Expect Nifty to end the December series on a positive note, reach a target of 18,900-19,000, says R Venkataraman of IIFL Securities

• Empirical evidence shows that Nifty has an 80% probability of closing in the green.
• IIFL Securities expects foreign institutional investors to continue to be net buyers in the coming months as India continues to be an attractive investment destination.
• Expects the Federal Reserve to reduce the pace of hikes in future, after a lower inflation print for the month of October.

The Santa Claus rally has taken many by surprise, but research done by IIFL Securities shows that December, on an average, has given monthly returns of 3.2%. After selling India heavily to recover some of the losses made in China and Russia, foreign institutional investors are back as the new year is expected to see many developed economies slip into recession. Even though the Nifty at a multiple of 19.5x offers little upside, R Venkataraman, chairman of IIFL Securities, tells Malini Bhupta that India’s relatively superior investability will keep multiple premiums intact. Edited Excerpts:

As markets continue to hit new highs, what is the outlook for the rest of 2022?

Nifty has seen a sharp rally of ~13% since the beginning of October. The return seasonality trend of the last 20 years for the month of December based on empirical evidence shows that Nifty has an 80% probability of closing in the green. In this study, we also found that December has also given the highest average monthly gains of ~3.2%. Thus, we expect Nifty to end the December series on a positive note and even reach a target of 18,900-19,000.

Are foreign institutions back in India?

As we have been mentioning earlier, going back as early as July, FIIs (foreign institutional investors) & FPIs (foreign portfolio investors) had been selling in India only due to them suffering huge losses in countries like Russia and China. FIIs have, since August, made a comeback in India and have invested ₹26,000 crore in the cash market. Even their speculative long positions in the index futures are significantly higher compared to their historical average. As India continues to be the largest investable market with other countries like the US and the EU feared to be in recession in 2023, China is under lockdowns and Russia continues to be at war. Thus, we expect the FIIs to continue to be net buyers in the coming months.

Many global investment banks have said while India’s long-term fundamentals are intact, near-term valuations are elevated?

Corporate India’s PAT (profit after tax, aggregated over ~31,500 companies, of which 80% are unlisted) has bounced back smartly to levels of ~5% of GDP in FY22 after bottoming out at 1.2% in FY20, following a decade-long profitability erosion phase. Also, a series of reforms/cleanups and inherent growth momentum makes for a favourable Indian growth outlook. However, global growth risks are all too real, given monetary winter setting in, and geopolitics worsening (Ukraine, Taiwan, chip wars), and earnings will see cuts globally. Nifty at 19.5x apparently offers little upside, but India’s relatively superior investability will keep multiple premiums intact. We expect domestic growth stories to outperform.

What about the Federal Reserve’s rate hike momentum? Do you see it slowing down?

Globally, the interest rate cycle is reaching its peak with the Federal Reserve indicating less aggressive rate hikes going forward. The aggressive rate hike cycle may see moderation, aided by a high base effect leading to inflation print being lower in the next few months. We expect the Fed to reduce the pace of future rate hikes after a lower inflation print for the month of October.

Economic growth is estimated to slow down sharply in 2022-23. Will that affect markets?

The economic growth is likely to slow down in 2023, due to a higher base effect. This will definitely have an impact on the market, but a long-term investor should look at it as a breather before the next move in the market. Capex cycles are global and to a large extent synchronous with commodity cycles. Global factors such as green energy investing, de-globalisation, and supply chain redundancy requirements can keep commodities and capex strong in the medium term. A capex cycle coupled with the Centre and States’ strong fiscal due to higher tax collection is likely to bode well for an expansionary period in the coming months.

What is your forecast for Sensex and Nifty50 in 2023?

Nifty50 is currently trading at a 1-y forward PE multiple of 22.4x and is now approaching the 1 Standard deviation from its mean of 18.9. If we cap the multiple near the +1SD of ~24x, we can expect Nifty to hit 20,000. However, an extraordinary upside is likely to be difficult as we have seen during the 2017 to 2020 phase that when the index approached the +1SD levels, the Nifty traded in a broad range with moderate returns. We expect the Nifty to continue to trade with a positive bias, but extraordinary returns are likely to be difficult.

What sectors appear suited to cope with the slowdown?

Listed developers seem to be on track to report 15-20% YoY pre-sales growth for FY23, based on the strong momentum in 2Q and 1HFY23. Developers have been able to largely pass on the input cost inflation; collections and OCF (operating cash flow) margins were healthy in 2Q. Net debt was flat QoQ, while borrowing costs went up marginally. Developers have, so far, not witnessed any meaningful impact on demand due to rising mortgage rates, though it remains the single most prominent concern among investors. We prefer real estate developers with high finished unsold inventories, high margins, and low leverage.

Financials have emerged as stars of Q2, do you expect the rally in bank stocks to continue?

Financial companies’ (banking, asset financiers, securities, MFs, diversified – listed & unlisted) PAT as % of GDP was stable through the cycle at 1.3%-1.5% from FY06-15. During this period, corporate debt/GDP rose from 25% in FY05 to 41% in FY13 and stayed there for 3 yrs, before a deleveraging cycle in the last 5 years brought it back to ~32% (FY21). For the listed financials, provision and write-offs as % of PPOP (pre-provision operating profit) increased from 44% in FY15 to 102% in 2018-19. It has fallen back to ~47% in 2021-22 and accordingly, the PAT/GDP has risen again to 1.2% currently, from being negligible in 2017-18 and 2018-19. With most of the banking clean-up behind us, prospects of re-leveraging by non-finance companies coupled with rising rates should increase banking sector profitability going forward.

What about slow deposit growth? Is that likely to impair credit off take?

Yes. Slow deposit growth has been a concern. Credit growth has been robust, growing at 18%, while deposit growth has been in single digits, amidst the tightening of liquidity. The primary reason for this is that the loans linked to repo rates have increased by 190 basis points on par with the current rate hike cycle, but the deposit rates haven’t gone up. Hence, although the deposit growth has improved Q-o-Q, on a Y-o-Y basis, (it) has remained moderate. We expect chase for deposits is likely to intensify in the coming quarters.

What are the next triggers for the market?

We feel optimistic that in the coming years, the PAT/GDP ratio will comfortably breach its previous peak in FY08 of 7.2%, given that 1) we have yet to see any operating leverage begin to play out since GDP (in real terms) has just about reached FY20 levels 2) services sector has emerged stronger with one-off hits like telecom AGR (adjusted gross revenue) behind, and e-commerce having taken flight 3) banks and NBFCs have seen a substantial cleaning up of NPAs (non-performing assets), are governed by a much stronger regulatory framework, and are substantially better capitalised than 3 years ago 4) corporate debt/GDP has fallen from 41% to 32% in the last 9 years thanks to chronic underinvestment 5) policy environment is supportive with the government having cut corporate taxes, introduced PLI (production-linked incentive) schemes and driven up tax collections, etc. and 6) other domestic clean-up/speed bumps like GST/RERA, Covid are behind us. These factors can drive a strong domestic growth cycle.

Should RBI go slow on rate hikes now?

Yes. RBI is likely to opt for a 35bps hike in the December policy meeting, after three consecutive 50bps hikes. Post the 35bps hike, we expect the benchmark to be raised by 25bps in Feb, which is likely to mark the end of the current rate hike cycle. The RBI wants to restrict the inflation figure within its tolerance limit. We saw the inflation cooling down in October and the Manufacturing PMI hitting a 3-month high as a result of lower inflation. Hence, we expect the RBI not to overdo the rate hike and wait for the impact of the hikes to be seen for a few months, thus avoiding a slowdown of the economy.

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