market valuations: As market valuations turn reasonable, here’s how to invest- Newshubweek

market valuations: As market valuations turn reasonable, here’s how to invest- Newshubweek
Written by Arindam

There’s some beauty in asset allocation. It provides shade in times of storms but in days of good sunshine, it allows the flexibility to enjoy a little more. Do I even say something new by saying we all want a better risk-reward opportunity? It’s ubiquitous. The question statement then is how do we achieve that objective? To that goal, watching macro data, valuations, yields, central bank actions and more help in completing the puzzle. In investing, however, even a completed puzzle looks different to different people. Hence, here’s our interpretation of data and the opportunities in the current market scenario.

The market narrative has swiftly changed from screams of “frothy” to “reasonable”. From highs of 32+ on forward PE multiple, valuations are now looking reasonable at ~20x. Even the broader market has seen correction, with only 20% of NSE500 stocks above their 200-day moving average. More than 50% stocks have corrected over 30% from their 52-week peaks. Clearly, the price correction has created some comfort on valuations. The key to successful investing remains paying less than what it is worth. So what can investors do?

Let’s try to understand what led to volatility in valuations. Earnings had collapsed at the outbreak of the pandemic and bounced back much sharply thereafter. Additionally, the interest rates were extremely low. These factors are reversing now – bringing the somewhat meaningless valuations of last year within reason. This creates an entry opportunity in specific sectors that must be leveraged. Looking at macros and valuations, there is an opportunity in banks and other financials, autos and ancillaries, healthcare and some construction material.

To start with, let’s address a global trend that is unfolding. India’s domestic growth appears resilient whereas developed economies are weakening as they let off the crutches from pandemic dole outs. Sequentially, high frequency data is turning worse for the US & EU whereas India is demonstrating resilience. This makes us focus on stocks and sectors that are benefitting from domestic growth resilience.

The second trend is flattening of the yield curve. Historically, when RBI starts to raise rates, long term yields tend to stagnate. This is either because it has already run up significantly or with rising rates, the growth outlook worsens. In either case, the short term yields rise up in direct relation with RBI’s repo rates and while long term stagnates, flattening the yield curve. When such a scenario happens, it is time to own lenders (banks) of credit over borrowers (metals) and users of commodities (auto) over producers of commodities (metals). Therefore, while metals have seen a rally in the past few months and a correction in the immediate term, our view is more aligned towards owning banks and autos.

Banks and autos have other fundamental tailwinds as well. Credit growth is improving with the latest number upwards of 11% YoY. Rising rates are also good for banking profitability. Autos were going through a bad cycle with volume numbers much below the trend. With metal prices, especially steel prices, easing EBITDA margins of autos are likely to improve. A sound bottoms-up approach in these sectors is likely to offer good returns. Both these sectors will gain from resilient domestic demand.

The other sector we like is pharmaceuticals and healthcare, the one which is now turning out to be a structural theme. The valuations for both domestic and global pharmaceuticals are now trending below long-term averages. Additionally, it is a defensive sector worth owning. Therefore, an allocation to pharmaceuticals is warranted.

While we have spoken on equity sectors, asset allocation is incomplete without balancing it with debt. On the debt front, since the expectation of rate hikes exists, adding low duration bonds made sense. However, as we reach a time when the long end seems to be stagnating, it will be wiser to add duration bonds. Even without the technicalities, a moderate risk appetite can look at allocating 50% to equity, 10% to alternate and hybrid and the remaining 40% to debt.

Having said all that, the mantra to investing remains – suit yourself! Suit your risk appetite, goals and individual circumstances. And while you’re at it, remember nothing lasts forever, in life and in investing! Therefore, we need to create resilient mechanisms to tackle the good and the bad.

(The author, Ankita Pathak, is Product Manager & Macroeconomist at DSP Mutual Fund. Views are her own)

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