investment strategy: Market turbulence to last another 3-4 months; FII selling continue near term: Manishi Raychaudhuri

“This is a pretty severe round of QT that we are entering into and the initial period of such balance sheet retrenchment is very scary and the period to be most cautious about. We should brace for the impact for now, play safe, play the defensives and maybe the interest rate sensitives and the sectors which are positively impacted by currency depreciation. Fortunately, India has a set of those sectors and so there are a few hiding places in that market,” says
Manishi Raychaudhuri,
Head of Equity Research – Asia-Pacific, Asian Equity Strategist,


It is quite overwhelming to see the kind of FII selling which we are getting on a daily basis. Is this technical, is this a multi-year trend? What is happening on that front?
There are fundamental reasons behind this. First, India was relatively expensive to start with which is well known and that has added some kind of fuel to the fire to the current account worsening for India as a consequence of the fuel prices rising and the consequent weakness to the currency.

Think of yourself as an investor whose assets are denominated in US dollars or in euro and you are anticipating the destination currency, in this case the Indian rupee, to depreciate maybe another 3% to 5%. You would obviously hesitate to put money in that market because you would lose maybe a 3% to 5% purely on the basis of the currency depreciation.

So that has affected the FII decision making over the past five to six months, in fact from late October and it is usual that in times like these when the dollar is gradually turning into a situation of short supply as a consequence of monetary tightening over there, it is the safe haven currencies, the safe haven destinations that would do better and attract more FII money. We are seeing this all across the emerging markets but more so in India because there are India specific reasons.

What is the best way to look at the market? Is it too late to sell, too early to buy or are we in a buy zone now?
The turbulence that we are seeing will possibly last another three to four months. It is difficult to put a finger to that time horizon exactly but over the next three to four months, maybe till September-October, a few things are going to pan out.

First, the Fed has entered a season of rather aggressive rate hikes and accelerated period of monetary policy normalisation and they would possibly stick to it until and unless there are clear signs of inflation peaking out and that does not seem likely in the near term. It is possible that the Fed would hike another 75 basis points in July, followed by one or two rounds of 50 basis points hike. We have to brace for it.

Second, quantitative tightening (QT) has just started. In June, the quantum of the Fed’s balance sheet retrenchment would be $47.5 billion and by September that would increase to $90 billion, three times of what the Fed did on an average during the previous QT episode during 2017 to 2019.

This is a pretty severe round of QT that we are entering into and the initial period of such balance sheet retrenchment is usually very scary and the time to be most cautious about. We should brace for the impact for now, play safe, play the defensives, maybe play the interest rate sensitives and the sectors which are positively impacted by currency depreciation. Fortunately, India has a set of those sectors and so there are a few hiding places in that market.

What would they be, where is it that one can hide because one is desperately looking for such pockets?
So, IT seemed to be one obvious choice not only on the front line companies for winning orders from the United States and continental Europe but for also being possibly the best currency hedges that are available. Few others in the healthcare, in the pharmaceutical space which are generic exporters to the US would also fit that bill. But the story is not really so cut and dried. In that sector, one has to be a bit selective in finding out companies which suffer relatively less from the FDA inquiries and so on, So investors would have to be selective.

Interest rates are rising everywhere in the world and India has also joined that bandwagon of tightening monetary policy and therefore trying to curtail inflation. The banks would have some degree of interest margin expansion as a consequence. It may not happen immediately but some of the private sector banks which would have a degree of net interest margin expansion and also market share expansion, which is a more secular story, could prove to be some of the hiding places in the present circumstances.

The other critical thing is also what not to buy in this market. You have pretty much spelt out where you find safe haven spaces but what are the spaces that are not going to come back safe from this crash? Would you say be wary of globally linked sectors for instance?

One of the linked sectors which I talked about is IT services. It is actually on our buy list. When it comes to what to avoid, consumer discretionaries and consumer staples are feeling the brunt of input cost pressures which they are unable to pass on to their customers. We just concluded a two-day India Investors Days conclave and this was kind of a consistent feedback from the companies and those sectors that they are unable to pass on input cost increases to customers.

Only a few top rung market leaders have some degree of pricing power and some of the companies are also apprehending the decline in consumer confidence and consumer demand as a consequence of the structural inflation that we are seeing.

A lot depends on where oil prices settle at and whether they go up from here or not. A lot depends on how the monsoon pans out but these are the main concerns that the consumer orientated companies are talking about and that is a clear area which we would like to avoid for the time being.

The short term pressure could also be felt in industrials, even though some of them have a pass through mechanism of input cost increases, it may not be adequate to curtail the margin pressures that they face and in times like these, the likely investment cycle, the capex cycle that we have also been talking about may get a bit postponed.

Those are the sectors that we would like to avoid in the short term. Obviously there are individual stocks that could still weather the storm but when one looks at a broad sector specific view, those are the sectors that we would be cautious about.

You have told us the sectors that you are cautious about. What are you looking at? In October, the FIIs oversold in the Indian equity market. Going forward, are you going to see a change of sentiment when it comes to their allocation for India?

This is an interesting question because quantitatively, the total FII selling since October and as a proportion to the market capitalisation of India is somewhere around 0.9% to 1% and that is actually quite high. We have not seen this level of FII selling for quite some time. The only period when the cumulative FII selling was higher in proportion to the market cap was the GFC period. During the Global Financial Crisis, the cumulative FII selling as a proportion of market cap went down to 1.5 to 1.6%. But that was an extraordinary situation.

So from this quantitative perspective, one could argue that the FIIs have oversold when we look at the global emerging market investors, they are actually at about 1%. They have not had such a stance for almost 20%. That is another data point which supports that view that FIIs have oversold India but at the same time, as I highlighted earlier, the fundamental reasons behind this selling still persists. As long as we have significant and stringent monetary policy tightening in the advanced economies, as long as we have the Indian current account and trade deficit growing as a consequence of the fuel price and other commodity prices staying high, FII selling is something that we have to brace for in the near term.

When we look at the US dollar index and just the way it is moving and the way we are seeing developing currencies including the Indian Rupee (INR) depreciate against the US dollar, can that impact flows at all? When we talk about FIIs, are we also going to look at more geographical diversification?
Geographical diversification for Indian investors has been a theme over the past two to three years and in times of severe uncertainty like the times we are living in right now, it can be an appropriate strategy. World over we are seeing investors concentrating on the safe haven markets even though even in the developed economies, there is a concern of recession and stagflation – possibly more than what you will find in the Asian markets. It is a delicate decision but at the same time, selective geographical diversification could potentially make sense in times of severe turbulence like the one we are living in.

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