Interview | Steep correction unlikely, but only select stocks to do well; temper expectations: DSP's Bhole

The macro-economic setup which is developing in terms of growth revival with some level of moderate inflation, ample liquidity and low-interest rates is very favourable for equity as an asset class. Corporates would be able to report robust growth with the help of nominal GDP pick-up. Government tax collections are robust even as several sectors of the economy are still not opened up or only partially working. A pick-up in nominal GDP growth would further bode well for government tax collections, which can be pumped into the economy by way of productive spend. India’s external side is pretty solid with a manageable current account deficit (CAD), favourable flows and a high level of forex reserves. Perhaps, the market is factoring all these macro-economic positives ahead of on-ground pick-up and before corporates start reporting better earnings.

There are some pockets of exuberance like newly listed IPOs, certain mid and smallcap stocks etc. One has to exercise caution while approaching such pockets, but by and large, there are a good number of opportunities to stay invested and make reasonable returns with typical volatility associated with equity markets.

The market level appears psychologically very high as we have seen fierce rally making an all-time high, in a truncated time frame from the oversold level of 7500 made in April 2020. From the pre-covid level, Nifty is up around 40 percent. A lot has happened during this period in terms of overwhelming fiscal and monetary support. Corporates have become much leaner and nimbler with step-up in technology adoption. Many sectors are seeing a massive change in competitive dynamics favouring bigger & better companies. Covid has acted as some sort of an inflection point for many sectors, like insurance, health & residential real estate. All these factors would help corporates get back and also improve their intrinsic earning power. Collectively, the market is trying to price in these changes, maybe in some cases ahead of time.

India is and always has been expensive than the emerging market (EM) peers due to favourable aspects of a more balanced economy, better growth profile etc. At the same time index composition is also changing with better representation of more B2C, insurance and new-age companies in India which typically trade at higher valuations than the resources or government companies that dominate many emerging country indices. At present, India’s valuation premium is almost at an all-time high of 70 percent to the MSCI EM Index. However, EM as a basket, itself is trading at almost the bottom of a 20-year range relative to developed markets. Indian equities’ extent of over-ownership in foreign portfolios has reduced to just around 15 percent over MSCI EM weight compared to the historical 30-60 percent range. With broader growth pick-up and macro stability, India still stands a good chance to attract foreign flows.

We have already experienced a good leg of the rally in many of the cyclical or beat-down stocks and better be wary of extrapolating the momentum there. The economic recovery can be broad-based going forward and many parts would participate in the same. The past 5-10 years have been challenging for businesses with disruptions like demonetisation, GST implementation, IBC adoption, NBFC crisis and finally Covid. Technology has been acting as the biggest disruptor as well as an enabler. To benefit from future growth and protect capital, one has to select companies and managements which are abreast of the changes and are aligning the business models to new realities. It has to be the most important element while selecting stocks rather than labelling them as defensives or beaten down. Both expensive growth or value stocks would do well as long as the underlying business’ earning power is intact and improving.

We are favouring banking, NBFCs and insurance stocks the most, obviously with a lot of stock selection filters. We like most of the large private banks, given non-performing asset issues are largely over and nominal GDP growth along with their tight cost structure can lead to a large jump in profitability. Some NBFCs are also primed to benefit from the growth in consumption with their technological prowess and customer franchise. Finally, we also hold most of the private insurers which have quite a few factors working in their favour. These stocks are reasonably valued compared to their historical valuations. At the same time, we believe, relative to the broader market, they represent the most attractively valued basket offering much better risk-reward.

Most of the midcap or smallcap, one would want to buy for their business strength and opportunities are almost priced to perfection. Many of them are trading at a premium valuation to largecap peers. Many midcap or smallcap companies that are into B2B or commodity nature of businesses are trading at 30-40 times PE or even higher, which to our mind is unreasonable and unsustainable. Given the broader recovery hopes, macro-economic dynamics of growth and inflation unfolding, these valuations might sustain. We think there can be a good amount of time correction or subdued performance from such stocks.

Given the sharp rally and higher valuation, we think, return expectations have to be moderated. The markets would continue the future journey based on how the earning picture unfolds and maybe highly stock specific. On the other hand, given the macro picture of growth, external stability, liquidity & lower interest rates, the market may not see a sharp fall and any small correction would be used as a buying opportunity.

It is unfortunate but historically it has been observed that the market upmove and momentum increase investors’ confidence to participate in the market either directly or through mutual funds. The current spate of IPOs and NFOs are benefitting from such behaviour. We are sanguine about the markets but some caution is necessary while dealing with some pockets where prices are running ahead of time and are driven by momentum.

We are advocating good enough attention to existing funds which have a decent track record and investors can take more informed decisions through an established investment framework supported by underlying portfolios. The best way to manage risk is to know beforehand what one is buying and the current market level definitely warrants such attention.

For the economic situation unfolding and keeping in mind the coming few years, it would be prudent to invest in a basket of companies across sectors and size, where business models are future-ready and nimble while managements are adoptive and aggressive to tap into the opportunities, even at the cost of paying slightly higher valuations.