investment strategy: probable corrections in small and mid caps; focus on large caps: Pratik Gupta

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From a relative performance perspective too, India is now an outlier compared to many emerging markets. India is up around 12% year-to-date while the MSCI Emerging Markets Index is only up around 6%. The markets of China and Indonesia are actually flat, according to Pratik Gupta, CEO and co-head – Institutional actions, Kotak securities


Why did we hit this break? It seems like suddenly the market is running out of energy?
In our opinion, it is market valuations that are the cause. When we talk to institutional investors around the world and in India, the common feedback is that India’s long-term economic growth prospects look very attractive, but how far is that already factored in? Look at the price action and valuation of Nifty. From a valuation point of view, we are at around 22 times current year’s earnings, 19.5 times next year’s earnings and this despite factoring in fairly strong earnings growth. . According to Kotak’s estimates, Nifty’s profits will increase by around 30% this year and 14% next year. So there is the valuation angle, that even if you get a little surprise on the earnings, a lot of it is already factored in.

From a relative performance perspective too, India is now an outlier compared to many emerging markets. India is up around 12% year-to-date while the MSCI Emerging Markets Index is only up around 6%. The markets of China and Indonesia are actually flat. Malaysia is down slightly. In some of the export-oriented economies like Korea, Taiwan and maybe Brazil among the big emerging countries, the markets are up around 12-13%, like India. It is therefore valuations that are the main concern of most investors. This is why you see people reluctant to sell very aggressively because there is an upside risk that profit growth will turn out to be very strong. The monsoons have been good and personally there could be an advantage in terms of events like privatization or the inclusion of India in global bond indices, which have not really been fully taken into account.

What will it take for the markets to rise higher? If the strong earnings growth is factored in, do you think the six-eight-month markets will take a break and the new momentum begins when we start talking about the year 23 and year 24 numbers?
There may be some things going on. On the bright side, some big upcoming privatizations – whether it’s Air India or visible progress on LIC’s IPO – will be a re-rating event for India in general.

Second, the inclusion of India in global bond indices could be another big event. Right now there is still a long way to go for the government. If this happens, some of the concerns about the RBI’s ability to manage bond yields and the government’s borrowing program may be allayed. Some fear that local bond yields may also rise quite sharply. Both of these are positive, but if not, we could be in a sideways market for a while.

On the negative side, the biggest risk we need to watch out for is what’s going on with the Fed. They have already signaled that this ultra-lax monetary policy will not be here forever but on the negative side, if they announce some sort of tapering in August-September at the September FOMC or at the Jackson Hole summit, it could lead to capital outflows from emerging countries. markets. Although we are not in the same situation as in 2013, but overall we could see an exit from risky assets and emerging markets in particular and in this scenario even India will be impacted.

Going forward, will we see resilience and optimism continue across the larger universe? What should investors do to take advantage of this opportunity?
This time around, the rally is much more widespread and is also reflected in the earnings of these small and mid-cap companies. This time around, it’s not just a handful of stocks or just one or two sectors that are pulling the market. It has been generalized but conversely, many of these average values ​​have become quite expensive. We actually advise caution.

The mid-cap index is up about 25% from the previous high in 2017 and many of these stocks are even trading at a premium to their large-cap peers in the same industry. Within mid caps, industry leaders in some of the smaller industries like real estate, chemicals, bearings, consumer durables, etc. have good prospects, but valuations have become quite tight. Right now, unless you have a four to five year time horizon and are willing to wait for a period of underperformance or maybe even a correction in some small and mid caps, it would be better to focus on large caps where the relative value is much more attractive.

What about finance as a space? Would it be prudent to look at some of the big-cap big-cap names or should it be extended to the whole basket like NBFCs, PSU banks as well as insurance games?
Financials are our preferred way to play the economic recovery in India, not just from a solid earnings outlook as we expect credit costs to stabilize this year for many private banks and even PSUs. .

Next year we will start to see credit growth accelerate and that should lead to a fairly strong earnings outlook for FY22 and 23 and hopefully FY24 as well. Asset quality issues are behind us, but in general we should look to banks that play more on the corporate sector rather than banks focused on MFIs or SMEs, where asset quality issues or loan growth could continue.

In general, we should be more interested in large cap private banks rather than mid or small caps. When the economic recovery really picks up in the next six to twelve months, we would expect these banks to have very strong liability franchises and low cost of deposits. In addition, their technological platforms are much more developed. They will be much better positioned to seize the opportunity compared to some of the smaller banks which in some cases are still struggling with their asset quality issues or are not well capitalized or well prepared to capitalize on the recovery. .

In the case of NBFCs, you have to be a little selective. Large NBFCs should do well in our view, especially those that are well capitalized or have access to parent organization capital and where asset quality issues are behind them. Some of the NBFCs will benefit. We love insurance too, but insurance is generally a lower beta factor in the overall economic recovery cycle. So we would prefer the large cap private banks and some of the better quality NBFCs, then maybe the insurance companies.

As far as PSU banks are concerned, apart from one or two large PSU banks in general, we would always be cautious. While there is an economic recovery underway, on an aggregate basis these stocks may look cheap at 0.4-0.5-0.6 times the book price, but keep in mind that their ROEs are likely to be just 6-7-8% over the next one to two years and in many cases there will be a massive dilution of equity below the book price for these banks to maintain their capital adequacy. own funds. We prefer private banks in general, with the exception of one or two large PSU banks.

What about the real estate sector?
Interest rates could possibly increase by the end of this year or early next year. Next year we could see an interest rate hike of 50 to 75 basis points. But that said, we believe that the demand for real estate is still quite strong, especially after the pandemic, as we have heard from various real estate players and various consumer forums etc. A lot of people want to upgrade and add that extra bedroom to their home and move to a bigger location because of the pandemic.

Combine that with the low interest rate environment we are experiencing right now and even though rates increase by 50 to 75 basis points over the next year, I think affordability is still very good and that there will be a very strong demand for residential real estate in particular. .

On the commercial side, there could still be challenges, but on the residential side, the outlook is still very good. In addition, many listed companies in the real estate sector have paid off a large portion of their debts. They are deleveraging quite aggressively and do not invest in building up land reserves, etc. The general management strategy is to use cash flow to pay down debt, which makes these companies much less risky than they were five or ten years ago. We are hoping that we are at the start of a bullish real estate cycle and that the residential games actually look pretty good.



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