What are your thoughts on valuations after this correction? Do you think some froth has been cleared?
Broadly, valuations across the market have come up in the last one and a half years, but looking at the broader market, I think the valuations are still reasonable in many pockets on the largecap side. On the mid and smallcap side, we can see a bit of expensive valuations. Also, some of the recent IPOs which are coming also have valuations slightly on the extreme side. I would say overall I am not so much concerned about the market valuations. We have a lot of good opportunities coming up on the large cap side and it is going to be a market of stock selection going forward.
How are you analysing the earnings quality of corporate India?
All of us are aware that the last three years have not been very linear or normal. We had gone through a lot of disturbances in terms of demand due to GST, NBFC crisis, and Covid was the height of it. It is very difficult to give a clean picture of the earnings but all of us are aware that cyclicals have made a big comeback.
So the profits from the cyclical sectors like metals and oil and gas as well as some of the corporate banks have started to come in a big way and that is supporting the earnings growth for the entire market.
On the other side, the defensive or the secular kind of companies, which give compounding profit growth, have gone through volatility in the last one year. But I am pretty sure that they will quickly come back to their usual growth path of 10%, 15%, 20%. Going forward, we are probably getting into a phase where we are going to see broad-based economic growth and some amount of inflation will also be there. Both these things are going to be very good for the corporate top line growth as well as earning growth.
So going forward, the rally is going to be broad-based. In the last five years, we have seen a narrow market rally in the sense of only 100-200 companies doing well. But going forward, we are going to see a broad-based recovery. Hence a lot of companies and sectors will participate in the recovery which is going to take place over the next three-four years.
There is a small niggling issue at the margin end, which is recurring and disturbing the market sentiment. It is the probability of taper. Every time the talk of taper comes on the table, globally markets get disturbed, as does India. What could be the worst case scenario if it impacts emerging markets like India?
Taper is a very big risk for the market given the rally and the valuations. But I think the important point to note is why will the Fed withdraw liquidity and raise interest rates? It will happen because of growth making a comeback and also due to inflation. Most of the central bankers are maintaining that some part of inflation is transitory and to that extent, they will not react sharply.
Going forward, one day this liquidity has to be withdrawn and tapering has to start, but the reason for that is going to be growth and inflation. Till that happens, we will keep on getting these kinds of signals from the central bankers. They will prepare the financial markets for the eventual tapering and the interest rate reversals. It might happen after three months or six months, I do not want to time that, but two things are clear; the liquidity withdrawal and the interest rate hikes are going to be gradual because the central banks may not be able to afford giving shocks to the economies and markets. Secondly, by the time it happens, I hope the growth and inflation narrative will come to the centrestage rather than the liquidity.
So even when that tapering off starts, I do not think the market will have a kneejerk reaction. Probably it is already getting factored in or priced into the market levels. That is my best case scenario that by the time it happens we will be in a growth and inflation dynamic situation and a lot of this tapering would have already discounted by then. So, I do not think there will be a big correction at that point of time.
So what are you bullish on? What looks good to you on risk reward and margin of safety basis?
When I said I am bullish on largecaps, it does not mean I am completely avoiding mid and smallcaps. I have a certain percentage of mid and smallcaps. I am just reducing it a bit and allocating that towards largecap stocks because on a risk reward basis, some of the largecap stocks are looking very attractive. We have had a very good rally in mid and smallcap stocks in last six-eight months, fuelled by retail participation as well HNIs or PMSs etc.
In many of those sectors, the valuations even for commodity nature of mid and small cap companies have gone to 30-40 times PE which I feel is not a good sign. But on the other side, largecap stocks have gone through some amount of time correction and consolidation. I particularly like large banks and even some of the insurance companies and NBFCs because compared to their historical valuation as well as compared to the broader market, this pack is looking very attractively valued and the future is also looking brighter for them because the with credit cost almost getting to a end, growth should pick up. Nominal GDP is picking up and their operating expenditure is under control. So we might get a big jump in the profitability of the large banks and some of the insurance companies and NBFCs, while valuations are in our favour. In largecap universe, I like that space most.
I am also selectively looking at some of the auto or auto ancillary companies. That sector has also gone through consolidation and we might have problems for one or two quarters because of chip or semiconductor shortage. But globally, as well as in India, we will see a big revival in the auto sector. This is a good time to accumulate those auto ancillary or auto stocks in the next one or two quarters.
Auto sector is facing chip shortage. Almost three-four companies have gone on record saying chip shortage is impacting them. There is also disruption from EVs. Some amount of positivity is coming from the revival in the US and Europe. Are you analysing all these factors for autos as well as large auto ancillary plays?
Yes,I will be looking at those auto companies. They are getting into a favourable zone but as of now, in the portfolio I am overweight with global facing auto ancillary companies. For these auto ancillary companies, electric vehicle or ICV vehicles do not matter as they supply small parts to all these vehicles.
I think we are going to see a revival in auto — may be EV or internal combustion vehicles — first in the US and Europe in a big way because those markets have gone through a sort of a dull auto phase for last two-three years. Also, those people in the US and Europe have lots of savings which they have sort of accumulated during the Covid period. I think auto markets will recover there first. The auto ancillary companies are actually in a much better position to capitalise on that growth and we will get operating leverage, financial leverage from them.
As of now, I will be playing sito through those global facing large auto ancillary companies and maybe after sometime, start looking at the auto companies in India also. Their preparedness for electric vehicles will be a big deciding factor
How are you looking at the midcap, small cap space?
In the first quarter results, the numbers have come in largely from the cyclical sectors like metal, oil and gas. While in other parts of the market and it includes midcap also, the results were not very gung-ho in nature. I mean for this kind of valuation I mentioned 30-40 times PE we need earnings to surprise the market positively and consistently. In this quarter result we have seen sort of some lack of that positive earnings surprise though all managements are giving out very positive commentary and pick up going forward in the second half of the year but for these valuations to sustain and to go up further, we need earnings support or the earnings surprises that was lacking in many of the midcap companies. At the same time, some of the large caps continue to deliver very well. This realisation probably happened suddenly in the last 15 days and that is why we are seeing people perhaps switching from midcaps to largecaps and that is causing this kind of volatility in the market.
