Domestic cyclicals better placed than global cyclicals

As cyclicals are becoming a consensus trade, investors should be more cautious on global cyclicals like metals and auto exporters, says Manish Gunwani, CIO – Equity Investments, Nippon India Mutual Fund. Edited excerpts:

Despite concerns centred around inflation and US Fed, the market has managed to climb the wall of worry. Are you surprised because inflation has always haunted equity markets?
While inflation is high, interest rates have not gone up. That is theoretically a great combination for equities because inflation gives you topline growth and corporate earnings give you profit growth, but the discounting factor or the PE multiples remain high because the interest rates are low.

So that is probably a big part of why the market remained healthy right through the second Covid wave.

Inflation expectations have started falling. Typically, it is a bearish signal for growth, commodities, etc. Globally, equity markets are still pretty optimistic, although sectoral rotation has happened from commodities and cyclicals to FAANG stocks. But it is a fascinating divergence at this point of time. The US 10-year yields have actually fallen quite a bit. So it is predicting that the whole reflation trade is past its peak. But I do not that think equity markets are looking at it that way.

From retail brokers to HNI investors, strategists and fund managers, everybody is suddenly bullish on industrials and cyclicals. Is the trade not getting crowded?

One needs to introspect because this is becoming a consensus trade. Global bond markets are not as optimistic as some of the equity markets are. You have to take into account that some of the global bellwether stocks like Caterpillar have corrected quite a lot recently. Arcelor Mittal corrected as well.

Also, I would be a bit more cautious right now on the global cycle. The Indian cycle is in its early stages, both from a near-term perspective and from a medium-to-long-term perspective. The US economy has been doing well for the last 8-10 years. It had a bump with Covid and it came out of it. But in terms of corporate profits-to-GDP or capacity utilisation, the US economy is far more advanced in the cycle.

When we look at the Indian cycle from a near term perspective, we had two Covid waves. More importantly, for the last few years our corporate profit to GDP has been falling. We have had a huge underutilisation in many big sectors like power, cement, etc. Now I think we are coming out of a fairly long down cycle. We have a good combination of macro factors to drive growth. We have a reasonably strong global growth which also feeds into Indian growth. You have low real interest rates, reasonably high fiscal spending and a huge pent-up demand. Now it is literally like saying that if India cannot grow form here, then we do not know when India can grow fast ever again. With this kind of combination, it is very difficult to see why India should not have a very strong economy for the next 12 to 18 months.

So you are correct that there is a bit of a consensus building up on cyclicals. But domestic cyclicals are better placed than global cyclicals. Global cyclicals are primarily metals, auto exporters, etc. I would be a bit more worried about them than banks, cement and real estate now.

What is looking attractive to you across financials and why?
One of the themes we stuck with for the last 4-5 years in financials is value banks. It did not work initially but in the last 1-2 years, it has worked pretty okay. They used to be called corporate banks. Honestly, right now their retail focus is relatively large and so may be (the term) corporate banks is a misnomer.

We believe that the theme has many legs to go because the credit quality is reversing to the mean. The corporate books are in pain right now. Think about how technology is playing a bigger role in determining where the profit pools are shifting in financials. We feel more comfortable being in large banks that have the necessary bandwidth and resources to put up best-in-class technology.

We remain positive on both sides of insurance, life and general.

We are cautious on NBFCs and small private banks because the scalability of these business models becomes an issue beyond a certain size. The technology part is becoming as issue.

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