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Markets are at an all time high but the economic indicators are at an all-time low — be it unemployment rate, GDP growth, corporate profitability, top line growth that companies have reported for the quarter gone by. Who is going to get it right and who is going to get it wrong? Do you think bulls will get it wrong?
It is true. The economy is at a low, largecap indices are at a high. There seems to be a disconnect but if you look deeper, I do not think there is a disconnect between the economy and the market. The NSE midcap index is almost 20 to 25% below its peak and the NSE small cap index is almost 40% off its peak. The broader market is exhibiting the same kind of stress that the economy is currently witnessing. There is no disconnect at all!
We are noticing that while the economic growth numbers are still subdued, the valuation is giving comfort to select mid and smallcaps and that is where in the last three months, a lot of investor interest has built up. We are also seeing that slowly the market breadth improving.
Overall, the markets may remain choppy but there is money to be made in the broader markets, especially in the mid and smaller segment. It is no more about getting polarised in terms of few stocks. If you are a stock picker, if you are finding good value at a certain level, then one should be building that portfolio and hopefully over the next recovery period this is the basket that will give better wealth.
We can work with the assumption that the economy will bounce back but all those assumptions have not made money. One assumes that you will not make money if you buy Bajaj Finance or a D-Mart or a HUL at these levels. but those stocks are making money. So, sensible investing is not working and more like a follow the herd or a Rip Van Winkle effect is working?
There are two buckets as you mentioned; one is a bucket where the valuations are high and maybe there is some steadiness in terms of earnings growth but there is that other bucket which is completely beaten down. It may look like a very attractive but obviously things are not great there.
While we are not completely getting out of some of the names where there is steadiness in terms of growth, we are also looking for opportunities where valuations have more or less discounted all the negatives and we are finding some opportunity in terms of growth recovery. That is where we are putting our money into. I think it is going to be a gradual process. I do not think you can choose one way or the other right now. You have to keep on gradually building your portfolio away from some of the expensive stocks, away from the pocket which has seen over ownership and slowly get into the pocket where when the economic activity revives, there will be better upside in terms of stock returns. That is where you need to go but how much you will go progressively has to be calibrated, based on the risk that you see in the market.
While you have got a 13% recovery from the 52-week lows on the midcap index, tactically do you reduce your exposure to largecaps and nibble a little bit more selectively albeit within midcaps?
We have been doing that across our portfolios, wherever the investment mandate allows. Let me share another statistic. The total mutual fund allocation to Nifty stocks is currently at about 64%. In the past, whenever this ratio has crossed 65%, some sort of shift has happened from largecap to midcap in terms of interest.
In the past, this proportion has peaked out at 67-68%. If you believe that will hold true, may be some more time needs to pass before you see the peak of the largecap indices outperforming mid and smallcaps. At some point of time, in the next few months, the mid and smallcaps are likely to start performing much better than the largecaps. That is where the money is going to be made.
Within largecaps, the other debate is whether one should diversify. Are largecaps headed for a broader participation strength moving out of those 10-15 names or do you continue to buy more of the same? Do you continue to add more of those names on dips?
We are moving away from some of those over-owned stocks. Yes in the immediate short term, the growth may be very steady but the valuations more than discount some of that in our opinion. Also it will be very difficult for us to change the entire portfolio composition. As soon as we see some recovery in the economic activity, we have to be ahead of the time and that is where the calibrated approach in terms of moving out of some of these stocks has already started in our portfolios.
Money will be made in largecaps too, but it will be more moderate than what you would see in diversified funds or in mid and smallcap funds.-Harsha Upadhyaya
How real is the strength in autos?
We still continue to be circumspect about recovery in the auto segment. The valuations have moved up from the beaten down valuation to current levels which more than discounts the recovery that is taking place. There has been some extrapolation of the festive demand to continue into the future. I do not think that is happening.
We see that within the sub-segments of autos, only two-wheelers at this point of time give some valuation comfort but the rest of the market is unlikely to see the same kind of demand that we saw in October and the valuations are also high. So to that extent, we have been very selective in our exposure to auto industry.
Among the beaten down spaces, do you see an opportunity in autos and auto ancillaries? What about the other pockets which have been underperforming?
We have increased little bit of our exposure to the metal segment. In our last interaction as well, we spoke about this particular sector where while the fundamentals are still subdued, the valuation comfort is there. So we have been selectively building some position in metal space . Although there have been a lot of news flows, up and down in terms of the trade war receding and vice versa, I do not think market is hoping too much from that angle.
We have seen some stability in some of the metal segments in terms of pricing. Demand has also been okay, subdued but nothing is really falling short of expectations. It is one of those areas where one can start to look building some exposure, obviously not for the immediate short term but over the next couple of years, this basket can give better returns.
What about some of these beleaguered banks which have had their fair share of bad news like YES Bank and RBL Bank? Do you sense opportunity within banks in some of these beaten down names as well?
We are fairly okay with our current positioning in the banking sector where we have bet on a mix of retail focussed as well as corporate focussed private sector banks and also a couple of non-lending businesses, such as life insurance and general insurance.
Overall, we believe the asset quality is still holding up. There is adequate capital to grow and if the management is focussing on the right segments to grow, there is money to be made. Yes with economic slowdown, the credit growth has also come off. There is some pressure in terms of the growth for most of the banks, but having said that, it is still one of those pockets where there is at least growth. If credit cost starts to normalise, there is enough kicker that you will see in terms of stock performance from some of these banks.
Other banks are growing reasonably okay on the retail side where risks have not been as high as what you have seen in the other segments. Overall, we will stick to our current positioning on the financials which is more like a neutral to slightly overweight position.
What is in for large cap investors now, Nifty is at 12000, most of the stocks where you see visibility are not priced to perfection but in this case they are priced to imperfection right now? Will money be made in two years in large cap stocks?
Money will be made in largecaps too, but it will be more moderate than what you would see in diversified funds or in mid and smallcap funds. Also whenever there is the next bout of volatility, I do not think the largecap basket will be spared. There will be volatility even in the large cap basket. What they have seen in the last two years was more like a one-way movement for largecaps, without much risk. That is unlikely to continue in our opinion.
What is the downside for this market if earnings do not recover for next six months? There is a very strong possibility it may happen this year because consumption is not going to pick up, investment cycle is broken down. Will stock prices start coming down or will markets continue to hide under this veil of liquidity?
It is always difficult to predict liquidity flow and sentiments. Having said that, I think if earnings do not recover even with some of the things that have happened in the economy in the last couple of months, then the market will consolidate at around current levels. Maybe the choppiness on the downside will increase but I do not see too much of a movement for markets.
When you are talking about the next six months, you will ideally be looking at 2021 or 2022 earnings. 2020 will be behind us at that point of time. The hope which has been leading the markets for all these years will continue to lead in terms of expected recovery. I would not see much of a downside, given that the tax rate cut boost has improved sentiments and also from a valuation perspective, some enhancement has happened to the market. Overall, the choppiness on the downside could increase if earnings do not recover.
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