What is the way ahead for markets?
The entire thesis of this rally which played out over the last one year is that India is at the cusp of a massive capex revival. There are three-four factors which are driving it. One is, of course an almost two decade low interest rate, the government’s intention of keeping the fiscal policy very loose and they have given targets which are much elevated than we have seen historically.
We are seeing some signs of capex activity picking up in select sectors be it renewable or airports, but that is a broad thesis. The market is about 40% higher than pre-Covid levels and the earnings growth over the next two-three years is expected to be very high, primarily driven by banks lowering provisions and some pick up in commodity earnings.
Our view is that people who are invested stay invested. There is no reason to exit the market. If the very loose liquidity and the earnings uptick continue, markets are unlikely to correct significantly. You might have short corrections but you should expect markets to move higher. Perhaps the pace of the rally will slow down but by and large, we expect markets to move higher over the next couple of years than where they are today.
How would you look at the sectors that you would want to play? How can you play these capex names?
One has to be careful because a lot of it is already getting factored in the price. I do not think the traditional plays of capex revival engineering and capital goods are that cheap and construction companies are not that great quality. Pockets, where some value remain include banks where valuations have still not reached expensive levels.
If one just wants to play the capex theme, then banks perhaps would be the best way to play it. But in case of broad general economic revival, one can have consumer discretionary stocks including auto companies where valuations still have not reached very expensive levels.
So if one just wants to play the broad economic recovery, then these two sectors might work but for pure capex plays, I do not think there is that much value outside of banks.
In terms of banking names you said there is valuation comfort but on the other hand, aren’t they massively overweight as well? Most of the largecap names or the mid to largecap names are owned by almost all fund houses because it has been the record weighted sector for the last one decade.
Possible, but my view is more from a fundamental perspective. I am not looking at some technicalities of overweight, underweight by institutions. Of course, the last sort of the entire rally was retail where institutional participation has not been that above historical levels. So they might be owned by a lot of institutions but just looking at where the earnings trajectory is coming from and what companies are going to drive the earnings leg over the next two-three years relative to where they are trading at. Banks look a lot more comfortable in terms of valuations than some of the other sectors.
In the last few days, all the laggards are trying to play catch up. So FMCG multiples are now at a new high. Cement or we can say that insurance is trying to make a comeback. Stocks are rallying without any news flow, weaker monsoon, poor consumption and GDP is being ignored. Should one look at laggard names? Banking would be a fit as it has not done well.
Some of the sectors that you mentioned including consumer staples and insurance are not that cheap. The reason they underperformed was because their valuations were very expensive and the other sectors where valuations had collapsed were offering much better value and that is where a significant rally took place.
Perhaps these sectors are also running because at this level, people want a bit more protection in their portfolio and given that they have not rallied that much, one might see some of the allocations happening because of that. But it is difficult for me to believe that in a cyclical upturn where capex cycle turns in a big way, especially in the initial years, consumer staples with those valuations might outperform other sectors. They might move up but they might continue to underperform other sectors which are much more geared to a cyclical recovery.
So how should one position the portfolio now that valuation is the most important factor?
That assumes paramount especially at levels that we are right now. One wants to play the upside but at the back of your mind, remember what happens if the market’s importance corrects. There are enough factors which can drag the market lower including a third wave, given where vaccination is in India and given that we are just entering the festive season, the probability of a third wave just increases and in that scenario all these sort of assumptions that are being built into strong earnings revival gets deferred. We might have a correction at that point in time.
So add some protection in your portfolio. If you have good quality companies at reasonable valuations, they will offer you downside protection as well. It is a stockpickers’ market right now; just blindly buying into sectors with momentum might not work.
How would you rate the recent listings? What does the euphoria around that tell you?
There are classic indications that there is some sort of retail euphoria in the market that we last saw in 2006-07. Again there are quality companies and some of them deserve the sort of valuations that they are getting, but IPOs tend to be overpriced and you might get an initial pop but over a period of time, retail investors do not make enough money while investing in an IPO because most of the merchant bankers price it very aggressively for the retail investors. So apart from signs that there is euphoria in the market and people just want to invest in equity markets, I would not give too much importance to recent listings at the valuations that they are listing. I expect a lot of them would be lower in a year or two.
In terms of capex names, it is difficult to identify capex companies but don’t you think that the people who have survived and managed to deleverage are not focused too much on equity from here on? From here on, can these companies give you multiple returns?
Companies are already trading at valuations around pre-Covid peaks. For me, given the nature of the business and given that if the capex cycle picks up, they will do better, just how much of that is in the price is a matter of concern. So just to get quality names at reasonable valuations is not easy.
