After very long we are seeing Nifty coming in at 20,000, but overall in the market scenario how are you seeing this market currently in terms of valuation? What is that looking like? Do you think it is something attractive in the market or maybe one should just wait and watch sometimes?
Sure, I think, yes, 20,000, is a great psychological mark. We have not spent much time above it, although we did make a new high, slightly higher than this. However, what we need to look at is what has been happening in the markets over the last two years.
In the last two years there has been a kind of a de-rating in multiples. For example, if you were to look at two-year returns on Nifty, I am talking about specifically, it is a paltry 15-16% in two years, at a time when earnings have actually grown more than 30% or so.
Basically, two years ago we started with very inflated multiples and slowly earnings are growing and multiples are falling. So, essentially from that perspective if you think about it, Nifty has underperformed debt returns over a two-year period.
So, yes, it is making new highs but it is still in a kind of a situation where it is impacted by the starting point which is a very high valuation. Valuations have not really cooled off to levels which are palatable.
I think that process is a multi-year process. India, with such a strong long-term story, the market is not crashing, but it is slowly catching up, getting to average valuations. So, in our note, which just came out yesterday, we talked about the importance of yields.Let me just put that in context. So, if I were to look at valuations, valuations, our favoured valuation benchmark in India is a comparison of bond and equity valuations.On that benchmark, the markets currently are at what I would call a danger zone.
Basically, the difference between bond and equity valuation suggests that equity is quite stretched as compared to bonds.
So, if that is the case, then how can more room be created for multiples to sustain or not much, that can only happen by cooling off yields.
In other words, what I am suggesting is, if there is not a dramatic cool-off in yields, by dramatic I mean more than a 100 bps cool off in yield, then getting more than cost of equity returns on the market over the next 12 months on Nifty would not be easy.
So, basically, that is really the thought process, do not expect very big returns on Nifty. At best, it will be a market like we have seen over the last two years and slowly multiples becoming more palatable, that might take another year, but that is where we are in terms of valuations.
So, a bit of a caution that you are maintaining, right, on the Nifty at least, but also obviously is that the same thing that you do in terms of small and midcap? We have seen that clear outperformance coming in in that last one year specifically what valuations also wise plus what do you think in terms of this outperformance for the mid and smallcap because is that more dangerous now or is that something you would avoid completely or is that something that could continue in terms of a trend for mid and smallcap?
So, firstly, in terms of caution, what I am trying to suggest firstly is that there is a very low margin of safety. Now India with its very strong long-term story has still been able to not do that badly with that low margin of safety for a while, so that might perhaps hopefully continue.
But mid and smallcap, now imagine very low margin of safety on Nifty, on top of that mid and smallcap valuations are at well over plus one standard deviation on a relative basis to Nifty, so their premium is nearly one of the highest levels we have seen in many years.
So, considering that, on a top-down perspective, that is not really the most, I would say that is a pretty high risk space to be in.
However, having said that, just to come back to the India story, if there is a lot of belief in the long-term India growth story, there will be some mid and smallcaps which will be attractive. They could become largecaps, so stock picking is something which will, there is a lot of room for that in India. In fact, you would be surprised with this, one of our favoured data is there is almost about 230, 250 stocks in India which trade over 10 million dollars a day that is a pretty big space to choose from, a large and liquid space to choose from, so there is always room for stock picking in India. But overall benchmark returns, I think we should tone down our expectations.
So maybe it will be more stocks. And in terms of that, then any specific sector-wise you would look at in such a market or anything that normally turns out to be attractive at such a time?
Well, I think what we need to appreciate is the key events for next year, the two big events for next year. Number one, the market is just comfortable and confident that we will have a soft landing in the US. Now, we need to see events if that is confirmed in actual events or so. So, how does Fed speak now that perhaps the market is confident that there is a pause? So far the commentary from Fed is it is going to be a long pause and a hawkish pause. They are not really toning down their commentary. Market believes that that tone will change in the next few months, in three to six months. If we do not get cues and confirmation of that and the Fed continues to be hawkish, then that could be the disappointment. But if that changes, then that is what is comfortable. Others are elections, not just India. We all talk about elections in India. There are actually elections in the US and in the UK, all happening in the next 13-14 months.
So a lot of global cues are going to be playing.
A lot of global cues will be very, very important for the Indian market. Otherwise, left to itself, it is Indian elections and at this point of time, there is limited expectation. You know, no one is expecting too much disappointment over there.
Okay, you know, talking about global cues, obviously, let us talk about volatility and crude also, right? Obviously, OMCs are benefiting from volatility and crude but also GRMs also that is a factor that is coming into play for them as well. So what is the kind of earnings growth that one could expect to see coming in in this space specifically?
See, I think there are two parts to this crude part. I think OPEC is very-very strongly inclined to protect its floor of somewhere between $75 and $80 of Brent prices. I believe that they have reasonable control of the market to be successful on that. If that is the case, then we are more or less within 10% of that floor. So, I do not expect further cool-off to sustain crude prices. On the other hand, going into elections, there is very limited pricing power that oil marketing companies will have because the government’s focus will be to keep inflation low, to not really to keep that focus on elections. So, I would say that for now, they remain anti-crude plays and a large part of that crude correction for now is done. So, that is something that one needs to bear in mind. What happens post-election? Do they get their pricing power back or something? It is something which is still up for debate, but that is really the key thing to watch out for from a slightly longer-term perspective for them.