Firstly, let’s discuss the market volatility we are seeing just ahead of the big event. What is your expectation for the election outcome? Everyone is coming out with their estimates on market movement. How do you see the market positioned at this point in time?
If you look at the last two election results, in 2014, the NDA had about 336 seats. In 2019, the NDA had 353 seats. Both times, the BJP was well above the crucial 272-seat mark. So, whatever the outcome, Monday will be very volatile as that’s when the counting happens and finishes. The market’s response will depend on the percentage of votes BJP and NDA get compared to 2014 and 2019.
A single party or coalition getting more than 272 seats to form a stable government is crucial. If we look a week ahead and consider the steady inflows from domestic investors, they’re already favoring a stable government. So, apart from a volatile week based on vote counts, if the seat count is between 330 and 360, we will see stability, and the VIX will likely decrease.
However, if the count is significantly lower, around or below 300, the market will correct before stabilizing and moving forward. As investors, we are fully invested and not holding much cash because in volatile times, especially when market sentiment is improving, it’s beneficial to be fully invested.
A key concern is that FIIs are not returning to India, causing continuous selling pressure. However, strong mutual fund buying by DIIs is helping the market hold ground. If the election results are positive, do you think this could encourage FIIs to return, or will valuations still keep them away?
It’s a question of perspective: is the glass half empty or half full? DIIs have invested as much as $6.5 billion this month, which is remarkable. DIIs and non-retail investors now account for more than 16.5% of the market, more than FIIs, who are at a 10- to 12-year low of around 16%. Despite this, the country has seen positive developments: strong GDP growth, significant contributions to global growth, and inclusion in emerging market bond indexes, attracting $15 billion in foreign debt over the past year.
MSCI has increased India’s weight from 6 to 18 over the last decade, with much of the increase in the past year, even as FII participation decreased. I believe FIIs are currently underweight and will return once a stable government is in place. Over the next two to three years, I expect substantial FII inflows, potentially as much as $200 billion, which could positively impact the current account deficit.
When FIIs start returning and investing more, which sectors do you think they will focus on? Many are talking about the consumption space, and recent earnings from FMCG and consumer players have been strong. What are your thoughts on lucrative sectors for FIIs and the consumption theme specifically?
The BJP manifesto highlights words like defence, capex, water, and power, with “capex” mentioned 59 times. This indicates a focus on increasing the country’s capex cycle for job creation and the “Make in India” story. We expect maximum inflows into these areas. Despite FIIs being net sellers recently, they have been investing in capex, industrials, and power, reducing their positions in financials and consumption. In the consumption space, we were successful last year with Trent and Varun. Now, we’re looking at tourism-related ideas like SAMHI Hotels but are cautious with consumption investments as growth is stronger elsewhere. We also play the consumption theme through housing-related investments like Chola Financial and the Bombay Stock Exchange (BSE).
Can you share some of your stock-specific ideas, particularly in the capex theme? For example, how do you view Kirloskar Oil Engines?
Our analyst, identified Kirloskar Oil Engines early. We started buying it at about one-third of today’s price. The reasons we liked it then and still do are its advancement in engine technology, increasing KVA, securing maintenance contracts previously held by global MNCs, tapping into export markets, and having a substantial NBFC, ARKA, within the company. ARKA, with a focus on real estate, has issued its first NCD recently. In terms of valuation, the company is trading at 20 times consolidated PE, with a return on capital employed between 18% and 20%, and earnings growth of 20%-25%. The demand for DG sets is rising due to power issues, making Kirloskar Oil Engines a great fit for our investment strategy, especially with its “Make in India” story and the potential unlocking of value from its NBFC.