Earnings expectations warrant near-term caution but medium-term outlook positive | INTERVIEW

Stock markets are now expecting earnings to improve sharply, helped by the massive liquidity inflow seen during the pandemic. Although this warrant some caution in the near term, but projections for the medium term see growth rebound leading to double-digit earnings growth for the market and healthy equity returns, Jitendra Arora, Executive Vice President & Senior Equity Fund Manager, ICICI Prudential Life Insurance told Kshitij Bhargava of The Outlooker Online. He further added that there is an opportunity for investors in stocks and sectors that are positively aligned towards the normalisation of the economy. Here are the edited excerpts.

Where do you see stock markets headed from here?

The last 15 months have been a very volatile but rewarding period for investors where we saw a 40% correction in a month and then a rally that led to fresh all-time highs for markets across the globe. The Covid-19 related demand shock was followed by both monetary and fiscal stimulus, leading to a sharp fall and quick recovery in the markets. At this point, markets are expecting earnings to improve sharply and given the backdrop of huge liquidity, it is trading at higher multiples compared to their own history. This warrants some caution in near term and we expect markets to consolidate around current levels. However, over the medium-term growth should rebound leading to double-digit earnings growth for the market and healthy equity returns.

What factors can drive markets in the coming quarters? 

In India, wave two has affected the demand recovery process. However, the markets are looking through that and expecting demand to start recovering as Covid-19 positive cases subside and vaccination improves. Stock prices are a function of earnings, liquidity and market sentiments. On earnings, it has been a mixed bag in the last 15 months where some sectors like commodities, speciality chemicals, paints and pharmaceuticals have done well due to global factors or pent up domestic demand, but certain other sectors like travel and hospitality, financials, refining and petrochemicals have been affected adversely. Market participants anticipate the affected sectors to recover and at the same time expect the sectors that have done well to consolidate earnings thus leading to a sharp earnings recovery for FY2022 and FY2023. Thus the trajectory of earnings and changes in financial conditions will be key drivers of markets in the coming quarters. We will not be surprised in case markets are disappointed by either of these factors in the next 2-3 quarters and correct as a result. However, the medium to long term view remains positive backed by expectations of a double-digit earnings growth for Indian corporates which should lead to healthy equity returns.

Metals stocks saw consolidation recently. Is it time to book profits and head out?

Global commodities like steel are very sensitive to minor demand and supply disruptions in the short term. So a supply cut in China, which is the largest producer and consumer of steel globally can change the course of steel prices. Supply cuts in China and expected demand stimulus from the rest of the world post covid has led to high steel prices. Indian steel stocks have been a beneficiary of these high prices and have used the cash flows to deleverage their balance sheets. However, forward earnings are building in a significant correction in prices from current levels. Thus, every quarter that prices stay at current levels will mean a significant addition to cashflows for steel companies that adds to their equity value. This can be utilised to deleverage further or fund growth. As a result, we may see some volatility and consolidation. However, valuations for a few companies are still attractive and may lead to healthy double-digit returns from current levels over 18-24 months.  

What are your views on the small and midcap space?

We prefer to look at each stock in its own unique light than as a category. There are pockets across the market-capitalisation category that appear rich. However, there are also stocks that are likely to deliver good returns over the medium to long term. Our endeavour is to identify the stocks in terms of attractiveness while we remain size agnostic (subject to bare minimum market cap that we can buy). The positioning in that stock is then a function of the market cap/liquidity/impact cost/materiality with respect to our portfolio.

In what sectors are you spotting opportunities now? 

We see opportunity in stocks/sectors that are positively leveraged to normalisation of economic activity. This includes financials, travel and hospitality, mobility and apparel.