Reasonable to expect positive FPI flows will continue: Abhiram Eleswarapu

"It is encouraging to see nearly $5 billion of FPI inflows this month into India after a long period of sustained outflows", he said

The market rally in the past two months has made valuations expensive. As a result, any new data that points to sticky inflation or sharply falling growth could hurt equities, says Abhiram Eleswarapu, head of India equities, BNP Paribas. He told Sundar Sethuraman, in an interview he would prefer to be defensively positioned and opt for cash-rich and dividend-paying companies. Edited excerpts:

What do you think has propelled the market off June lows?

The market narrative has changed from one of rising inflation to peaking inflation. Fears of an imminent developed markets recession have receded, and investor expectations of a “soft landing” have risen. As a result, the US 10-year bond yields have corrected to 2.9 per cent from a 3.5 per cent recent peak on expectations that the Fed will slow its pace of hikes. But more than anything else, we believe that investor positioning around late June and early July suggested extreme risk aversion, and therefore any positive news was likely to be met with a stock market bounce.

Is the market over optimistic with its assessment of inflation and less aggressive about monetary tightening?

Our outlook is somewhat stagflationary, with GDP growth expected to slow to below trend and inflation likely to settle above pre-pandemic levels across both developed and emerging markets. But we don’t entirely disagree with the market’s assessment of inflation or tightening. The July FOMC Minutes support the view that the Fed has turned more cautious and data-dependent and looks set to downshift to a 50-basis point hike at the upcoming September meeting. That said, inflation and payroll data in August are critical for this view to sustain. In my view, the rally since June has been sharper than expected.

With valuations no longer being that favourable, any new data points which point to sticky inflation or sharply falling growth could hurt equities. The quantum of quantitative tightening (QT) is expected to double starting in September, which in turn, could be an additional negative trigger.

What’s the outlook on oil? Has the recent correction improved India’s macro outlook?

Oil prices have reacted, of late, to expectations of weakening demand, higher OPEC capacity, a potential Iran deal and higher shale oil output offsetting declining Russian supply. Our view is that in absence of a global recession, oil prices will moderately rise from here. From India’s standpoint, weaker oil prices but healthy overall domestic demand are the best possible outcome as most macroeconomic projections were built around oil prices staying above $100/bbl through this year.

FPIs have turned net buyers since July. Do you expect positive flows to continue?

It is encouraging to see nearly $5 billion of FPI inflows this month into India after a long period of sustained outflows. We are overweight on India within Asia, excluding Japan. Given the broader environment of a global slowdown, India’s corporate growth and fiscal position seem relatively healthy. A considerable proportion of India’s inflation is also imported rather than because of local factors. Thus, in the absence of a macro meltdown, it is reasonable to expect that positive flows will continue, even if not at the same magnitude as we have seen this month.

 Index valuations are back above their long-term averages? Is there any scope for significant gains from these levels?

The Nifty trades at nearly 20 times one-year forward P/E. This look somewhat inconsistent with higher inflation and yields and the prospect of at least some slowdown in demand. We would prefer to be more defensively positioned in the near term, and would consider cash-rich and dividend-paying companies or those, which have a sustainable competitive advantage within their sectors.
 

Which sectors are you bullish on, and which would you like to stay aloof?
 

From a long-term perspective, banks still seem to offer the best combination of valuations and earnings comfort to us. We prefer large high CASA banks that we think will gain market share. These banks also happen to be investing the most in their digital footprint. We also selectively like telcos, healthcare, and IT services where demand is still healthy, and margins may have bottomed. In consumer durables and autos, we see larger players as being better positioned to benefit from falling commodity prices given the high competition and continued supply chain issues. Some metals stocks also screen well on valuations and could be a play on China's reopening.
 

 Your thoughts on the June quarter results. How soon will input cost pressures ease for Indian Inc.?
 

The first quarter results were largely as per expectations. Inflationary pressures are reflected in more than 50 per cent of companies beating topline estimates, but only about 30 per cent being able to do so on the bottom line. That said, these figures are not a large deviation from what we have seen in the past five or six quarters. At an aggregate level, we have seen marginal earnings downgrades, but not enough to be concerned. Over the next few months, inflationary pressures easing could coincide with slowing demand, and we could still end up with a net neutral impact on earnings estimates.