Is this the best time for investing in the market? Vinod Karki answers

"A combination of animal spirits rising, demand rising and availability of financial resources and interest rates being low and commodity prices and now finally, we are also seeing the real estate cycle showing signs of pick up – have culminated in a right environment for the capex cycle to pick up," says Vinod Karki, Equity Strategist, ICICI Securities

After a decent amount of returns under the belt for the last two years, how could this year turn out to be? How should investors keep their expectations from a return point of view?
Two counterbalancing forces are acting on the market right now. On one hand, we would see the normalising of liquidity and interest rates which will obviously have a downward effect on equity valuations; on the other hand, we are seeing that after two decades of low profitability, corporate profit cycle is rising right through the whole pandemic and recession that we had. The earnings upgrade cycle is also continuing.

Normalisation can fizzle out if the investment cycle does not follow up. We are seeing that the ingredients of the investment cycle are falling in place which makes us more comfortable on the earning cycle that is picking up right now. So while valuation expansion will not continue the way it has over the last several years, there will be support from earnings and investment trade picking up. That is how we see counterbalancing. But having said that, we had fellowships for the fifth or sixth time during this bull rally. Starting from March 20, the market went in a straight line. From 16,500 level, we are now currently around 18,300 without stopping. This has taken away some of the attractiveness obviously and it was giving high expected returns when it was below 17,000. But now the upsides will be capped because we had a very sharp run of late. That is how we see it but we will see some positive gains even from these levels, this year.

Do you think this is the best time for investments? The capex cycle in India is taking off and if that is indeed the case, what is your view on domestic cyclicals like banks, capital goods and cement?
The heavy lifting in the capex cycle is obviously done by the commodity companies. You must have seen a lot of large capex plans in the metal commodities like steel being announced and also the large energy sector investments that we have been hearing about. This is animal spirits. We are hearing about a lot of these large scale investments being announced in the capital intensive sectors.

If you look at some of the other schemes that the government has done in terms of the PLI, even in less capital intensive sectors like food processing, digital equipment, auto, chemicals, we are seeing a lot of action in terms of capex announcements. In terms of ingredients, first of all, animal spirits has to be there, driven by growth outlook. That is improving and that is why large private sector companies feel that they should be investing.

Second is the availability of financial resources. The cash flows of capital intensive companies have improved a lot over the last several years. So the availability of financial resources internally and externally from the bond market, equity market interest rates being low and liquidity being high, it is much easier for companies to avail financial resources for investing.

So this combination of the animal spirits rising, demand rising and availability of financial resources and interest rates being low and commodity prices and now finally, we are also seeing the real estate cycle, a very capital intensive sector, also showing signs of pick up – have culminated into the right environment for the capex cycle to pick up. If the government keeps following it up with their share of investments through Budget allocation and the states also following up, it is a right mix of private and public sector investments picking up along with all these other factors that I just talked about.

What is your positioning on the most abandoned and ignored sector in the market – the auto space, especially two-wheelers?
Yes, There are two aspects to this. One is the demand outlook and second is how stocks are positioned. If you talk about the two-wheelers, there are no excesses in terms of optimism or high valuations. That gives a margin of safety in terms of valuations. We know that some of the transient issues might go away as the economy revives and normalises. But we still do not know whether all the issues in the auto sector will go away immediately. But there is some amount of caution which is giving a margin of safety in some of these stocks. But I do not think the longer term outlook is as bad as it is being made out right now.

What is the one space you are quite bullish on where people still are not paying adequate attention and where we could have a good next couple of quarters?
What we are feeling is that the whole investment cycle theory is not a consensus right now. Believers believe in that but a lot of people have to get their confidence going. If the investment cycle and the credit cycle has to pick up, then one can easily play this story via large infra developers like L&T and some of the corporate banks which have shown some signs of running up but have not outperformed significantly.

If the cycle that we saw from 2003 to 2010, where GDP growth was led by the investment rate and the credit growth were to play out, then these could be the leaders of the bull run that could start because of the investment cycle and the credit cycle picking up. But it will take some time to show up in the data. We are seeing some improvements in credit data. The last number was close to 9.2% which was quite good compared to the recent numbers and we are also seeing some of these companies in the infra space doing better.

So, real estate, infra are some of the sectors where it is a consensus view that everything is fine and valuations are reasonable right now. It is not as high as it is for the overall market which seems to be at a very high level but these sectors do not give you that impression that they are at the peak valuations whereas we think that a cycle is on the right path going by the latest data.