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The RBI meet is just round the corner on May 4. There is a talk that this time perhaps there will be a 25 bps hike and not 50 bps as the Street was estimating earlier. Then there is the US rate hike trajectory. How long do you think this inflation and curbing of liquidity by central banks remain an issue? Has the worst of inflation already been made and in the coming quarters, we may see lower commodity prices?
Six months back, very few people were talking about macros and today that is the headline everywhere. The uncertainty over the Russian Ukrainian War has not helped matters, but in my opinion we are well past the halfway mark, if not the final stretches of this macro anxiety.
I am not referring only to commodity prices and inflation. But ultimately, markets have already reacted to all of this news by the form of pricing in as far as the rates are concerned as well as in terms of tightness as far as the forex market is concerned, especially with respect to dollar strength.
So from now on, the question is what can further surprise the markets and in my mind, this is something that only time will say and it is also event dependent like the Ukrainian conflict. It could also spring a surprise and get further elongated. But leaving aside any of those events that can potentially come through and which we are not aware of, pretty much whatever worries the Street has as far as inflation is concerned is already in the price as far as the rates are concerned.
Clearly the Fed rate hike which could be 50 bps or even 75 bps according to some, is already in the price. Possibly the next two sessions of Fed rate hikes are in the price. Post that, we will get to know whether there is any softness of the economy and therefore whether there can be any change in the overall trajectory. So long story short, I would think that bulk of the macro uncertainty is already in the price and we are in the final stretches of this macro uncertainty.
What are your thoughts on the earnings downgrade cycle? This is perhaps the third quarter in a row, when in general, earnings estimates may be trimmed. Is that cycle also kind of troughing out?
It is always important to look at the context and the big picture to give a sense of earnings in India. The top 1,000 companies’ earnings on a quarterly basis pre-Covid was about Rs 1,25.000 crore and the last few quarters is close to about Rs 2,50,000 crore. We have doubled as far as earnings are concerned. Obviously such a sharp increase in earnings is unlikely to keep going at the same pace.
I think the worst of commodity prices are not yet reflected as far as margins are concerned. When the March numbers get announced, possibly the June quarter numbers are where the bulk of the margin compression will come through and it is only post that the commodity prices will ease for the moment.
Post that, one will have to make a sense of whether the margins have bottomed out and price increases have happened across the board. In certain cases, they have covered some bit of the margin compression and in certain others, possibly over the course of the next six months, there would be a lot more than what is required to cover the margins. Post that, we will see earnings growth bottoming out and then the cycle will continue as it was in the past.
What are your views on some of the concerns over big demand destruction going forward across categories because of high inflation and slowdown in the economy? Do you agree to that and is that already in the price?
Absolutely. Demand destruction is something that is inevitable but it is a bit more nuanced. Let us speak first on the bigger picture and demand destruction. If you look at the broader energy, metal, food basket account for about 8% to 9% of overall GDP pre-Covid in 2019 and as the current prices are concerned, that is likely to go up close to about 12% to 13% of overall GDP.
That effectively means that the incremental delta in economic output has increased. Almost 50% to 60% of the consumer wallet is going to go primarily to this increased delta in food, energy and metal prices. Now this is unsustainable. Obviously the wallet is only so large and therefore there will be an impact in terms of demand in other categories. The nuance is that in India specifically, a lot of these consumer discretionaries are essentially focussed on the top 10-15% of households. So while demand destruction is clearly going to happen, it will happen more in the bottom of the pyramid because savings pools are much lesser and they will have a greater impact on consumption of food, energy and metals.
From a discretionary point of view, the top 10-15% of households may see lesser impact but clearly there is going to be a scale down in terms of volumes in all of these categories. In some sense, in the next two quarters, the commentary that various companies bring out along with the quarterly results, should set downward the expectations that the street is building in the space.
You appear to be relatively constructive on equities as an asset class. If one were to take a three-year view, what kind of earnings growth could mirror the returns outlook on earnings growth outlook on a multicap kind of a product or a basket of stocks?
I think that earnings are likely to be in reasonable teens as far as the broader markets are concerned. If you were talking about 17-18% earnings growth before all of these events happened, I would think that we should be more realistically looking at anywhere between 13% and 15% kind of earnings growth from a three-year out perspective.
Having said that, what is more encouraging for us is the balance sheet strength of corporates and the fact that the investment cycle is starting to come through, that is private capex. All these are nowhere as close. They are in the fourth gear or something, a lot of them were in neutral gear for the last seven, eight years and they are just moving now to the first gear. One will have to assess that in terms of the rate of change as far as private capex and housing is concerned and these are the two sectors or themes that we are far more positive on over the next three, five years. They underpin the overall earnings trajectory that the broader market should see over the course of the next three to five years.
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