While it is easy to make a case that why markets are expensive and why markets should go down and the rise should get arrested, that is not happening. What does one do because it is an expensive market to invest in but if the market continues to rise, one would miss on this opportunity of making money?
The market does look expensive based on historical valuation trends. Nifty is trading at about 24.5 times FY22 earnings about 22 times FY23 earnings and at Kotak, we are assuming fairly strong earnings growth this year of about 31% for Nifty and 15% for next year. Despite that, the headline multiples do appear expensive but if one had sold out, one would have lost money as the market is continuing to rise.
In our view, there are no major local triggers that could cause the market to correct in the short term at least. Also, keep in mind that for the last four to five months, the market has been driven by local money and the retail and HNI investors have been the big buyers. In the retail market, for example in the futures market, we have seen single stock long positions go up from about $7 billion in early April to north of $10 billion right now and the foreigners have generally been absent from the market.
The Fed managed the taper guidance really well yesterday. It is one of the big fears for emerging markets that the Fed would start tapering and that could cause the big selloff and so on. We have always been in the camp that there would not be a major selloff and the way the Fed has managed it has been actually quite impressive. They have effectively guided for a taper starting from November, going all the way till middle of next year and with no interest rates hikes in 2022, rate hikes will probably come in from 2023.
There is a benign global liquidity environment for the next six to nine months. Let’s see what happens after that. In the short term, the market could continue to inch up. The local factors are very very positive, the vaccination pace has been picking up and hopefully we will not have a third wave. The underlying economic recovery is actually picking up and we are seeing sector after sector — whether it is IT services or the real estate sector or chemicals, across the board companies are generally sounding very positive and so in the short term, there is no immediate trigger to pull down the market.
But one should not ignore the fact that from a medium term perspective– over the next six to 12 months, the impact of the liquidity withdrawal by the central banks can impact all EMs including India. But that risk is probably still a few months away.
What does one do sit on cash because if risks are building up and if the risk reward ratios is in favour of going long, it is 50-50 or 60-40 — whatever that number is depending on what your view on the market — should one buy puts or sit on cash and wait for a decline?
For those who can, buying puts is definitely one strategy. The volatility, the VIX is quite low and one gets puts relatively cheaply, given the relatively bullish environment over here. The second main thing I would actually suggest to institutional investors as well as retail investors is to reduce their risk levels in their portfolio and reduce portfolio risk. What that means is companies or businesses which are inherently weak have just benefited from the market rally. One should look at booking profits in those kinds of businesses.
Wherever valuations have gone out of hand and even on the next two, three, four years level, it is difficult to justify those valuations and where we might see an impact as and when interest rate increases or companies where the leverage ratios are very high or companies with governance concerns which have rallied nevertheless, are the areas to cut back positions on.
Also, be careful about the small and midcap sector, where a lot of stocks have done exceptionally well– BSE midcap index is up about 40% odd this year and it is trading at about 25% above the 2017 peak. Given that risks are building up, given that valuations are beginning to get quite expensive, one should look at cutting back portfolio risk in particular.
So you are finding the midcap valuation to be high at the moment. What would you suggest? Move towards the largecaps?
Yes definitely. In midcaps one needs to be quite careful. Generally these companies do well in an economic recovery cycle. One also has to keep the valuations in mind. In a lot of cases, the midcap stocks are trading at a significant premium to their largecap peers and in case of a rate hike or for whatever reason, if the execution does not pan out as is being implied by the stock prices, one could have a fairly sharp correction in the midcaps. For example, in the case of midcap IT chemical companies, the valuations have gone way above some of the larger cap peers. One should be careful and move the portfolio more towards the large caps in those respective sectors.
Within the largecap story what are you leaning towards because largecaps are quite highly priced in case of IT and consumption stocks?
We are finding it difficult to recommend consumer stocks at these levels. Valuations are quite high and the growth rates are not really picking up. We have seen limited upside to earning surprises. One area we would recommend within the largecaps is still the banks which have actually underperformed. On a relative basis, the banks still offer good value compared to the rest of the market and especially the private banks.
We are focussed on private banks where we think credit growth will pick up next year. The credit cost will continue to come down and a lot of these private banks will actually be beneficiary of the ongoing consolidation within the banking space. They have continued to gain market share at the expense of the PSU banks. So the private banks is one space we would recommend.
Insurance is another area. A lot of the insurance companies are quite badly impacted by the Covid environment because of the high claims being made. But typically, worldwide, as and when there is a major disease outbreak or a pandemic, after a gap we start seeing insurance growth picking up once again.
The other segment is IT services. We are still quite positive on IT services. We think this is a multiyear cycle. The migration to cloud services for a lot of the global customers of the Indian IT vendors has only just begun. We are still in the early stages. This can carry on for a couple of years and while the valuations have gone up compared to where they were a year ago, the growth outlook and the visibility on the growth has also gone up.
These are companies which are generating a tremendous amount of free cash flow. The ROEs are very high. The balance sheets are very strong. Governance levels are very good. We have the risk of the withdrawal of global liquidity from early next year and these companies are actually going to be very well positioned to offset against that.
Meanwhile, there is a strong growth environment and we might even have earnings surprises. Our analysts’ estimates are generally above consensus for most of the IT companies. So IT services, private banks and insurance companies are some sectors. Even the metal stocks, the steel and aluminium companies have got a breather lately given the concerns over China. But our view is that the Chinese situation is not as severe or not as bad as some of the headlines suggest and this is an opportunity to accumulate over there.
