Short term, market will likely remain in a consolidation mode: Rahul Baijal

“The next 6-12 months is where the focus in terms of the slowdown lies and we have done some stress testing and the current portfolio construction in terms of direction of overweight and underweight is building in some sort of a slowdown which we are expecting and the implications for the relevant stocks and the sector positioning in the funds,” says Rahul Baijal, Senior Fund Manager (Equity), HDFC AMC

What are the key monitorables in your view right now? A section of the market believes that CPI in the US as well as in India, has rolled over and directionally will be going down. But the other section believes inflation will be sticky for long and it will not be that easy to get over it. They say the market may have run ahead of fundamentals. What is your view?
Two big macro variables are important for the equity market going forward. Locally and globally, especially in the US, the focus of investors are on these two variables. Firstly it is the inflation peak timing and therefore the Fed rate peak timing or the local repo rate peak timing. On that front, there is some more comfort coming in, given the last few weeks’ data. The risk-off, which is happening in the market on the back of that variable, seems to be tapering off a bit.

But the second variable is the impact of the slowdown ahead and how long and intense it is going to be in the west and the implications for emerging markets like India. The debate on that is still out and it will take about three to six months for clarity to emerge on that front.


From a market perspective, on the first leg, some more clarity has come out. In the second leg, we will keep throwing some uncertainty and from that perspective, my sense is short term, the chances are high that we probably will remain in a consolidation mode.

Where do you find the most robust earnings quality and then we will come to whether the valuations are pricing it in or not. What is the trajectory of earnings from your observations of this earning season gone by and commentary?
It has been a mixed season. Some sectors have clearly surprised and delivered on earnings. Banking is top of the pack over there. Then even IT on the margins front was a positive surprise. On the consumption front, we have seen high-end consumption, earnings quality being good. However, mass consumption still seems to be having a soft patch which has been the case for more than a year now.

So, it is a mixed bag. Banking is looking good, high-end consumption is looking good, there are parts of the auto sector like the CV cycle, the passenger vehicle cycle which is looking good and there are pockets in the domestic private sector capex cycle where earnings quality is looking good. So, that is an area where earnings quality is looking good.

On the other hand, there is some soft patch in mass consumption as we can see in the way two-wheelers and many FMCG businesses are reporting the performance. Over there, some softness continues. Even in the case of metals, which are more linked to the global cycles, the soft patch continues. So, it is a mixed bag out there.

What is your view of the broader end of the markets, the smallcap and the midcap end of the market versus the largecaps? That particular end of the market sometimes gets ahead of the fundamentals and gets too compressed. How do you see the valuations argument on broader markets right now versus the benchmarks?
The valuation froth to a great extent has been taken out across asset classes even in equities. If you look at the kind of correction we are seeing in global technology space and even locally, the kind of correction we are seeing in tech names which were listed last year or IT services YTD.

Broader markets had pockets of euphoria and given the last one year of corrective phase, a lot of valuation froth seems to have been taken out across many mid and smallcap names. I am in the camp which believes that after a prolonged corrective phase over the last one year, a lot of valuation froth has been taken off.

How concerned are you about the global slowdown because around 40% of Nifty earnings are global in nature? The fact is Europe is melting away on the economic front, particularly Germany. How will that impact the overall earnings for a vast area of corporate India which does business with that region?
That’s a very valid concern. I mentioned the extent and the intensity of the slowdown ahead in the west is a key monitorable for the macro behaviour of the markets. I think Europe probably has bigger problems versus what is happening in the US. The underlying strength of the US economy looks pretty good to me.

My sense is that India has a higher correlation as far as the economic performance and even market performance with the US markets. My sense is that the US probably will manage to come out of this much easier but I agree with you that Europe is where probably the bigger problem lies and many manufacturing companies which have export linkages to Europe, will have a hard time in the slowdown ahead. Clearly one has to be very careful picking stocks on the export front over the next one year clearly.

You must have stress tested your portfolio over the last few weeks. 12-24 months far out, what comfort are you getting on the earnings on a blended earnings part of your portfolio after discounting some of it?
We keep doing stress testing regularly in terms of one year forward, two year forward earnings. At the end of this earnings season, it has been a mixed bag. There has clearly been some reinforcement in the overweight positions I have been running in terms of sector calls. There is clearly more of a negative reinforcement in some of the underweight bets.

So while this is an ongoing exercise, in terms of two-year forward, it is still a bit too early. Like I said, the next six to 12 months is where the focus in terms of the slowdown lies and we have done some stress testing and the current portfolio construction in terms of direction of overweight and underweight is building in some sort of a slowdown which we are expecting and the implications for the relevant stocks and the sector positioning in the funds.