The economy and stock market have a negative relationship with high inflation. However, the market likes inflation on a short to medium-term basis when price increases bring a replica effect on the earnings growth.
But consistent high inflation leads to imbalances in the economy. The real income is not compensated enough to sustain demand.
Today’s high inflation is due to an imbalance in demand and supply, money flow is higher than the economy’s capacity. It is feared that this could lead to hyperinflation.
For example, CPI in the US is forecasted to be high at 8% in 2022 and reduced to 4% in 2023, higher than the 2% target of the US FED.
In India, the 7.4% CPI in Sept 2022 is forecasted to fall to 5-6% by mid of 2023, which is in the higher range of the RBI’s target.
Though India is in a better position, high inflation in the rest of the world will have a cascading effect on the domestic economy and the stock market.
It is logical to invest in areas that are less elastic to high inflation like service providers as well as staples. Industries that have a high growth cycle, steady source of raw materials (no supply issue), and low leverage.
Secondly, value buying should be the theme of investment because highly valued stocks cannot perform during inflationary and high-interest rate cycles.
Some sectors in the theme are:
The beta of large-cap IT companies is low, and positive in a volatile stock market. Q2 results have reported a decent double-digit growth, propelled by cloud, engineering, and digital services.
Furthermore, during COVID & aftermath, orders have increased as most clients shifted to digitalization and cloud platforms for better cost optimization. Also, the IT sector is trading at an attractive level after the past 1yr correction.
Pharma & healthcare are unlikely to get impacted by discretionary spending cuts. The industry has been facing selling pressure over the last one year due to a rise in chemical raw material costs & slowdown in demand in post covid.
Currently, the raw material prices have started to ease, which will support the margins in the coming quarters. We expect US price erosion and inflationary pressures to soften.
We presume that the pharma sector will trade at premium valuations due to high healthcare demand in developed economies and the acceptance of Indian products.
Consumer staple businesses are less affected by inflation due to the essential nature of the products and grammage adjustment formulae. Consumers continue to buy products even if charged higher prices.
B2C companies with dominant market share and pricing power, though they may temporarily experience some impact on their margins, are able to pass on cost increases to the customers.
These established and mature firms offer low stock price volatility, consistent dividends, and a good hedge to an inflationary environment.
Currently, the demand is picking up, supported by a normal monsoon and festive season. At the same time, the correction in input prices in recent months is expected to be reflected in the margins from Q3FY23 onwards.
Valuations are at the upper side, which we presume to stay high, any correction will lead to a long-term opportunity.
The telecom sector is in rapid expansion mode, led by low tariffs, increased accessibility, the introduction of Mobile Number Portability (MNP), the availability of cheap handsets, and the rise in the digital economy.
Spectrum prices are declining, and governments have increased the spectrum’s life to 30 years reducing annuity costs.
We expect ARPU to increase in the future to drive profitability. The industry has taken price hikes on prepaid tariffs by 20-25% in the last year.
Going ahead, the telecom sector is well placed to capitalize on emerging opportunities from 5G deployment.
On a short-to-medium-term basis, large caps are the best category to invest in because they are in a better position to handle inflationary uncertainties. They are at a low risk of earnings downgrade compared to Mid & Small caps.
We foresee opportunities in sectors like IT, Pharma, FMCG, Telecom, Gas, and Pvt Banks. Broadly, we like consumption, green initiatives (like solar, wind, hydropower, hydrogen, battery), specialty chemicals, and manufacturing. Idea is to invest in non-inflationary growth.
First published in The Economic Times