DSP’s Gopal Agarwal on why he has bought into market correction

We expect there will be a recovery in the market because the benefit of a rate cut and improving liquidity will seep through the economy in the next three to four months, says Gopal Agrawal, senior fund manager and head of macro strategy, DSP Investment Manager. Excerpts from an interview with ETNOW.

Since the Budget, there has been a 6.5% fall in the benchmarks alone and a deeper cut for the broader markets. What explains this kind of weakness?
The current weakness in the market is primarily due to the fact that we are seeing softness in demand across the board. Added to that, the benefit of lower interest rates has not percolated into the system, because of which we are seeing the results reported so far are reflecting softness in demand as seen in the market price. I would add that the tax on FPIs which are trusts has also created some uncertainty about FII taxation.

That explains the fall we have seen in bluechips that had been holding up Nifty. The growth engine slowing down and the IMF cutting our growth estimates also seem to be souring the sentiment. How long will the pain last? Would you say there is a recovery in sight? Is a time-wise correction coming?
We expect a recovery in the market because the benefit of a rate cut and improving liquidity will seep through the economy in the next three to four months. The rate transmission will certainly happen and that will be very positive. Apart from this, there is certain uncertainty on oil supply in global markets. But despite this, oil is trading favourably in a narrow band, which is positive for India.

We will see that the foreign fund flows in debt market will also be positive in the event of a rate cut which is expected in the next month or so. All these are giving us a positive feeling for the coming months. Add to that, with Nifty at 11,200, if you look at normalisation in earnings that is expected and the 10-year being below 6.5%, we are trading at close to 17-17.5 times the PE multiple. This is a point where risk-reward is favourable. If we take a medium-term view, the great point is that the bond yields are low, liquidity is turning positive and the global macros are in favour of a positive liquidity side.

You have said that you would be buying into staples and retail on dip. You are anticipating things to turn around. What are the specific pockets or names which are looking attractive at lower levels and the kind of potential you see on the upside?
We are likely to see the benefit of lower rate cuts coming to the cost of funds. Certainly we will see some revival in demand, even in the discretionary space. The financials and insurance will be the beneficiary of that. In this correction, we are adding all the financials and buying some of the users industry which will benefit from lower commodity prices. So name wise, let us say the cement industry, downstream marketers in the oil and gas industry, specialty chemical industry and also some selective auto names are likely to be the beneficiaries of the input prices and lower interest rates.

What gives you confidence that the volumes are going to come back because for the last six months, one has seen a big slowdown across the board? There has not been any silver lining, and more importantly, the shift to EVs and the phasing out of diesel is going to incur high capex costs for the auto industry as well.
What you are saying is reflected in terms of the valuation. Relative to the Nifty, valuations have almost reached a trough and now many companies are offering 4.5% to 5% free cash flow to yield. Our sense is that we may enter into a phase of time correction. Then, as soon as there is some revival in demand, which I expect, the repo rate cut and positive liquidity will flow through in the next three to four months, which will coincide with the festive season. We may see some revival in demand actually. That is what made me buy into some names during this correction.

How have you read into the overall crisis within the NBFC space? Do you believe that there still is a lot pain left in the system and the recovery is a long way down the line?
The Budget has not offered any incremental near-term growth trigger which played into to the expectations of the Street because the way we have seen the NBFC crisis emerge since September 2018, there had been liquidity tightness and the credit offtake has softened. We were expecting there to be some stimulus in the economy which was not there. But for the last 30 to 45 days, that liquidity in the system has turned positive, the repo rate cut has happened. I expect that transmission will happen over a period of time. That gives me confidence and optimism that things will look better in the times to come. The only thing is that during this period if we get some positive support to growth from the government, in terms of policies in the automobile sector and some PSU recapitalisation money which should come very soon, lending activity will start and be very positive for the market and economy.

What is the outlook in cement and is infrastructure on your radar as well?
The infrastructure sector has now corrected to a single-digit PE multiple sector, barring the sector leader. My sense is that risk-reward is favourable and we are witnessing global deflationary pressure in terms of major input prices coming down. That gives me optimism for the margin expansion story to continue playing out in India. If there is some stimulus in terms of growth revival, that will be positive to the top line. We are seeing the operating metric turning very favourable and positive. The only thing that we have to see now is how the projects are executed depending on financing support from the government.

What are you doing with the traditional defensives like pharmaceuticals and IT? Are easy money days of IT behind us and currency will not be much of a tailwind this year?
Yes, I concur. The worst of rupee depreciation is certainly behind us. We may see the rupee trading in a band which may be slightly negative for this sector. The best is clearly behind us in my view. The only point is that two to three months ahead, the liquidity benefit and the interest rate cut will flow down to the economy. In this period, the large cap IT will support the downside actually. That is where people are aligning to hold IT in the portfolio. In terms of the pharma sector valuation, it has derated materially because of issues in US business. We are still seeing 8-10% top line growth in India. Most of the pharmaceutical businesses are being supported primarily by domestic businesses and as soon as there are positive green shoots from US in terms of pricing and approval, you will see the individual stock perform better. So, the risk-reward is certainly favourable in pharma where valuations have now come to on an average of 9 to 10 times EV to EBITDA.

Would you say that on a tactical basis more money should be allocated towards the broader markets -- the mid and small caps as opposed to large caps -- for the next two to three years?
For a long-term investor, the multicap strategy still works out quite well because you always have the benefit of a one rate cycle down and one rate cycle up in the longer run. So, you tend to average out and any sensible investor should look at more multicap funds for a long-term period depending on your risk profile -- that is the right strategy. And if you are taking risk, then midcap funds at present valuation, offer a favourable risk-reward at this juncture.

What is your outlook when it comes to the overall liquidity situation? Do you believe that India as a destination among the emerging markets is slightly losing its sheen?
Yes, certainly on a relative basis, India is losing some sheen because of what has happened. The Indian market was trading at a premium based on higher ROE and superior growth profile. And now on a relative basis, we are seeing moderation in the ROE and also the growth. It is trading at a 50-60% premium to MSCI PE multiples. So, certainly some money is off because of this super premium in the Indian equity market.

My sense is that if you look at MSCI, the 64 companies offers you more than 16% ROE which is very high if you look at the relative market space. The FIIs can reduce some weightage, but they cannot completely go away from the Indian markets because of our superior ROE profile and higher growth prospects over a period of time. But in the near term, we need to see some support to boost the growth. That is a real near-term requirement.