Let us first start with the big picture overview on equities in general. It is not only in India. Globally, also, with the exception of China, markets are in a good groove. So, do you think that rather than getting worried about India in specific, we should look at the big picture which right now of equities is quite attractive?
Sunil Koul: You are right. In fact, even China has started to recover from the lows. So, we are definitely seeing a rebound rally in the region across Asia right now and so the market is already up 12% from the lows. The key construct for the markets here is that. But valuations in general across the region are probably more fair and we do not think there is a lot of room for valuations to re-rate in most of the markets. But what we are really looking for here is profits and we do expect earnings to continue to recover in some of the markets in Asia which is why we think the markets can continue to gain momentum here and be higher in 12 months. So, for the region overall, we are still baking in a high single digit to kind of 8% to 10% returns for the overall Asian markets here. It looks like things are still looking pretty decent.When you say 8-10% returns, the earnings are expected to grow in the region of about 10% to 12% or 12% to 15% depending on the universe you track. So, are you making a view that in India now markets may actually underperform earnings?
Sunil Koul: Yes, that is a good question. For the region overall, we are baking in 15% earnings growth for CY2023, another 11% for next year, but that is really upwardly distorted by deeper cyclical markets like Korea and Taiwan which are coming in from very low levels. In Korea’s case, in round numbers, we are looking for 60% earnings growth.

So, if you strip that out, we are really looking for kind of 8% to 9% earnings growth for the region as a whole, which is what our full-year targets are and that basically tells us that multiples are flat on an aggregate basis and the underlying 8% to 9% earnings growth kind of drives the markets higher. Within that for India, we are baking in 15% earnings growth for the next couple of years and I would also like to make one point.

I think a lot of the people make the point that the market has done well. If you look at the underlying earnings, it has been three-four quarters in a row wherein earnings are actually better than expected. We just had the December quarter which concluded and profits were up 17% year-on-year, which basically took the calendar 2023 profit growth for MSCI India, similar to Nifty, 20%.

What that means is that the 20% move in the index for last year was entirely driven by the underlying earnings and so if you looked at the aggregate multiples, that for the index is actually flat year-on-year. It is an important point and the reason we continue to like India is because of this consistent earnings delivery and so if we are right that earnings continue to compound at 15%, so lower than last couple of years but even if we get 15% earnings growth, we still think markets should be higher in time.

Over the weekend, we were just going through Warren Buffett’s annual letter to shareholders and one thing really stands out from there. He is saying, obviously in correlation to US equities, the markets are exhibiting a far more casino-like behaviour, saying that the casino now resides in many homes and daily tempts the occupants. Correlate that to India, do you see pockets or signs of any exuberance or risk-taking ability if you will here in India?
Sunil Koul: Yes. before I answer that, I just saw the targets being flashed on your monitors and I would like to correct that our sort of year-end target for Nifty is 23,500, so as I said we are kind of still looking at sort of the high single digit returns given from current levels for the market. Obviously there have been pockets of the market that have run up quite a bit compared to fundamentals and I mean, PSU, for example, is a good starting point, wherein it seems like obviously the index has almost doubled in the last one year.

Some of the pockets in those could be justified, for example power, for example defence. Whilst if you look at some of the other stocks like OMCs and banks, we do not think that move was warranted. So, clearly, there are some pockets which have run up overall, but I think overall one of the core views we have coming into the year and probably that manifests more after the elections is that you should see rotation in the markets and as foreign money comes back in you should see largecaps taking the lead again and that is where we are kind of more focused on.

But are you getting a lot of pushback when it comes to the private banking performance in India because your top bets remain HDFC Bank, ICICI Bank, even IndusInd Bank features in that list. What kind of feedback are you getting from investors on that?
Sunil Koul: Yes, the largecap private banks have been underperforming almost for a year now. I think near term there are clearly some headwinds. We do think there are two issues going on. One, I think the cost of funds will continue to rise for the banks. Number two, as well flagged by now, there are obviously pockets of concerns on the consumer leverage, so we do think profitability comes under pressure in the near term for the large private sector banks and so ROEs should start to moderate both in terms of loan growth slowing because the loan to deposit ratios are stretched but also margins coming under pressure. But the way we are positioned in the banks is that we are more selective there. So, one of the themes, intra-bank themes, we have is that of favouring commercial retail-oriented banks or the consumer-oriented banks and that trade would continue to play out.

What gives you the confidence that we are in for another good year of double-digit growth because double-digit growth on this kind of a base is incredible?
Sunil Koul: That is a great question. Look, I think, one, as you very well know, we have been seeing the slowdown for the last two-three quarters now, whether it is in the consumption space where it is obviously in the new orders in terms of infrastructure also heading into elections. Despite that, when we came into the year, last year, we were looking for around 18-19% profit growth and the market delivered 20% percent.

From current levels, the way we are looking at things is that if you look at the last year, the key construct was that demand was still slowing which we just discussed, but margins came through and so much of the earnings growth actually came in from margin expansion. Looking forward, our sense is that from very low levels, sort of 5-6% earnings and volume growth or sales growth, you should start to see things improving a bit over the next few quarters, over the course of the year and so we are baking in like 7-8% volume growth and then some moderate expansion in multiples which should get us to that 15% number.

On the composition there, I would say, look, on the consumption pockets, as we all know, high-end consumption still continues to do very well. We are hopeful that some of the discretionary bit, especially the mass market consumption should start to improve especially given that inflation has come down and that means disposable income should start to improve as well, so that would be a positive delta, I would say, compared to last year.

IT on the margin has also started bottoming out. We think that in the December quarter, growth bottomed out and we do think earnings should start to improve there as well. We are baking in 10% earnings growth for the IT sector compared to low-single digits last year. Keep in mind also that 60% of the revenues, they are coming from US and we, as a house, have above consensus view on US growth and we have been not in the recession camps and for a year or so and that seems to be already playing out.

I think that that should kick in and then we do think there are some signs already in the data that private capex should come back after the election. If you put all of that together with a bit of improvement in the volume growth and some margin expansion, we think that 15% earnings growth is realistic there.

How much of this earnings growth template which is now more like in consensus is in the price? See, markets will make money if you find something which nobody is betting on. So, the fact that India is growing, India will grow, India will continue to grow, earnings will be in double digit, is more like a ghar ghar ki kahaani.
Sunil Koul: Yes, that is right. Even in our broader Asian allocation, we think India is one of the structural growth stories out there in Asia and that is pretty much what a lot of the clients agree to. And as I said, if the earnings continue to grow double digit, even with some moderate valuation compression, which we do bake in our numbers, you could still get decent upside on the market.

In the near term, things could flatline and we do think post elections probably market goes higher, but in a lot of the other markets in the region earnings are much more cyclical in nature and you are coming in from very low levels, so you get that boost.

But for India, obviously, the macro looks very good or as you said growth is looking pretty-pretty decent and if earnings continue to come through in double digits that should get markets higher. And within the market, we have been seeing that there is enough dispersion, both at the sector and the stock levels and as I said, one of the core views we have is that you, A) should see rotation into largecaps which have not performed as well. And B) there also could be rotation back from value to some of the quality pockets as well and so that probably takes the leg higher in terms of markets.

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