Ukraine War: Transient Impact On Equities

Russia’s invasion of Ukraine has accelerated the recent market correction. We see continued volatility in the near-term as the geopolitical risks may take some time to recede. However, we remain bullish on FY23 fundamentals for Indian companies, and see this period of uncertainty as an opportunity to enter the market. The sector leaders for the next rally, however, will be different from 2021 and we see some laggards playing catch-up through the next few quarters. We would advise investors to maintain their full asset allocation to equities and use this correction to cover any under-investment that may have come about.

Geopolitical risk
Russia’s invasion of Ukraine military could potentially destabilise global macroeconomic stability. We believe that India, in particular, is vulnerable on multiple fronts.

CRUDE PRICES have already shot up to ~$100/bbl and may continue to stay elevated if the conflict persists. This hurts India on the trade and current account deficit and inflation. India is more resilient to an oil shock than it was in 2008-2015 with a lower fiscal and current account deficit, but it still is an incremental headwind to the economy.

INFLATION. Persistently high commodity prices threaten our base-case assumption of inflation easing by 2HFY23. In addition, sharp hike in domestic petrol and diesel prices is likely in March 2022; given that the recent spike in crude prices is yet to be passed on. This could create a short-term consumption shock in early FY23. RBI, however, is likely to look through this near-term inflation spike and maintain its easy monetary stance.

GLOBAL RISK-OFF. FPI outflows have accelerated in anticipation of the conflict and will remain a short-term challenge for the market. Expected Fed tightening kick-started the risk-off trade, but our base case was that this was a temporary phase and would be offset by strong global growth. An extended period of geopolitical uncertainty may upset our forecasts.

We do not see a significant RISK TO GLOBAL GROWTH in this period. Supply-chain disruptions could get worse in the short-term, depending on the severity of sanctions that are imposed on Russia. An extended military conflict in Europe does make this risk a possibility, but we think it is a remote one.

All the four of these negatives are unlikely to persist. Not least because there are self-adjusting factors – eg, high crude prices and fed tightening are unlikely if global growth slows.

Macro positives for India
Looking past the near-term negatives, we remain constructive on India's macro outlook for the next 2-3 years. We see a sustained post-pandemic recovery in growth, with 7%+ growth sustaining as the economy normalises, global growth remains supportive and some of the reforms of the last few years start to impact. We are expecting some key trend shifts in FY23.

OPENING UP. We believe that FY23 could be first year in four without any disruptions to normal life. The obvious beneficiaries would be the high-contact businesses that have gone through a tough 12-24 months. On the other hand, we see some businesses which temporarily benefited from lockdown, like e-commerce, go through a consolidation period. Within verticals like retail, financial services and dining, market share could shift back to the "offline" players.

INCLUSIVE GROWTH. India's K-shaped growth recovery, concentrated on higher-income segments, could become more broad-based. As high-contact sectors recover, blue-collar employment should also improve and help improve incomes at the bottom end of the economy. This segment has gone through multi-year pain, and this has reflected in the performance of companies catering to it. We think that FY23 could be a strong year for such companies in sectors like FMCG and financial services.

MODERATING RM PRESSURES. Raw material pressures should start easing from FY23. A correction in global commodities may be unlikely, but the YoY inflation should start to ease on a higher base as we get deeper into the year. As companies pass on the higher prices over the coming months, the consumption shock should start to ease – especially if blue-collar employment picks up later in the year. Companies would also be able to restore gross margins through price hikes, creating space for discretionary expenses such as advertising and promotion.

Sectoral outlook
We believe that there could be some key sectoral shifts once the market recovers from this period of uncertainty:

CONSUMER names could make a comeback. A recovery in aggregate demand, coupled with dwindling RM pressures, would create opportunities for investors. The challenge is the elevated valuations, which makes them vulnerable in a rising rate scenario – but there still could be selective opportunities where there is potential for earnings surprise.

TRADITIONAL BANKS that have underperformed in CY21 could start to recover. There is an “opening-up” element in the earnings profile of some of these banks, as they depend on offline spending for revenues. Some of these banks are also clawing back their gap with fintechs on the digital experience offered to clients. Finally, the aggressive pandemic provisions could cause credit costs to undershoot in FY23, creating headroom for investments in areas like franchise growth and technology.

ONLINE TO OFFLINE. As mentioned earlier, a normalising economy could restore some of the balance between online and offline, creating opportunities within high-touch industries. Service sectors such as retail, dining, hospitality and entertainment could throw up some opportunities as we get deeper into FY23.