Where not to invest in today's market? Rana Gupta answers

Rana Gupta, MD, Manulife Investment Management, says relative to the market, IT stocks are not very expensive. Many of the largecap IT stocks trade at around 3% yield of thereabouts, so they are not very expensive, and given what just happened on the structural and the cyclical theme on the Fed rate cut outlook, and the US boardroom confidence being back, this sector has seen some up move.

Gupta also says if we look at last year’s returns, some of the industrials and the PSU stocks are probably about 100%, whereas some of the select consumer or banking or the non-banks, are probably up 15-20%. So while industrials can be avoided for now, there’s a lot of opportunity in those segments due to the way the macros are aligning.



In the context of where IT and global AI are moving, where do Indian IT companies fit in? The IT index is at an all-time high even though the general view is that these businesses will get disrupted. Given that the market is confused about the impact of AI on Indian IT services, why is the IT index at an all-time high?
Rana Gupta: It was the view probably six to nine months back that AI will significantly disrupt Indian IT businesses. They will find it difficult to grow the revenues. But the way it has panned out in the last six to nine months, we have seen that the Indian IT companies, have disrupted themselves by embedding AI into the solution to the clients. This has meant pretty low revenue growth in the near term, but very large deal wins.

Now, when these companies come and talk to the investors, they highlight that as the deal wins have grown at the cost of near-term revenues being slow, the revenues will gradually ramp up and as they deliver these AI solutions, their margins will also go up and they have enough levers to control that margin. That has been the narrative.

I think right now there is some comfort among the investors that the gen AI may kind of affect the revenue in the short term, but in the medium-term is not such a bad thing. But that is one of the structural outlooks. Cyclically, all the IT companies have been highlighting that in the corporate boardrooms of the US, some kind of comfort has now revived given that the Fed put is now back. So, they are not as cautious. Therefore, the sentiment towards the IT sector has become better.

Anyway, relative to the market, these stocks are not very expensive. Many of the largecap IT stocks trade at around 3% yield or thereabouts, so they are not very expensive, and given what just happened on the structural and the cyclical theme on the Fed rate cut outlook, and the US boardroom confidence being back, this sector has seen some up move.

Where within this current market would you avoid putting fresh money to work or are sensing some signs of fatigue?
Rana Gupta: We have to look at the industrial sector because this sector has had a huge run-up. In the industrial sector, the government investment themes will continue. But given the valuation, they are trading at 30, 40, 50 times. One needs very accelerated growth of 25-30%, which has happened in the last three years. But we doubt that kind of growth rate can be sustained for a very long time. At the kind of valuation these stocks are trading at, they demand constant catalysts and growth surprises. We suspect this may not be the case going forward. So that is one segment we would be cautious about.

What should be in your mind when you look at managing funds in India, dollar return expectations for the next three years in terms of CAGR?
Rana Gupta: If I were not to factor in any re-rating of the market, we think the earning and EPS growth can call it strong and it could be in the mid-teens – 14-15%. We have a pretty constructive outlook on the rupee as well. But even with a 1-2% downside, we are looking at probably early mid-teen US dollar kind of returns and these returns are perfectly consistent with past trends. If you look at the last four, five, or seven years longer-term timeframe, Indian markets have returned that kind of US dollar returns. And we see no reason that cannot continue.

Let’s say this market is trading above historical averages. When you look at things like liquidity, domestic flows, and problems in the world but India growing on a relative and absolute basis, could these factors keep the PE multiple high? I remember there was a time when China traded at high PE multiples because they had growth. US tech stocks have traded at absurd PE multiples, but they are growing. Can the same happen with India?
Rana Gupta: At an aggregate level, Indian markets are a tad expensive, but not very expensive. The expensiveness has come more at the sector level. If someone is expecting that 50-60 PEs will sustain for some of the companies, that is where one would face some challenges. But at the market level, the Indian market PE overall for the last many years has been 15-16 times, it has gone up to 17-18 times.

It is trading a tad expensive, but better macro, domestic liquidity, and good earnings, are all helping. For all the factors that we discussed, this market has seen a re-rating and at an aggregate market level, the valuations are only a tad higher justified by all the macro improvements. At the sectoral level, there are dispersions. Just look at the last one-year returns. Some of the industrials and the PSU stocks are probably about 100%, whereas the sector that we are constructing and that we discussed, some of the select consumer or the banking or the non-banks, are probably up 15-20%. We see a lot of opportunity in those segments due to the way the macros are aligning.