We are staring at two parallel markets. Nifty at an all-time high, blue sky. But there are dark clouds over mid and small cap stocks. Which is a better benchmark? Should one look at the mid and small cap stocks and judge what is coming next or should we look at Nifty and understand where markets are headed?
We just need to take a step back and understand the price action that has led up to this move. If you take the Covid bottom in March 2020, from there the small cap index has been up 233%, if I am not mistaken. And the Nifty is up 116% or 118%. What has happened is that from the base, the small caps have outperformed the Nifty. If that is taken into perspective, it is very logical that at some point in time, the large caps need to catch up or the small caps need to rest. If we take that bigger picture, then the 3-4% correction that we saw two days ago, will not really bother you because the runup has been so big and the outperformance in smallcaps so big compared to the large caps.
I have always found that this is a relay race where the baton passes from the large caps to the small and midcaps and then goes back. Ultimately Nifty 50, which is the front line, is driven by largecaps, also gets into the act. Then after some time, the baton passes back. Net-net, the good point is that there is very good market breadth. If you look at sectoral performances, global market performances, what heartens me or why I find the market has a lot more legs going ahead is market breadth. If you look at equity markets, it is not just India, globally markets have doubled from the Covid bottom. The US is of course the mother market; Europe, which, has been an absolute dead place for almost a decade, is also at new highs.
Look at France, Germany, commodity heavy markets like Australia and Canada zipping into lifetime highs. Look at something like Saudi Arabia. Induced by crude prices, that has also gone up. What we are really seeing is a very big global equity breadth. Again it is not just the US or Nasdaq, world markets have doubled and even the Indian markets have doubled. It is a question of liquidity and global equity markets have doubled and that is what we are subset of.
You are calling it a relay race, let me use the word musical chair. The problem with musical chairs is that one day music is going to stop and if you do not have a chair, you are out of the game. How does one figure out that this relay race is still on?
The beauty of it is that nobody knows the answer. It is only after the top happens that you say oh! well that is where the top is and we experience that even at the bottom. So I can give you a number but honestly nobody has the answer. What I look at and through my experience of multiple cycles, is the market breadth. So I spoke about the global equity market’s breadth but look at even the Indian markets. Look at sectors. We have across-the-board sectoral performance. Three sectors which have underperformed for over 10 years post 2008 — PSU banks, commodities and real estate – have shown a lot of up moves and touched new highs in this bull market. In fact, they have been the outperformers. A very important trait of any bull market is that they should have a very good market breadth. Large caps, midcaps, smallcaps all have been doing well. We mentioned all sectors. Even the biggest decadal laggards are doing well and that is very positive.
I saw two major crashes in 2008 and 2000. There were major bull market tops and towards the end, the market narrowed. In 2000 it was just IT; the rest of the market breadth got decimated before that. In 2008, it was more driven by infra and a couple of
stocks towards the end; the rest of the market breadth had deteriorated. What gives me confidence right now and why on a longer timeframe I feel that this race has a lot more legs is because of the breadth. There is global equity market breadth; there is sectoral breadth and one can also see it in the advance decline ratio.
The big giveaway for me is that when the market breadth starts deteriorating, the index will keep up thanks to a very narrow set of stocks. That very often is a big red signal for me but I don’t see it now. Corrections will come, however, I do not think that the market top is here.
Pharma is getting punished in the bull market where everything has gone up from real estate to metals, from IT to even infrastructure stocks. For a sector which had only buyers, suddenly has no takers. How would you approach pharmaceuticals?
Pharma actually has done very well. The pharma index is up 136% from the bottom. What I see in pharma is the migration away from generic to APIs. If you look at the famous names that are getting plastered which were very good a decade ago or five-six years ago. To name a few Sun Pharma, Lupins, Dr Reddy’s, etc. The stocks that still are doing very well in the pharma space are in a different segment. Pharma as a whole is not destroyed. What has changed is the move away from generic to the API plays.
Some of the API plays continue to make new highs. So in pharma also, a shift is happening. It is not an across-the-board sector and as I said, the pharma index is up 136%. In the Covid fall, one of the sectors that probably fell the least was pharma. Some of the MNC pharma stocks which had paused for a year or so, have all started making new highs. So within pharma, a shift is happening within themes. We are more positioned in the API and MNC pharma spaces.
We are not at the top, we may see some short term correction but there is largely more room for an up move. Where do you think the returns will moderate or stagnate from here on?
As I said, the market has doubled last year and markets do not double, indexes do not double every year. When I analyse two major market crashes or tops of 2000 and 2008, I realise that whenever the markets crashed, the first pullback was very similar to what we have seen, the indexes just doubled. So after the 2000 fall, in 2003, a similar thing happened. The first stage of the bull market is always a very oversold space or the beaten down stocks do well.
Even the three sectors — PSU banks, commodities and real estate — that have done best were decadal underperformers. and we are seeing that happen again. The same thing happened in 2009 post the financial market crisis. The first leg, which is a year and year and a half, always tends to be a very sharp up move in the indices. There are oversold pullbacks and that is when the beaten down stocks actually do the best and that is what we have experienced.
The second stage tends to be a period of consolidation. After 2003, there was 2004 which was not a great year. It got a bit choppy but sideways and post that, the market takes off. The same thing happened after 2009. 2010 was nothing spectacular. I feel markets would enter the second leg of consolidation. In a phase of consolidation, the indexes may be up 10, 15, 20%. Interestingly, this is when the differentiation in stocks and sectors happen and people start rewarding.
In the first leg, people go and buy whatever is beaten down, whatever is cheap and those stocks double or triple. In the second stage,the index may not do much but lots of stocks may go up 50%. Lots of stocks may be down 50% and this is where growth gets rewarded because after the first euphoria, things settle down.
I feel that we would head into a year plus phase of consolidation, maybe at the index level, may be 10-15% here or there. But still one can make 50% in stocks of companies that deliver. Stocks of companies that fail to deliver may go down 50%. We are heading into the second phase and what I saw in 2004 and 2010, is playing out in 2021.
Even in the pharma space, some stocks are falling 20% while some others are up 20%. So, it is not going to be a rising tide that raises all boats. We are entering a phase of differentiation. The index may be range bound but stocks will do their bit based on how the companies are delivering.
Since we are in stage two where not anything and everything will rally but only select stocks, where have you seen the parameters of strong growth, good fundamentals and good financial performance? Where could we see that stock specific outperformance?
Going ahead, we will continue to see performance in quality stocks that deliver good numbers, it is not going to be just a beaten down trade which is something that we experienced earlier. It is not going to be this sector or that sector. Within sectors also, we are going to see differentiations.
I guess that has already begun to play out in banks. ICICI Bank and SBI are taking leading roles while erstwhile leaders like an HDFC Bank and Kotak are taking a back seat?
That is right. The Bank Nifty for the last few months has done nothing but there also, we may start seeing the differentiation. Bank Nifty has definitely been an area of concern. A sector that really led in 2017, 2018, 2019, 2020 and post the pullback, the Bank Nifty is doing nothing. It is going sideways and is in fact slightly corrective.
Will that phenomena play out for momentum sectors such as metals as well?
Metals is a totally different play. It is linked to the underlying commodity prices and for that one has to take a step back because I always like to see the bigger picture first which is global. The CRB index shows a decadal downslide has reversed. Metals are going to be a very very interesting play again. The whole commodity basket is going to be a very good play. There are a few stocks that will get rewarded but they tend to be volatile because that is how commodities behaved and they are linked to underlying prices.
The big story is going to be the impact these high commodity prices are going to have on your margins and that can be seen in a lot of sectors because commodities are inputs for many companies and sectors and rising commodity prices are going to really have an impact there.
So this is a bigger story which is a role play on inflation — the biggest gorilla in the room. If you ask me what is the single most important parameter or area of interest, it is really where the bond yields are because the whole easy money policy is going to play out and support the markets till inflation remains under check. If inflation takes off globally, that will be demonstrated by how US bond yields perform and then the challenge to equity markets will come. So net-net, I do not think that equity markets are going to be massively challenged. There will be corrections and there will be opportunities to be in good quality stocks that deliver good numbers. The only risk to markets is the bond yields take off and that will happen because of rising inflation.
