarter and the quarter to come?
Yes. This time it’s different. What is different about margin pressure is cost inflation due to supply constraint. Unlike normal times, probably 2004 and 2008, it was more of demand driven cost inflation, maybe raw materials, maybe electricity or whatever.

This time around, it’s more of a supply constraint, and when it comes to supply constraints, the short-term triggers for this inflation have been geopolitical issues. Although in some commodities this has been further aggravated by underinvestment over the past five to 10 years. But the recent trigger has been the supply constraint and that too triggered by geopolitical issues.

In my opinion, if the sanctions and the associated geopolitical problems ease in the short term, this can lead to the reduction of the pressure on commodity prices. Especially for India, what matters is gross and that’s where the emphasis is. It is therefore certainly not requested. It’s not that demand is growing so much that it justifies such high prices. It’s definitely supply and if there’s a reserve it should go down.

How overweight are you at the moment? If interest rates continue to rise, there is no hurry then, which sectors will do well in this type of market?
Already, the market has played a role. The best performers in the market so far this calendar year have been producers; it can therefore be a producer of raw materials. This also relates to utilities and this has been the trade so far in the market. In the future, when this inflation will subside remains the key question, especially since it is triggered and revolves around geopolitical issues and it could repeat itself.

What matters for India’s consumption story is crude oil and because it adds a huge burden on the country. Regarding this inflation, consumer stories are definitely hurt because there is a double whammy of commodity price inflation on the one hand and demand translation because of it.

What do you think of midcaps and smallcaps in terms of valuation? Traditionally, they traded at a discount to large caps. How do you analyze the valuation? They trade like a basket. What is the quality of earnings they are likely to post because these companies are more disturbed on the margin front and the rate hike scenario?
True. As far as mid caps are concerned, you are right to say that the valuations are higher. If you take any sector from consumer to IT to any other financial service, the only segment where it remains as always discounted to large cap. These valuations are high for multiple reasons and above all it is also the result of the rally that has taken place over the past two years.

In the midcaps, there are several segments. The beneficiaries of geopolitical tensions, China plus policy and supply constraints, are more in the midcaps and in sectors such as chemicals and textiles. The beneficiaries of some of the policy changes have been in the industrial segment, the sugar segment and so on. When you look at the midcaps as a whole, the market has rewarded a lot, including the industrials, but after this rally, the valuation of some of these segments is really high compared to their historical averages.

In this context, looking at large caps and Nifty, financials and consumer, which accounts for around 50-55%, has been downgraded due to challenges in the consumer segment. The fact is that the weighting of this segment is higher in largecaps and that is why, also on the front of the index, largecaps underperformed compared to midcaps.

When $95 billion begins to be withdrawn from the international market each month in the form of liquidity withdrawals by the fed, how do you see the global markets reacting? What is the share of this tightening in the price and what will be its impact on emerging markets?
Global markets have already reacted. They reacted with interrelated factors, be it a cycle of rising interest rates or reduced liquidity. This has been playing out now for six to eight months – both in developed and emerging markets, probably in India. Some of the companies benefit from it and they have a significant weight in certain indices and this is doing well.

Whether the valuations are correct or not is always debatable, but those beneficiaries have been there in Indian indexes versus global indexes. As far as global markets are concerned, this is already playing out. Some of the markets are down 20-20% and this is a result of both rising interest rates and earnings not being delivered as expected earlier.

India, again at a specific stock level, has seen significant corrections this calendar year in several stocks and this is where the market at a global level has gone nowhere as stocks have fallen significantly in various segments.

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