markets: High valuations flash warning signs amid uncertain market outlook: Vijayaraghavan Swaminathan

“All this are clearly putting a spanner on consumption growth. So, consumption growth, which is another core pillar in the last three-four quarters, I think, we do not see any legs for us to surprise positively as we move ahead, especially when it comes to urban consumption demand drivers are concerned,” says Vijayaraghavan Swaminathan, Avendus Spark Institutional Equities.

I was quite taken by your note, which actually starts off with the quote saying, I cannot change the direction of the wind, but I can adjust my sails to always reach my destination. We all know the kind of times that we are sitting in, both in terms of the global uncertainties with the changing interest rate regime that you are having, both in the Far East as well as the Far West and, of course, political uncertainties and geopolitical tensions other than that. But when we talk about India, it is really all about valuations, that is the sort of screaming amber light if I can say so. What is it you are making of the market construct right now, especially here in India?
Vijayaraghavan Swaminathan: So just to give you the context, from a demand perspective, last three-four quarters, we have been excessively cautious, especially on the consumption factors. This is largely coming from the fact that household balance sheets today, we do not draw enough confidence because of excess leverage, which households are sitting on.

On top of it, if you look at the last three-four quarters, there is a weak job hiring when it comes to IT sector and weak salary growth. And adding to that, if you look at last three-four quarters, banks and NBFCs have been cautious when it comes to retail lending.

All this are clearly putting a spanner on consumption growth. So, consumption growth, which is another core pillar in the last three-four quarters, I think, we do not see any legs for us to surprise positively as we move ahead, especially when it comes to urban consumption demand drivers are concerned.

If we juxtapose that with the uncertainties, which we are talking about, especially the political, the state elections, which is lined up, and more importantly the US elections and the impact of that for emerging markets like us is still not quite clear to us. As a result, we still seek better margin of safety, which is simply not there in majority part of the market, where we think valuations are pretty excessive right now.

So, what is the best approach right now? I mean, how is it that long-term investors who are listening to you right now try and sort of balance it out? Sure enough, there are those uncertainties. Sure enough, the valuations are high, but you have got to find the mean path. How is it that you find the margin of safety in the kind of exposure that you have right now?
Vijayaraghavan Swaminathan: If I look at the long-term perspective, there are few positive silver lining, no doubts about it. So, if you look at, if you step back, what are the things which are improving as we speak in the last three-four months? Liquidity which is one of the problem statement or deposits growth which was one of the problem statement faced by banks in the last six months or so, that should logically seems to be settling as we speak, because government accumulated a lot of cash balances during the course of elections, that has started seeing some sort of spending.
So, this should logically mean liquidity environment should get better, which would be largely positive for private banks in particular. So, on top of it, so one of the key thesis which we have been having pretty much for the last, say, 24-36 months, the entire private capex recovery.

So, if we look at the lead indicators clearly suggest that be it sanction proposals lying with the banking sector as a whole clearly draws confidence on private capex recovery. So, I think these are two important silver lining factors which is very critical for the long-term macro standpoint, so that seems to be going the right direction at this point of time.

Now given the fact that you did flag off the demand side concerns, just wanted to understand what the outlook is in the backdrop of the fact that yes, there is the weak IT hiring, salary growth has been a little bit stagnant, exports as well. What do you believe that could play out for individual sectors and what do you believe is going to be the turning point or what do you believe is going to actually help to improve that momentum?
Vijayaraghavan Swaminathan: So, what is happening is if you step back and look at the last three-four months, what we are observing is if you study the state fiscal priorities very clearly, so there is a clear impetus which has been given for freebies, especially the states which has gone for elections in the last 12 months and the states which are going for elections in the next six months, there is a lot more freebies which is coming back. Mind you this is coming at the cost of capex.

If we do channel checks around rural, so multiple channel checks suggest that rural related drivers are looking up. So, if we combine the freebies on one side and rural recovery on the other side, so logically mass consumption which has been struggling for the last three years, that should see a rebound in our assessment over the next 12-18 months or so.

But then the point that actually stands out when you talk about demand side concerns is that the government capex growth is actually slowing down. What kind of a bearing would it have on the entire capex related theme that the market has been so fancied and obsessed about? I mean, do you think that they have actually seen their peak, at least for the interim period?
Vijayaraghavan Swaminathan: Actually, if you look at the last six months, what we have been recommending is the government is clearly very particular about consolidating their fiscal deficit targets. So, as a result, both central government capex and state government capex incremental growth is going to moderate.

This is pretty much our thesis, pretty much at the start of the year. But that will get balanced out by combination of private capex recovery. So, what we are effectively trying to say is the best of the government capex growth is largely behind us, whereas the best of the private capex has still not played out in our assessment, especially from the large sectors like power, metals, semiconductors kind of sectors or meaningfully participate in a private sector capex recovery.