Blue chip stocks | Stock market analysis: The next two quarters will be difficult for the market: Jinesh Gopani
Do you think the peak of pessimism is behind us?
For India, oil plays a very important role in deciding whether India’s macros will be good or deteriorate or if the momentum will continue. So, Oil, Inflation and Currency are the three critical parameters that we should look at for India. The good part is at least Oil which had gone up to $130 has fallen to $100 and that gives some breathing room. According to our macroeconomic understanding, oil below $100 should be good to maintain momentum and GDP growth momentum may continue if we don’t have a fourth wave of Covid. If this continues, I think we will be in good shape three months later.
So how much of the oil price spike is the market pricing in?
Oil went from $77 to $130 very quickly and it also fell very quickly. Always the geopolitical tensions and everything continues. I think it will be another 15 to 20 days before we know how this geopolitical tension is easing or reinvigorating further. Moreover, by tomorrow we will know how the US Fed also reacts in terms of inflationary pressures. So most of the events that led to so much volatility will happen and people will then focus on the profits.
The fourth quarter is going to be very difficult and it will be a difficult quarter for many companies to demonstrate their growth and their margins. We will have to see how things go for the different sectors. Different companies will have different numbers and this will decide how markets move and how flows move to different sectors.
What are you doing in this market? Do you change your portfolio assuming a lot has changed in the last three months?
It is very difficult to answer this call because many things are happening at the same time. In January, we had a big sale of blue chip stocks by FII. Then people moved from India to China and after that China was down 10% and stocks were down 20%, 30%, 40%. If we do well, the quarterly numbers come in, the companies are able to demonstrate good earnings growth momentum, the money will just come back.
What’s going on with all of the new-age tech companies? Zomato has secured approval to lend up to $150 million to Blinkit. If the acquisition does eventually materialize, will it result in a significant cash burn? There has also been unfavorable news flow to Paytm. Some experts believe that valuations have fallen significantly across the newly listed universe and that having a tiny position in a bucket of these names may not be a bad idea. Is it even worth that effort?
We need to assess each business – whether the space is right, whether management is able to show a path to profitability, and whether capital allocations are being made according to our expectations. I think spaces are good; obviously the valuation was out of kilter given the market frenzy, given that FIIs were trying to buy these stocks because they’ve had so much success around the world in these types of businesses. An important task would be for companies to demonstrate good growth, a path to profitability, a path to cash flow and if they are able to do this, some of them will become real winners. Either way, if their capital allocations are wrong or the path to profitability doesn’t present itself, then at some point people will lose interest in that space.
What about the banking space? Until now, management was held by ICICI Bank and SBI. Now that RBI is removing restrictions on digital launches from HDFC Bank, could there be a tactical transfer of money out of ICICI Bank, SBI, and into HDFC Bank or a Kotak?
All four to five private sector banks are healthy; some might grow 15-16%, some might end up growing 17%, but when you look at building ROE, they’ve managed asset quality very well. More or less, everyone is in the same boat. Investors can choose the management they like and where they want more comfort in terms of long-term growth. There is no major uniqueness between these four or five private sector banks.
If you want to play cyclically, financials are a great game. It’s an evergreen sector. We need 6-7% real GDP growth and if that happens we will have 10-11% credit growth and these companies that are gaining market share can grow at 15%, 16%, 17% for longer periods. The problem with the bank is that it was an overly owned sector. We had huge outflows from FIIs and the bulk of the outflows came from this sector. If the sale of FII declines, this sector may well recover. Also in the inflationary scenario, private sector banks tend to gain because assets revalue faster than liabilities and NIMs can improve. Overall they are in good shape, the numbers are good. Hopefully the fourth quarter should also be good. The simple sell off has led to the underperformance of this sector and hopefully things will turn around.
Many consumer and FMCG companies reported product price increases. Additionally, increases in commodity prices are to be expected as they battle commodity price inflation. How do you see the overall margin dynamics of these companies?
It’s going to be difficult for many companies to pass on prices. Leading companies in their field have 60-70% market share in their product category. They will be in a better position. We only stick to companies that have significant market share, the ability to manage inflation while passing on 70-75% of costs, and then driving efficiencies and managing margins. Leaders, strong brands, would do well, but FMCG consumer-base companies will struggle too.
Where are you in terms of automotive space? Commodity prices will also hurt the margins of many of these companies. There have been new launches and they also focus on electric vehicles.
Automobiles are unfortunately facing two problems – the first is the shortage of chips and therefore the productions are not at the best levels they would have liked despite the good demand after the second wave of Covid and now after the third wave of Covid, so that’s been a damper in terms of production.
In addition, the ongoing Russian-Ukrainian war has led to an increase in commodity prices, particularly that of palladium, a commodity, which will further weigh on margins. Consequently, the cost of raw materials will remain high.
Unfortunately, both happened at the same time. The price of oil is also an important factor in this regard. With oil below $100 things can be managed and even this sector will start to do well. But if Oil remains above $100 and holds at $120-130 for a longer period, then this sector will be under pressure.
So let us figure out what’s in store from here. It will be a chaotic quarter. When do you think the markets will be able to look through the clutter? Will it be this quarter, next quarter or the second half of this year?
The next two quarters are going to be tough as crude oil prices move, raw material cost movements are not going to be reflected in this quarter as there is a 30 to 40 day lag and we will have to see how these companies are able to pass on this cost and raise the prices of the product for their end consumer. So two quarters will be difficult. However, if things ease on the commodities front and oil and other commodities decline significantly over the next two months, then there will be a gradual recovery and the numbers may not come. only from the second trimester. Keep in mind blue chip stocks are down 15-20% and mid and small caps are down 20-40% depending on the sector. Much of it seems to be priced.
While it is easy to explain why we should be optimistic vis-à-vis the banks, the reality is that the drawdown of credit has not resumed. The CPI is at 5-6%, the WPI is in double digits. But there is no demand for credit and if it does not come now, when will it come?
There is too much volatility, too many stops and restarts in the system. So in case there is a fourth wave of Covid, again all bets are off. If things are going well, oil goes down, inflationary pressures aren’t there, even the Fed event passes and if the outflows that were happening go down, then we’ll have a reversal in the outflows. When there are entrances, people will enter this sector. Six months ago, the numbers weren’t coming in and the other sectors were delivering good numbers. Now, at least from a cost of credit perspective, things are much better. Major private sector banks are growing at an odd 15%. The figures will be better compared to other sectors at least for the fourth quarter and the next quarter. From this perspective, valuations are also attractive, having not performed well over the past one-year period. So it’s more of a shift from other sectors to this sector. Given the inflationary scenario, banks would be better placed and if there is an inflow of FII, then this sector will have the largest inflows given their index weightings.
What happens to pharma because it showed resilience when the market fell?
I think it’s more of a defensive game. When oil is at $130 that’s the best sector to be in because it’s not significantly impacted and there’s general growth in the system and pharma continues to do well on that very front if oil is at $120-130. It’s more of a defensive game. When the going gets tough, people tend to shift some of their money to that side because it’s defensive in nature. However, pharma is complicated and needs to be looked at very, very carefully because there are many issues – ranging from the US FDA front to therapeutic segments to pricing pressures in the US.
A company is like a sector and should be looked at on a specific basis, rather than generalizing the whole sector.