‘Normal monsoon, likely rate cut to support market’

Indian markets will remain range-bound but with a positive bias, supported by a normal monsoon outlook and expectations of an interest rate cut in the second half, according to Amisha Vora of PL Capital-Prabhudas Lilladher.

Vora, managing director and chairperson of the company, doesn't expect net outflows from mutual funds despite the high valuations unless a black swan event upends the apple cart.

Edited excerpts from the interview.

The earnings season has been modest. Markets, save large caps, seem to have priced in all the good news. What's your short- to medium-term expectations of market direction given the valuations?

The earnings season has indeed been mixed, with sectors such as pharmaceuticals, healthcare, consumer durables, capital goods, and automobiles showing more than 20% Ebitda growth. However, pressure in oil & gas and cement has kept overall Ebitda growth subdued in low single digits. For the last six months, we have seen that mid- and small-caps have been doing better than large-caps. In fact, some mid-caps are even trading at a premium to large-caps. Given this backdrop, we expect large-caps to outperform mid-caps over the medium term due to the valuation differential in their favour. In the short to medium term, I believe the markets are likely to remain range-bound with a positive bias. This outlook is supported by factors such as normal monsoons and the expectation of an interest rate cut in the latter half of the year.

The profit margins were slightly better because of lower input costs, but top-line and bottom-line growth was tepid. What's your forecast for the whole year (FY25)?

Margins have shown improvement in sectors such as automobiles, capital goods, consumer durables, healthcare, and metals. However, overall universe’s profit margins have been under pressure mainly due to the decline in margins in the oil & gas sector. In the upcoming quarters of FY25, we expect profitability to improve as the impact of elections wanes off and normal monsoons boost demand.

Financials comprise a major part of m-cap but banks are faced with a high cost of funds. Stuck in a sense as the EBLR hasn't been changed while fight for deposits intensifies putting pressure on NIMs. What's your call on banking?

We believe that the reported number in financials will remain under pressure as many large banks have a high loan-to-deposit ratio (LDR). In turn, the deposit rates are inching up because of the need to reduce LDR.

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As interest rates are expected to decline in the second half, net interest margins (NIM) and overall profitability in the banking sector are likely to come under pressure. We believe most of it is already factored into the stock prices and the valuations of major banks are favourable. But chances of significant outperformance look unlikely in the near-term.

What about IT? What are your plays for the current fiscal and what's the logic for the same?

At present, IT growth rates seem to have bottomed out as segments like BFSI, telecom, retail and manufacturing have shown green shoots. Segments like EDS (electronic data systems), data analytics, digital, artificial intelligence and supply chain, etc. will drive growth in the next cycle. While current valuations may not be cheap, we believe that the IT sector can give a good defensive hedge against market volatility.

Even if the Fed cuts rates RBI's hands might be tied because non-core prices (food/fuel) are volatile. What's your take on this?

India's retail inflation moderated to 3.54% in July (from 5.08% in June), the lowest in 59 months. This also brings inflation within the tolerance limits of the RBI. Given the normal monsoon in August, the RBI has room to consider a rate cut in the second half of the year, particularly if the Fed also moves in that direction.

The way share prices have shot up, the mutual fund investors have booked profit thanks to stock aspect. So, stoppage is happening in SIP. Do you expect any net outflows in the coming months given the lofty valuations?

Mutual fund inflows have been witnessing a steady rise with net inflows hitting ₹23,332 crore in July (up from ₹21,262 crore in June 2024). It is also a 53% increase from ₹15,245 crore in July 2023.Given the positive economic outlook and the maturity demonstrated by investors in navigating market volatility over the last few years, we do not anticipate net outflows based purely on market valuations. Not unless there is an external factor or black swan event that affects the markets in a significant manner.

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Further, the structural under-penetration of financial services in India, compared to global averages, suggests a long runway for growth. For instance, the mutual fund industry in India accounts for just 29% of GDP, compared to 117% in the US, and only 11% of India's population holds demat accounts, versus 65% in the US. Moreover, Sebi’s push for smaller-sized SIPs is expected to enhance retail participation in a responsible manner, further strengthening the foundation for long-term growth. We are just at the beginning of what could be a significant expansion in domestic equity investments.

What are the main risks to our markets domestically (state elections) and globally?

On the global front, geopolitical tensions in the Middle East, Russia, and Ukraine continue to pose significant risks, particularly concerning their potential impact on commodity prices, inflation, and global economic growth. Domestically, political stability at the centre and the outcome of upcoming state elections will be key factors to monitor in the near-term.

The measures on curbing F&O for retail. What's your assessment in terms of its impact on volumes? There is also STT rise from October.

Sebi's recent proposals are aimed at enhancing the robustness of the derivatives market, with a focus on curbing speculative trading among retail investors. The key proposals include increasing the size of derivatives contracts (from the current ₹5-8 lakh to ₹15-20 lakhs initially, and later to ₹20-30 lakh) and reducing the frequency of weekly expiries (from 5 a week to 1 a week per exchange). These measures are likely to moderate trading volumes, particularly among small retail investors. However, these changes are crucial for ensuring long-term market stability and reducing the risks associated with excessive speculation.

Also, it may impact discount brokers, whose business heavily relies on retail F&O trades. However, traditional brokers like us, with higher transaction fees and a focus on research-backed trades and investments, are less likely to be affected.

Further, the rise in STT, while initially a concern, has not significantly impacted trading volumes. In fact, data shows an uptick in both futures and options volumes post-budget, indicating that market participants are adapting to the changes.

Would you look at debt favourably now?

The consensus among market participants is that the Federal Reserve may initiate rate cuts between September and December. This is driven by the incrementally weaker than expected labour market in the US. Job cuts among major tech giants, often referred to as the "Magnificent Seven," also indicate a weaker outlook going ahead. In India, the RBI measures focused on risk control and strengthening bank balance sheets have largely been completed. This creates a strong probability that interest rates over the next couple of years will be lower than current levels. Given this outlook, we are cautiously optimistic about long-duration debt and have increased our allocation towards longer maturities.

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From a credit perspective, the robust domestic growth story makes credits an attractive investment. We are comfortable allocating a portion of the portfolio to mid-cap entities with above-investment-grade ratings. Additionally, with India's recent inclusion in global bond indices, we anticipate a more benign environment for bond yields, driven by increased foreign investor participation. There is also a growing possibility of an upgrade in India's sovereign credit ratings, which could provide further downward pressure on bond yields, making this an opportune time to consider debt investments.