A $520 million fund manager believes this is a crucial week for the markets

Subramaniam believes that the upcoming LIC IPO is yet another important listing but one should not put too much emphasis on it as, "extreme outliers do not define market opportunity".

Q: How should we look at the US Fed - largely factored in or do you think this market could get jitters?

A: The Fed is doing its job of telegraphing well in advance what their policy moves are likely to be. So I think the 50 basis point this week is pretty much in the price. I increasingly see the market starting to price in 50 basis points at the next meeting, but potentially even 75 basis points. However, we should move away from what they are doing in individual meetings and look at the larger picture.

A larger picture of the commentary that we are getting is essential that the US for the first time, at least in 30 years that I can recollect, is now explicitly articulating that a -inflation is well above the comfort level and they wish to hike rates and impact demand through the financial channel so as to bring demand-supply back in balance, and so as to allow the employment market to settle down.

Now, the implication of both of these is that for the first time, they are actually targeting a reduction in demand to get that demand supply back in balance. Now, history is not really on the side of the Fed over here. But if you see their past history, whenever they have come out trying to swing against inflation with rate hikes, even if they have been successful, they have actually been successful equally in triggering a recession.

So I think that is the longer-term issue that everybody is going to be a little bit perturbed about that in this fight against inflation, if they were to be successful does that mean actually engineering a slowdown at some point in time? Is that the high-risk outcome based on their past track record? And I think that is the issue that the markets really have to grapple with, rather than this issue of will they do 50 or will they do 75.

Q: Is this just a temporary hiccup, like in 2004, after the big Greenspan statement?

A: To my mind, it is not comparable. The starting point in terms of debt to GDP is completely different. The starting point in terms of inflation is completely different. You are talking about an economy that by their own definition is red hot that was not the case in 2004, they were just starting to withdraw the emergency accommodation that had been in place for a long period of time. So if anything, it increasingly looks like they have been late in terms of starting to think about reducing the liquid, reducing this accommodation and that is actually putting them into a tight spot where the risk of a policy error, the risk of actually triggering a dramatic slowdown is going up.

Now will all this withdrawal of liquidity impact markets, without doubt, I also worry about the ability of the US market to absorb these kinds of interest rate hikes? I mean, if you look at their debt to GDP, whether the sovereign or their total debt to GDP, both are very, very high. So when you talk about a 200-300 basis point increase in interest rates, that is a massive dent to the spending power of households and government and I think we are yet to sort of see how well the economy will be able to handle that.

Q: You nevertheless as a fund manager, have to take a call on some of the high valuation stocks. If the liquidity goes away or the cost of capital becomes expensive, valuations won't be sustained. What is your sense? Are you prepared mentally to look at lower valuations?

A: Honestly, I have been sounding a little bit like a stuck clock for almost eight-nine months now saying that the valuations were rich and you don't have to look at the Fed to determine whether valuations are rich. I think equity valuations in India and in many parts of the world were rich, even, going back to September, October, or even maybe before that. Therefore, we have been in some kind of a de-rating phase.

You could argue prices are unchanged over six months, but in valuation terms, the markets actually already started to de-rate, because remember, you have got six to nine months of earnings that have come through and the market is not responding to that. So I think we are in some kind of a de-rating environment and that will continue.

It is only a question of will prices see a sharp cut at some point in time or do we just sort of see a muddle through the process of earnings and prices and whereby prices go nowhere, valuations over a period of time go through a full set of correction. But I certainly think we are in a valuation correction mode. From a macro point of view, we could tally it back to the fact that rates are higher and that has to get accounted for in the valuations.  We will also have to worry about how good these current earnings estimates are likely to hold up in the face of some of these pressures.

Q: Actually, if there is inflation, if you lose out on one set of stocks, like maybe consumer durables, you make that money on the EPS of metal stocks. So, not necessarily?

A: That is true, but the challenge with that is two-fold. The challenge with that is the market does not pay the same multiple for metal earnings as it would for consumer earnings. The second challenge over there is - look if it comes to buying metal stocks or energy stocks the whole world is your playground. When you look at the Indian opportunity and where market money tends to flow in, it tends to be driven a lot more by what people see as the strong domestic story which is there in India, which includes consumption and anything which harms household P&L account and balance sheet will not be taken so kindly by investors be there local or be their foreign.

Q: Will you still persist with metal plays or is it time to play contrarian?

A: Interesting question. We were taken by surprise when this whole Russia-Ukraine conflict played out and metal prices, energy prices rallied, and stocks have done well. But when I think through their long term sort of earnings potential, and where they are in terms of valuation, remember their actual PE valuations or EV- EBITDA don't look expensive. But historically, our experience with metals is that the best time to buy them is when profit margins are extremely low relative to history and valuations, particularly earnings-based valuations are very high.

Today, we are in a pretty much the reverse situation, the margins are at record highs, and the valuations earnings-based are at a record - not record lows, but pretty much in the low - less than five, six times, which to my mind doesn't really make them look very attractive. So it is not something that we would go towards. We have a lot more comfort in some of the discretionary stuff that you mentioned, we might just have to be a little bit more patient but that is something I can live with.

Q: Did you look at the auto sales numbers, are you happy with auto stocks now?

A: Auto is one of those strange areas where we look at the current volumes 20 to 30 percent off their peak volumes of FY2019. I think over there, they have gone through multiple issues, starting from inflationary pressures, the sticker shock for the customers, and then of course, now you got supply-side challenges. So everything rolls into what we would sort of consider as being a good contrarian sort of opportunity, because as volume starts to recover, you will not only see that benefit, but you will also see margins start to go up slightly. So auto would be one of our sort of preferred contrarian players right now.

Q: How are you approaching the LIC IPO as an investor, as a fund manager, and if I were to ask you to advise investors.

A: I don't think we need to overemphasise. This is India's largest insurer. It is one of the sorts of jewels of the government of India in terms of public sector companies. They need to raise money for disinvestment, it lists a large attractive business, which is, in many senses, a leader in the market in which it operates. So as an investor, it is just putting more choices on the table. I don't see it as being something which is an epoch-defining event for the markets per se. It is yet another important listing, but I wouldn't overemphasise its importance of it.

Q: Well, no doubt about its success, is it?

A: Well, that is your job to figure out how it does over the next few days. But at least from what we hear from the bankers, I think it has seen a reasonable response. It is a household brand name so I won't be surprised to see people sort of line up for it. But again, not my job to speculate on that. We will go by the fundamentals and, invest in our schemes if we believe them to be of interest.

Q: How are you picking stocks at this point? Is it like you think of India as a K-shaped recovery and go for consumer discretionaries? Are you worried about the Nykaa, Zomato kind of valuations?

A: Good question, I think there is no point looking at the outliers, right? I mean, you talk about some of these New Age companies, they are outliers. At one end, we talked about metals, which could be outliers, if you see earnings-based valuations at the other extreme. But I don't think the extreme outliers define the market opportunity. There is a fairly wide range of stocks out there. We have talked about this in the past, we think financials look reasonably attractive today. We know credit is not growing, but we think the sector is well consolidated, has very clean balance sheets, and is well placed for growth. We do like many of those opportunities that you mentioned and consumer discretionary.

Without a doubt that K-shape recovery means perhaps things which are at the top end of the consumption basket would end up doing slightly better than the stuff at the lower end. So I would say there is a wide range of opportunities. But as I mentioned earlier, from an asset allocation point of view, equity valuations are sort of lukewarm. They are in fair value, if I look at the large-cap, not so much in the small and mid-cap space. So you know, we would continue to sort of being, trade a little bit gingerly over here.