2022 was not a good year for the entire board market or board sectors. It is a complete mirror image of what we started with and where we are ending with many promises. IT is down, pharma is down, banks are up and PSU stocks are outperforming?
I think this year is a classic year where the markets are expected at the beginning of the year and where we end it is completely different. If you remember at the beginning of the year, the market was saying that we would have four rate hikes at the most or at most, but as we are closing out the year, we had about seven rate hikes and the largest increase in history by the US Fed. .
Our understanding is that 2023 is likely to be a volatile year for domestic and international equity markets. In the year We expect a more favorable global economic outlook in 2023 and the outlook on inflation and monetary policy to continue to drive markets next year as well.
There is a good chance that higher inflation and higher US FD hawkishness will pass in the second half, providing some relief to riskier assets such as equities. We believe we are at an all-time high this year, at least for domestic equity. To begin with, we should use equity and dip buying as an opportunity.
We currently advise investors to maintain a neutral stance on equities and be slightly overweight on large caps and underweight on mid and small caps. We think it would be best to maintain a disciplined asset allocation with a mix of equity, debt, real estate and some gold.
What will be the main theme in your mind, will it be value, is it growth? It will be growth at affordable prices, what will that theme be for 2023?
In our opinion, let’s look at two or three factors that will determine the course of the market next year. The rate of initial acceleration will slow down significantly from what we saw in 2022. But our view is that going into calendar year 2023, the rate may stay longer, which means that all central banks, including the RBI, may have one or two more rate hikes, but they will be on hold for a longer period of time, which means rates will remain higher for a longer period.
At least in the first half of 2023 we will see several steps down to continue. This is one very important thing to note. The second important thing is that what we’ve seen over the last two, two and a half years is very little room for a positive earnings contingency. And our sentiment is currently the best from positive earnings expectations baked into prices. And given the global slowdown in demand and challenges, we believe there is very little room for a positive earnings surprise for the market as a whole until next year. So bottom up stock picking will be the order of the day.
In addition, we want to understand what the two underperformers of 2022 are doing, IT and Pharma? Talking about IT in particular, do you think it’s too soon to at least start entering the sector?
Yes, we can look at IT stocks that have posted third quarter numbers where we believe another bearish cycle may play out. We are looking at IT more constructively from 2023 onwards, stocks have corrected 40-45% across the board and we believe value is starting to emerge.
Some of the names are still not super-cheap but have reached reasonable reviews. We will see feedback from IT companies in the third quarter, but I think it will come back somewhere in the second half of calendar 2023.
As far as pharma is concerned, I think our approach to the sector will continue to do well domestically, but it will be very concentrated. It seems that there are still challenges in price erosion for American genetics, but some companies on the American side are doing well. We believe there is an opportunity for some names and the downward trend of stock accumulation in the sector will continue until 2023. So it’s not so negative on the pharmacy, but we will have a different approach to the sector.
With India emerging as a strong manufacturing hub, what is the outlook when it comes to betting on the overall long-term capex theme? It looks like there’s a lot of potential to really play out this way over the next few years. How would you like to bet on that story?
Absolutely, as a theme manufacturing is a perennial theme and we believe that many pockets will be found in this manufacturing theme. There are light engineering capital goods, precision engineering, chemicals with Europe and China plus one. There are many areas where we are seeing import substitution playing a dominant role. I think the way we play our bets is generally on these sectors and our feeling is that India is very likely to double its manufacturing base from 450 billion to 900 trillion in the next three-four years. Dollars and if we don’t make any personal goals or make any mistakes, production can surprise us upwards.
We believe that there are different ways to play; One is import substitution, second is capacity utilization at 75 percent in many industries, third is the possibility of exporting to Europe and the world, and fourth is becoming a global factory.
You’ve been talking about manufacturing, import substitution and capacity additions, but I want to ask you specifically what it’s going to be in, is it going to be in textiles, are the industries you’re looking at? Do you work through capital goods? Since this is your big theme for this year and the previous year, how exactly should it look?
I think there are two ways to play it. The first way we play is short round plays. So what we mean by short cycle plays is that all the carriers like consumables, abrasives, ceramics that are part of the production cycle will go up and help you ride the production increase. So we are the first. Playing in our portfolios.
The second thing we play with is capital goods, once you decide on new capex, you need plant and machinery, you need turbines, boilers, waste heat recovery and so on. I think that’s a late cycle game. I think in the next 12 to 18 months the short cycle play will be the order of the day as we have seen in the last 12 months and long cycle plays will play a bigger role as new capacity starts to add.
Also, what we are seeing is some drag on public side or government side capex coming, which means road infrastructure, railways, defense could be a major theme as we move forward in the next two to three years. The way we play the whole production part.
For chemicals, demand traction still looks good but reviews are not helpful. We’ve seen significant appreciation on the chemical side over the last five years so multiples are unlikely to improve and it’s going to be a more earnings-strengthening story on the chemical side, but demand remains very strong.
They have already said that it should be a certain stock in the pharmaceutical sector. In the past, you said it could be like a dark horse. Now you’re talking about composting, you’re talking about rail stock, so I want to go into that a little bit and after it’s over and the multiples you’re talking about will never make their mouths water – it’s quite the opposite. So will that still be a theme for 2023?
Therefore, our belief is that instead of categorizing themes, what we believe as owners is to go from the bottom up and choose the best businesses in each sector.
It is very easy to get carried away but it is very important to keep a balance and not make big mistakes. While the momentum or theme continues, we choose businesses that show predictable earnings during periods when balance sheets and cash flows are strong.
We have been positive on a few PSUs for the past couple of years, not today. If the demand in the defense sector continues, both domestically and through exports, we believe there may be a few names that can show signs of hope as we move into the next couple of years. So instead of classifying it as a basket, I think it will be more of a unique presentation of stock in each theme. So we should not get carried away by the recent events and buy anything.