Credit cycle driven stocks will do much better going ahead: Vinod Karki

"But even from markets like US and all the underlying economies are not getting into that recession that people have been expecting for almost a year now, it is still resilient," says Vinod Karki, ICICI Securities

Do you think markets now are looking bloated and they are due for a correction or this party will continue?
I think this fast rally, if you may call it from 17,000 till now, was mostly to do with what happened in March when the banking crisis started in the US and that kind of created an environment where people thought that domestic demand and overall demand will take a big hit but if you look at the numbers, the high frequency data that has not happened.

In fact, relative to other economies which were really gaining traction prior to this, like China and Taiwan, they have started to fizzle out and our fundamentals are looking better. So I think all this is resulting in this outperformance, which I think is based on the underlying trend if you see in the GDP expansion is driven by the investment cycle, the real estate cycle, the credit cycle, and also the profit up cycle.

So I think this will continue, although I would say that valuations are now getting richer, which should limit returns from here on. That is the view. I do not see any reason why the market should correct big time because our observation all along has been that the underlying themes within the domestic economy were quite strong only the external sector was looking a little worrisome due to these banking crises. But even from markets like US and all the underlying economies are not getting into that recession that people have been expecting for almost a year now, it is still resilient.

So let us see how it pans out but the external sector seems to be the biggest risk. While domestic investment cycle and credit cycle driven stocks should do much better.

One space that you have been very positive about has been real estate as well. What are the top bets there? What is the thesis with respect to real estate demand continuing, despite the interest rate hikes that we have seen?
If you look at the breakup of the investment cycle, and that is what we have been talking about in our reports also, that the previous peak of the investment cycle was around 2011-12. And if you just break it up, the gross fixed capital formation, almost 37% of the contribution was from real estate investments by households and that 37% till about 2021 dropped to close to 25% odd.

And as of now, if you see post pandemic recovery in the economy, I mean, the GDP expansion has been led by gross fixed capital formation.

But what people forget to see that if you break it up the institution wise, only two major institutions have been driving it up; one is the government, the central government capex. And the second one is real estate investments. We know that corporate capex has been slow, although it is bottoming out, but it is not really picking up to the extent we would have wanted it.

But since the overall gross fixed capital formation is leading the overall GDP growth, then obviously, these two are driving this thing.

So real estate for us is more to do with the overall income growth in the economy because it is the second largest employer in the economy after agriculture, especially in the unorganized and informal segment.

And there are a lot of allied activities, manufacturing activities, which are connected to real estate, which again, get benefit when the real estate cycle picks up.

And we have seen this example of China and other countries where the real estate cycle has picked up and it has really moved the entire lot of allied manufacturing.

So I think that is the bigger theme for us. We have mentioned some of the real estate companies also. But it also moves the mortgage demand, the overall credit cycle, manufacturing, job income growth . So it is a big stimulus for the overall economy.

What is your take on IT as a sector and if at all you had to take top bets, what would those be?
IT has corrected quite a bit and it is getting into an interesting zone but our experience with equities has been that valuation seldom results in outperformance. It is only the excitement around growth and when you start seeing growth upside, growth surprises. And even if things are expensive, they keep outperforming. So from a near-term outperformance perspective, unless you see a reversal in growth and the growth factors will only be, I mean, you will only be able to gauge growth when they start hiring.

But if you were to just look at from a valuation perspective, long-term perspective, things are starting to get better here. But as I said, equities seldom work on something getting cheap in the short term, obviously. So unless you have growth catalysts for IT sector coming in, it will be very difficult for these companies to outperform. The valuation also has not become so cheap that it is below long-term average. It is still around that or a little above average kind of number.

Do you think best of the gains in banks are over? Credit cycle is almost midway, NIMs are not going to expand now, if at all, slowdown, I think is there in a lot of big sectors like power, steel. Do you think one should lock out, lock some gains in banks?
I think credit cycle, if I look at from a corporate re-leveraging cycle, I do not think it has even started. So retail has been sustained growth so that is fine but from a corporate re-leveraging or an NPA cycle, we are going to form a bottom in the NPA in this year, 2024.

So the NPA cycle is just bottoming out while the corporate re-leveraging cycle has not even started and that is where the whole deep cyclicality comes in because the retail is not deep cyclical, it is more of a sustainable growth, if you may call it, it continues with its robust growth.

So from a cyclicality perspective, I would not say that the credit growth cycle has kind of peaked out to any extent. From a corporate side, I do not think it has even started properly. So I think there is a lot of runway there in terms of corporate credit cycle. And NPA cycle is just about finished. So I think it is a much longer story, I would say, the credit cycle thing. So you will have phases where they run up quite a bit, outperform, and then take a step back but from a medium term perspective, I think the credit cycle still has a lot of legs to go.