Corporate Profits Face Two Challenges, Says Satish Ramanathan of JM Financial Asset Management
The increased influx of investors into the stock markets and expectations of higher future earnings growth have pushed stocks into the stratospheric valuation zone. This has raised the stakes for retail investors, who are increasingly using the mutual fund route to allocate more funds. BL wallet met Satish Ramanathan, MD & CIO – Equity at JM Financial Asset Management, to provide an update on national markets, mutual fund trends and the Indian economy.
Is the pandemic risk really over for the domestic stock market?
The risk of a pandemic now seems contained. India has carried out a massive exercise to immunize its population, administering more than a billion vaccines, and the percentage of people with two vaccines exceeds those with a single dose.
There are signs of normalization of economic activity in many sectors, and now there is an opening opportunity there. From a stock market perspective, Covid is not a major risk, as both individuals and businesses have learned to live with it. The total number of cases and, more importantly, the death rate have declined dramatically.
In July, you raised the possibility that corporate earnings may fall short of the FY22 estimate. Has there been a change in your outlook?
Corporate profits will face two challenges: higher input costs and higher labor costs due to inflation. Input costs have increased in all segments, some temporary and others structural.
We expect costs to come down somewhat as China normalizes and shipping congestion decreases. Areas such as edible oils, fuel prices have significantly damaged customer wallets. All of these increases can cause customers to reduce their consumption or decrease their trade. Therefore, we remain cautious on earnings growth while being positive on the longer term structural aspects of Indian companies.
Indian companies continue to reduce their debt and improve their financial health. We expect large business investment to drive the next level of growth. Mid-sized businesses will continue to benefit from lower leverage and better pricing power as the economy has shifted from an unorganized to a significantly organized segment. Therefore, while the growth rate that we have seen in the past may decrease, the growth will definitely be there.
Is inflation a serious risk for domestic markets or will inflation now be seen as a sign of growth?
Inflation impacts the economy at different levels and increases the cost base for everyone. We do not yet know whether the inflation we have experienced recently is due to a surge in demand in the short term due to the opening of economies or some inherent structural problems.
We believe that many of the bottlenecks we’ve seen recently will ease, so central banks may not be in a rush to raise rates. The US Federal Reserve is cutting its bond purchases, which is already a form of tightening, and yields rose before falling.
We believe that many factors of commodity and natural resource inflation will ease, while labor costs will remain on an upward trajectory as labor participation after the pandemic has yet to normalize.
From an equity market perspective, inflation could reduce earnings growth and therefore market PE, leading to a short-term correction.
Domestic stocks are trading at above-average valuations, but these have held steady so far. New age IPOs have raised billions at even exorbitant valuations. Can this situation last for a long time?
Stocks that are trading above historical valuations may indicate one of two things: 1. A greater influx into the stock markets from retail or institutional investors, or 2. A higher expectation of a dynamic of future earnings growth. We would like to think that it is a bit of both. The earnings dynamics after the pandemic may surprise us positively, both in terms of the quantum and duration of the growth momentum. Sensex’s profits have increased 4-6 times over a short period of 5-6 years and we believe this could be repeated in the medium term as well.
So, yes, the markets are expensive on a historical basis, but may also reflect some optimism about growth. Retail investor euphoria pushing markets may subside, albeit gradually, as large IPOs attract money.
Large IPOs coming into the market help the Indian investor to buy new companies, which offer higher growth and are also capital efficient. Current valuations may not justify the current cash flow, but there is a need to follow these new age companies as they represent a shift from a traditional manufacturing / commodity based economy to one of more service / bespoke manufacturing that is based on software and intellectual property. LED. The point I would like to stress is that companies can be good and valuations can be negative and we will have to be careful about that.
How does your AMC balance the risk and return of its equity funds? What do you do differently from others?
Our AMC follows a rigorous risk assessment methodology covering several parameters, such as price volatility, business risk, sector allocation and liquidity. We also follow a multi-level reporting structure. With the new SEBI risk guidelines, mutual funds will have one of the most comprehensive sets of risk measures in the industry. We are aware of our fiduciary responsibility and view risk through several parameters in order to minimize the impact of any untoward incident.
Since your arrival in January 2020, what has been your vision for the MF company?
Our vision is to become a major player in the mutual fund industry. The Indian mutual fund industry has good potential ahead as the savings pool grows. At JM Financial MF, we will introduce new funds to fill the obvious product gaps and also aspire to become an innovative fund house that caters to investors and meets their expectations.
What is your take on passive investing and how does your AMC plan to meet the demand for passive products?
Passive investing is gaining ground on a cost basis and as a way to invest in the asset class rather than an independent fund management team. Passive products, which offer some added value to clients, such as sector, index or quantitative structures, can also benefit the investor and constitute a good bridge between active and pure passive ETFs. We believe that given the dynamism of the Indian economy with the rapid creation of new businesses, active management of funds will help investors. We may choose to improve our product offering with certain passive / ETF products in the future, depending on the opportunities.