The hyper bull market continues both locally and globally. We saw numbness in mid and smallcap stocks but the benchmark indices are holding on beautifully. So what is in store for the second half of this year?
At some level, you just need a certain amount of stepping back and consolidation. The pace of the market expansion is far more aggressive than the economic rebound and to that extent, unless there is an acceleration in the economic rebound that one has seen, there should be a little bit of a consolidation if not actually a little bit of a pullback at the market level.
This is a slightly split market. As far as businesses are concerned, there will tend to be a little bit of normalisation, a little bit of more outperformance if you get into the right spaces than necessarily a one-way move as far as the broader market is concerned.
But hasn’t the one-way move got challenged? I am surprised that even though Nifty is at an all-time high on average, smallcap stocks have corrected 15% to 20%.
We had done a very interesting piece about a week ago where we showed that over the last 15 odd years, there have been four occasions when the smallcap index has got to about 20% kind of premium to the largecap index, post which, there has tended to be pretty sizable corrections; that is the kind of place we had reached earlier in this month.
So to some extent if we were to just look at historical trends, I would believe that this pullback is not an anomaly, this could actually have been forecast. I think that is one way. The second bit is what is happening with underlying businesses and to that extent, while previously there has been differences between the largecaps and the smallcaps and the unorganised space. Since the unorganised space has lost so much space, we have ended up seeing some of the midcaps gain in terms of underlying market performance.
I would tend to believe that the larger cap businesses or the larger businesses continue to have a disproportionate share in the underlying business growth which is not necessarily so for the smaller caps and to that extent, there has been a market element in this correction. This is true as far as underlying businesses are concerned and to that extent I do not think it has been that much of a surprise.
Another area one needs to look at is the fact that India has outperformed the EMs very, very substantially over the last couple of months. Now to some extent when you have this kind of outperformance, it tells us that the global market effect is not there. This is something beyond the global market effect. I would tend to believe a lot of it lies in terms of the local market support or the local inflows that have come through and which has really created this differential performance and not necessarily the underlying economy.
So the bottom line is I am not too surprised by what you have seen with the midcaps. I would not be too surprised if even at the market level, there is some kind of a pullback, not necessarily of the magnitude of what we are seeing with the smaller caps but a little bit of a pullback over the rest of the year, is a reasonably fair call to make.
In terms of the texture of the market, going forward from here should one realign the portfolios? In the interim, it seems that banks have it all going for them. Does one need to ebb off from IT, allocate more to banks or do you think it is a rising tide and all will hold up well?
The tide has risen quite a bit in any case, so I do not know whether you should continue to play for a rising tide. We are not really switching our portfolio given the performance. One, we would continue to be reasonably overweight as far as the IT space is concerned, even though stocks have moved very dramatically. The reason for that is the business support one tends to get there is phenomenal. The demand cycle for the next three to four years seems very comfortable.
On the supply side, wages have been going up and there may be a lack of availability of people. That should also ebb off over the next couple of months. So when one has markets that have moved a lot, one looks for a lot of comfort in terms of the underlying business and to that extent, IT provides us that and so we would continue to be decently overweight. If anything, in view of the very sharp rally in the market, we would tend to believe a space where there is much business comfort and where one can hide in the event of a little bit of a pullback.
As far as the banks are concerned, it is a little bit more challenging. We are overweight on banks. We also believe that as we move from the first phase of the economic recovery cycle into the next level, banks are going to be an integral part of that transition and an important place to play. That said, the one place that we would be a little bit more watchful is in terms of whether we are going to get enough bank credit demand for the next leg of the economic recovery.
Conventionally that always happens. It is a chicken and egg situation. If you do not get credit growth, you are not going to see the economy expand and to some extent, credit growth is required to see the economy expand. This time, the setup is more or less the same.
The difference could be a little bit at the margin which is in terms of what is the nature of growth that we are going to get. Is the next leg going to be a fixed capital formation driven growth?. I think fixed capital formation driven growth at the end of the day is a necessity. In the interim, it could still be a little bit more services driven, a little bit more equity capital support driven rather than necessarily fixed capital expansion.
But all and all, it is a space that we would remain relatively comfortable with. It has done okay in the recent past but in a longer context, it has not done so well and so to some extent, we would continue to stay overweight even though that will be more variable and to some extent a little bit more vulnerable if the markets come out substantially.
There are already reports doing the rounds that perhaps Google is going to be investing into Bharti and also reports that Reliance Jio is going to launch a low cost smartphone in association with Google. How excited are you about the prospects of telecom as it seems to be turning into a two-player market?
At the end of the day, that is the backbone of the kind of growth we have seen in the economy and it is necessarily going to be the backbone of a broader growth in the economy. As it is largely becoming a two-player market, at least in terms of incremental moves, just makes it a very good setup for stocks like these to do particularly well.
There are two caveats; one, it is not very clear how much of tariff hikes or the direction in tariff hikes is under control of Bharti. In many senses, it is a two-player market. One has to take the lead and they have been a little reluctant to necessarily take the lead. From a timing perspective, that creates a little bit of uncertainty or it lessens the confidence in terms of the term of the way the stock will tend to play out. That is one bit.
The other bit which we need to watch for from a stock perspective is the entire 5G rollout. Historically, whether it is in India or globally, whenever the next leg of technology comes, it has been great for broader market expansion and obviously for the efficiencies it provides.
The reality is the incumbents have been forced to end up putting in a lot of capital and that is not necessarily good for stock performance. It does not mean that it would not be good for stock performances but it is not capex of this nature given what has happened in the past with telecom in India, the market is going to be a little bit more watchful. So, we are in a good space in terms of the direction, in terms of the competitive flavour and in terms of how Bharti Airtel can stay on and Reliance on top of the sector. All of that I think is in place, but are we going to see this as the start of a long, strong cycle? I think the timing is a bit of an issue and to that extent, I would not say that the next three, six months this is where all the response is going to be in terms of stock market performance but directionally, it is in a good place.
As far as yesterday’s analyst call is concerned, I think the Bharti management has very clearly laid out what their thinking is, what their action steps are likely to be and they have also cut out a lot of the speculation that goes around a lot of these things. So, a very positive development. Directionally, we are on a very good wicket, exact timing in terms of how a lot of this plays out is a slightly harder call.
Within the banking space as well, you said this is going to be about stock picking. How would you pick out banks?
This cycle is going to be a little different in terms of how banks perform based on an upswing. Historically, when there is a credit upcycle, it is the smaller banks, those with slightly riskier credit profiles and slightly more aggressive approaches to lending, which lead the rally and they can go on for quite a while. This upcycle or upswing could be a little different. It could be a little discerning.
The ones who are going to grow a little faster are likely to perform a little better; those where balance sheet inflation will help them from a credit perspective disproportionately, will tend to lead a little better. But I do not think smaller is better from a stock performance perspective because of what has happened in the last down cycle and it has been a grinding down cycle.
What has happened is that the differential between liability franchises, between platform efficiencies and between credit skills has actually widened quite a bit and we will have a bunch of lead banks. There will be three, four of those which are big and which have disproportionately gained over the smaller banks or the more challenged franchises.
So unlike in the past when the riskier ones would be doing much better in an upcycle, this time probably greater outperformance will come from the leading pack in terms of size, franchises and experience. That is a broad categorisation and that is why there will be a differential in terms of how it plays out.
Within that, credit growth is going to be a differential element. So between a very high quality bank which is going to grow at 10% and a historically less high quality bank which grows at 20%, from a credit perspective the 20% bank will do better than the 10% one. So there are two distinct buckets.
The rallies will be different this time compared to conventional wisdom But within those buckets there will be a certain amount of difference. Also, in terms of the kind of recovery that we expect, this time post the challenges that the system has had, we are not necessarily going to get a credit boom like in the past. It will tend to be discerning and we are not necessarily going to get the banks as a massive trade, unless a particular balance sheet re-values dramatically or a particular stock from a very low valuation, comes back very substantially.
I might have run all over the place in terms of defining it but I think rallies will be more nuanced and a little different from the last time but they do require that push up in credit growth which has so far lagged what conventional recoveries tend to see.
What about the auto sector? It is under owned and has underperformed quite a bit and has really been far away from that momentum trade seen in ITs, metals etc. Which company do you think will be able to emerge from the chip shortage problem the best? Also how do you see the EV play bearing on some of these individual stocks?
On the EV issue, we have done a fair amount of work in terms of the dislocation of the existing market. But the number is a little modest. It starts becoming a little bit of an overhang in terms of longer term performance simply because eight years down the line, a large part of the market is going to be different from where we are currently. It does not support valuation and so it has become a little bit of an overhang in terms of some of these businesses.
Coming to the other question, not enough has been focused on this point in terms of the demand cycle that you have seen because of the dislocations on the consumption side in terms of income side. That is a little bit more challenging than what the market is reading. The numbers have been soft but there have been different explanations whether it is supply chain issues, chip supply shortage or whether people are just seeing it as a timing effect which will come through once the pandemic lockdowns ease off. We are a little bit more cautious there simply because there has been more dislocation on the consumption side for large discretionary items than the market is factoring in.
The third bit is the chip problem which seems extreme at this point in time but I do not think that is fundamentally going to change their valuations. It is a dislocation from a three to six month perspective but beyond that, it will tend to settle down. If you take all these factors into consideration, the bottom line is the demand issue will probably drag a little bit longer than the market is anticipating at this point. We would generally be a little bit cautious on that space, There is a certain amount of comfort in terms of valuations, A lot of these, particularly the two wheelers, have become much cheaper and the cash flow profiles continue to be very good.
These are very competitive businesses and overall, I would be a little cautious from a demand led perspective and less from a chip supply perspective. I would fundamentally underweight it. Within it, I would probably have a little bit more comfort in the four-wheeler space than the two- wheeler space and it looks like some of the globally led companies in this space are probably better positioned than those domestically and the same applies to ancillaries where the demand from a global perspective might be more robust than from a domestic perspective.
