In an interview with ETMarkets, Sood said: “We expect a mixed bag of earnings for the rest of the financial year; with the automobile and financials expected to perform resiliently, the earnings of cement and consumer companies are expected to be under pressure” Edited excerpts:
What a week for Indian markets – 20,000 and then some profit taking in the week gone by. How are you looking at markets?
At the current levels, we believe the markets are fairly valued and foresee limited scope for multiple expansions in the short term.
Incrementally, the returns exhibited will be a function of the earnings growth trajectory. Between the financial years 2021 to 2023, we have witnessed consolidation in the markets.
With the Nifty surpassing 20,000, the index’s TTM Price-to-Earnings ratio stands at 21.8x, higher than its two-year average but still below 26, which is its five-year average[Motilal Oswal data].
Further, regarding valuations, the Nifty is currently trading at a 12-month forward P/E of 18.3x and a 12-month forward price-to-book value of 2.9x.
One would need to take cognisance that we are heading into the election year, which will act as a major cue. In emerging markets like India, election cycles are important from economic and market perspectives, and the outcome of this momentous election would be a key factor to watch for.
It seems like the maximum interest is in small & midcap space. Is the FOMO which is causing the catching-up?
Between FY2021 and FY2023, small and mid-cap companies were severely impacted by rising inflation, which can be attributed to factors such as elevated raw material costs, high power and fuel costs and increased freight costs.As a result of these inflationary pressures, many companies in the small and midcap space have corrected meaningfully.
The phenomenon being reflected now revolves around the moderation in raw material prices, power and fuel, and freight costs. Accordingly, we are witnessing normalisation in the gross margin and an improvement in the EBITDA margin.
Despite these positives, demand moderation continues to be a concern, specifically in sectors closely linked to the global economy.
At present, the NSE Small Cap 100 index indicates a compounded annual growth rate of 17.3%[Bloomberg data], between 2018 and 2023, which is in line with Nifty and the mid-cap Index.
There are certain sectors within small caps wherein the valuation is expensive, with the companies trading at more than 2 standard deviations from the mean.
Looking at the small-cap index does not do justice to the entire universe of small and mid-cap stocks, which comprises almost 3,500 traded companies.
This means that success is determined in small and mid-cap investing by how investors stay disciplined over market cycles and tide through phases of volatility in a concerted attempt towards building long-term wealth.
Strong investor interest is witnessed in these categories since small and mid-cap investing offers exposure to sunrise sectors with superior earnings growth and under-representation in the indices.
Hence, these assets enable clients to meet their diversification goals optimally.
From an investor’s perspective who is looking at the portfolio and with handsome gains – what should he do? Time to book profits or stay put?
If we consider the 10-year data depicted by the Small Cap index, we notice that the benchmark has garnered significantly higher returns than the Nifty.
The higher return realised by the Small Cap sector has occurred in the backdrop of a major change in regime across parameters such as the ruling government, COVID-19, GST, and demonetisation.
Going ahead, as long as we are subjected to lower disruption than the decade gone by, we expect the returns to turn out better than what has been realised over the last few years, making this an excellent time to stay put.
How do you see earnings to pan out for the rest of FY24?
We expect a mixed bag of earnings for the rest of the financial year; with the automobile and financials expected to perform resiliently, the earnings of cement and consumer companies are expected to be under pressure.
Further, healthcare companies are expected to perform well due to increasing opportunities in India and select pockets of growth in the US.
Considering the government’s push on infrastructure development, companies in the sector will likely put up a good report despite slight weakness in Q1. Overall, we expect a mixed bag of earnings for the rest of FY24.
What should investors avoid doing, especially when the market trades near record highs?
At the outset, investors must stay disciplined and book profits in stocks with unfavorable risk-reward ratios. This can be undertaken in sectors or businesses wherein the valuation multiple is high, with a standard deviation of +2 from the mean.
It is important to avoid over-exuberance in sectors and companies where the narrative and the exhibited numbers do not tally.
We have observed this phenomenon occurring typically in high-growth sectors wherein people tend to ignore balance sheet risk and cash flows only to focus on high earnings trajectory growth instead of the quality of growth.
There is a belief that cyclical companies have become secular growth companies. For example, in FY 2021, the median P/S of the chemical sector was 10x and, as a result of the China +1 narrative, there was an expectation that the sector would enjoy multiple growth opportunities, but the fact remains that the sector is a cyclical one.
Which sectors are likely to drive the next leg of the rally?
Going ahead, we expect sectors such as IT, Healthcare, Manufacturing, and Consumer Discretionary to drive the next leg of the rally, given their attractive valuations and strong fundamentals.
Globally, we are the only market that is hitting record highs. How do we stack up against peers in terms of valuations?
The 10-year dollar returns on the Nifty came in at ~148% as of the end of June and ~247% in local currency terms.
While the US enacted the role of the best-performing market for a decade, with its indices depicting out-performance in the period, India was the best among emerging markets.
Now, the 3-year dollar return from India is 70%, with the US indicating 35%. India’s USD index returns have exhibited 2x the growth of the best-performing market.
On the other hand, Mexico has performed 87%, in dollar terms, during the same period. While the developed market outperformed the emerging one in the last decade, this decade is expected to be a mean reversion decade for Emerging Markets vs developed markets.
India has traded at a great premium when compared to the MSCI EM Index, due to the higher earnings growth opportunity and an improving RoE profile.
How are FIIs looking at Indian markets?
Given the recent turmoil in China and the prolonged period of no return depicted by the MSCI China index, the GEM (Global emerging market) allocators treat the economy as a separate market within the Asia allocation.
India is a prominent country in the MSCI emerging market index with 14-15 percent, which means that FII remains bullish on the domestic economy.
Accordingly, we believe that, over the next three to five years, the weightage of India will improve in the index.
Further, while FIIs have indicated a selling momentum during this cycle, it can be attributed to the fact that these players usually are cautious closer to an election.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)