What has really changed the table, from massive smallcap outperformance to the breathtaking move in largecap stocks led by Reliance and TCS?
If you look at it from the bottom, the market has done wonders. It has more than doubled. But now over a three-year period, we are talking about a 15%, 15.5% growth in the market indices. Nifty 50 is what we are talking about. Even if you stretch it to five years, it is again 15 odd percent growth. If you have looked at the same figure pre 2007, it was 46 odd percent for three years and 44% for five years.
So we are not seeing a runaway market in any way. From the bottom, it looks runaway, but frankly the market has done a fairly decent amount of work. August looked good because of a rub-off of two events. These are two hurdles. One was the quarter’s numbers and the second one was obviously the Jackson Hole Fed chair speech where there was hardly any meeting.
Even in this quarter’s numbers, only three sectors did well and they were all largecaps. There were commodities, there was financials and export oriented sectors. The midcaps and smallcaps took a backseat and as a result, we saw what we saw. I do not want to discuss Jackson Hole. It is akin to riding a white water raft. You see the white waters and you wonder whether there is going to be a grade 3 or grade 4 kind of ripple. But it just turned out to be excellent rather than anything else and that is what has happened in the last two.
But going ahead, there are quite a few hurdles to be crossed. One obvious one is the waning monsoons. The kharif crop is in place but rabi crop may become an issue, given the reduced reservoir levels. The rains were not as good as was expected and that is why north, central and west to an extent are impacted on the reservoir front.
Also, the festive season is around the corner. Onam was not that great and frankly that can be explained because Kerala was going through a massive Covid wave, but hopefully, that would not stretch for long. But indications are that it is not looking too great either for the festive season. Plus, we believe that the market never learns from history. The way smallcaps had rallied, they were coming at a premium to the largecap indices.
Frankly, if one looks at 15 years’ history, every time there is a premium to the largecap, the smallcaps have corrected over a 12- to 24-month period and this is the fourth time in the past 15 years, it has happened. We are very wary about it.
If the festival season demand optimism is fuelling the market action, then why are auto stocks down? In a raging bull market, auto stocks are down 25-30% from their 52-week highs ahead of the festival season.
Semiconductors is going to be a big issue. Yesterday Toyota came out and said that they are looking only at CY23 when the semiconductors supply will stabilise and that coincides with semiconductor company TSMC talking about capacity expansion in around 18 months to go on stream.
But the fact is that even with the enhanced supply levels, demand also will be higher with 5G kicking in in a big way. The semiconductor problem will remain. Also, there is the matter of commodity prices. In the beginning of September, Maruti took a price hike but as brought out by analysts, it is still not covering. Despite 4.5% odd average price hike that they have taken this year, the company is still not able to cover 50% of the commodity hike that they are facing, So, that is another big overhang for them.
Further, the mix has changed. SUVs and XUVs have come in a big way. The crossover vehicles have created a bit of an issue with Maruti in particular because we do not have too many SUVs on crossover vehicle offerings. We are still in the entry level where the market and the share of the entry level has gone down.
The biggest bull in the China shop is electric vehicles (EVs). I do not think the market is still discounting that fact and we have been saying this all along that on a longer term basis, EVs is going to be a reset for the whole industry and if you do not pick up now, there is no way you can pick up in the future. Even if you do, traditional IC guys get into EVs. There will be more players in EVs. Also, EVs are not about manufacturing. It is about the consumer mindset. These are the problems which the auto industry is facing in particular and that is why that industry will remain on an overhang.
What is the best way to capture this festival season demand – hotels, white goods?
No. The sound bites which are coming out are not that exciting for the festive season. They are looking at a steady kind of growth. There is no one big upside which can be expected. There was no pent-up demand after wave two. So, that is more or less done and dusted. Our feeling is that now is the time to remain in largecaps. Forget about trying to find ideas in the market. It will be a very selective run from here on because the way the market has done, year to date, the market is up 20% plus. One has to be very selective. We stick to our old and tested large caps in private sector banks or NBFCs or for that matter the IT companies as such.
What are you making of the roaring rally that one is seeing in IT?
If you go back 10 years, there were probably only two IT companies in the top 10 global companies — Apple and Microsoft. Today, there are only two non-tech companies in the top 10 global companies — Aramco and Berkshire Hathaway.
Yesterday we were on a call with TCS and they said that the BFSI space is the largest contributor to Indian IT. There, only 8% of the spends go into digital today and this is despite the fact that in the future, digital will be the only way forward. There will be only digital currency, physical currency will not be there and these banks have to change as such. This is the biggest sector. The other sectors were in the 2-3% range and they also need to change. Media, healthcare, telecom sectors have to change going forward. So spending on digitisation will keep happening.
Do not forget there is 5G around the corner and 5G is not only about telecom, it is also about the way we will be living and buying things, the way we will be working; it is all about IoT and stuff like that. So that will again be a big booster for tech spends, We are very clear that there will be a multiyear tailwind here and probably bulk of the rerating is done. They are already at 30 times forward earnings, which was probably what they were a decade back or so.
But from here on, the earnings will kick in. The only company which gives out a forward guidance, Infosys, has already upped it to around 18% odd and that should go to 20% odd. So if you are talking about 20% top line kind of a growth, we are talking about mid 20s kind of a growth for the bottom line, which should be very exciting for these stocks and prop them up.
Where else do you see scope of rerating as large as the one that played out in IT back in February?
There is not much scope left now as such in the market today because the whole market has been rerated. If we compare it to the emerging market index or even if we look at the global indices, we have fairly rerated along the way. If anything, there are pockets or excesses in the MNC FMCG space, where they are quoting at 70-80 times forward earnings which I do not think can be sustainable.
In fact, there are other stocks also which are at 70-80 times but those are not sustainable valuations given the fact that there is no earnings growth happening. The earnings growth is at best early teens or such. That is going to be a bit of an issue and so the bulk of the rerating is done. In fact, from here, pure earnings growth will kick in and that is looking very good.
Nifty earnings growth is at 30% plus this year. Going into the next year, it is about 18-19% odd. That itself should be enough for the market to move. In fact, on a yearly basis, we are looking at a 14-15% kind of growth in indices which should be good and which one should be able to support with this kind of earnings.
Let us talk about ferrous companies. We have seen steel prices falling for the last three to four weeks. Would you say there are perhaps some hints of us having passed that peak steel price period?
Analyst numbers next year anyways show a drop in earnings despite this year likely to be a phenomenal year. In fact, the first quarter was an eye opener. Steel prices going down means input prices have also gone down. Iron ore prices are looking a bit tepid today. So, that way, maybe the margins will be sustained. Look at it this way. A handful of countries like China, Korea, Japan and Russia are the four major exporters. Within Europe, they were exporting to each other. So let us leave out Europe. Out of the rest, China is already out as they have reduced their exports and are looking at controlling their production given the pollution levels.
Also they have started importing coal from Australia and that input cost has gone up for them also. But it still looks pretty decent even today. We were very sceptical when the rally started but then we realised that some way down the line, these are longer term issues and the fact that production will not keep pace with the demand which has kicked in, looked exciting too!
But having said that, auto numbers globally have come off and that is mainly because of the semiconductor issues. That may create a dampener for the time being but on a medium term basis, there is a health scope for the stocks continuing their journey upwards. Bulk of the return has been done but all will depend on next year’s numbers, if and when they are upgraded. They are right now at a massive discount to the current year numbers. If that happens, then again an up move can be expected in the metal stocks.
