There has been a big shakeout in the mid and the smallcap space. Is this sign of things to come that the froth in the market is getting cleansed and now the market will revert to its mean because it has been a great quarter? August, September and the early part of October have been nothing breathtaking for investors. Is it time for a reality check?
What you say is true partly in terms of the froth going away but I would also say it is a time for a sector leadership change. The rally that so far was entirely liquidity driven and anything with earnings visibility went up. Now the Indian economy is bottoming out and there are still lots of sectors where very reasonably valued stocks did not get any attention. Now the focus is shifting forward and this is a leadership change.
Now, a leadership change cannot take place without profit booking on the one hand because one needs that cash to be deployed afresh. There is fresh money coming into some extent but I would say a lot of the domestic institutional and retail participants would be rejigging their portfolios with a view to the future. That is what is also playing out. So there is profit booking with a view to redeploying in sectors of the future.
What are the sectors of the future because everything which has potential to grow is already trading at a multi-year high or valuations higher than historical average — be it banks or metals, IT or a combination of consumer tech? Right now growth is visible but is the market now offering gold at the price of diamond?
It is a problem with linear thinking. The issue is that we look at the past profit growth and project it and say that valuations are expensive. I think because of the Covid crisis and because of the previous downturn, right from December 17 onwards, corporate profits grew only by about half a per cent for an extended period of time but just project forward FY20-22; in that three-year cycle, corporate profits are expected to grow at 51% per annum and in the next cycle that is FY22-24, they are expected to grow at 15% per annum. Has the market discounted? Partly only.
So I would say that yes not every expectation is going to turn to reality and there will be negative surprises but there will be lots of positive surprises too. India is at a seven-year corporate capex low. At the same time, corporate balance sheets have been deleveraged tremendously. Demand is seeing a V-shaped recovery and if you go by the commentary in the earning season, lots of corporates are announcing capex and they are saying that they are going to run out of capacity in a couple of years from now. So the capex cycle is ideally positioned; interest rates are soft; the government is spending on capex and so there is demand for capital goods from the government side and the private sector is announcing capex. I would say the leadership will be coming from the classic industrials, building materials, capital goods suppliers. Those are the sectors where I see a very sharp V-shaped uptick in earnings and a more sustainable maybe a five- to seven-year bull run in the economy for these sectors.
I do not think the market is anywhere close. I would argue that while one year back, we had value in terms of the fact that the market was just ignoring them, today there is growth available at a reasonable price. The issue is what do you think that growth is going to be? If you say 20% per annum looks too rich, I would argue that that is not the case because when you are coming off a bottom numbers like FY20-22, 51% per annum corporate profit EPS growth is the expectation. If you take a bet on that, people will say you are buying an overvalued market. I would say look at the data on hand, on what India is going to become, a sustained decadal high single digit growth is in the realm of possibilities. I think from that perspective, not all of the market is overvalued at this point of time.
Auto had a terrible 2018, a horrible 2019 and a pathetic 2020. 2021 is no different. After three-four years of stress test, are auto stocks looking attractive?
Auto has disappointed in terms of the previous three years in terms of expectations because both the first and second Covid waves hit demand very severely. But today, the sector has been hot with two major problems — semiconductor shortage that caused the supply shortage and input cost rise. If oil prices rise, there is this spillover effect in the auto sector. Naturally there was a pressure. But right now, they are in a fairly sweet spot.
It is a very rate sensitive sector. So interest rates for housing loans, auto loans all are at an all-time low. There is fresh liquidity with all the banks and the NBFCs and this festival season, I expect that uptick and the boost which is going to come to auto sector is in terms of EVs. India is probably ahead of the curve in terms of pushing for EV and there is going to be capex in the auto sector and those companies which have a clear cut EV strategy and start implementing will demand higher valuations. So I would say yes to auto. The fourth and the final leg in auto is the auto component sector. It is one of the most export sensitive sectors and India has been seeing an export boost. The PLI scheme has given a big push and so auto component exports will also support that sector. Overall, auto looks like a good bet in the year ‘22.
