Small and midcaps stocks will outperform only when the market enters a bull phase based on sustainable economic recovery, Mayur Patel, Principal Fund Manager, IIFL Asset Management, tells Moneycontrol’s Kshitij Anand in an interview. Edited excerpts:
Q) The Indian market hasn’t looked back after hitting a low in March despite a rise in coronavirus cases and border tensions. Why this optimism?
A) Despite bleak visibility of economic recovery, the Indian equity market has bounced by around 13-14 percent over the last fortnight, tracking the global risk-on rally driven by a massive $15 trillion liquidity infusion by global central banks and governments.
Short-covering has led to a sharp rally across the board irrespective of fundamentals. Companies such as Hertz (filed for bankruptcy) and Luckin coffee (admitted to accounting fraud) listed on NASDAQ have doubled over the last few days.
This liquidity-driven rally may stretch a bit. Eventually, the market would start responding to economic factors and corporate earnings outlook, which look challenged at this juncture. Hence, it’s unlikely to be an easy one way upward journey.
Q) The Indian market went down in a hurry and then recovered swiftly but investors lack conviction in the move. Do you agree?
A) The Indian market declined by more than 20 percent before even reporting any meaningful number of cases and sharply bounced back from lows even though recent stimulus announcements may not be sufficient to kick start the economy.
It moved with unprecedented velocity on both sides, responding more to global factors. The Nifty seems to have created bottom at 8,000 levels, which implies a 2x price to book.
Historically, investors have made decent returns entering these valuations. While the odds of the Nifty falling back to those levels may be low, we need to see the timely flattening of the curve of the COVID-19 cases.
Besides, some bold stimulus announcements would be needed to develop more conviction on the current market momentum.
Q) Which are the stocks and sectors likely to benefit the most as and when lockdown ends?
A) A large part of our economy has opened up post the relaxations starting June. There would be sequential improvement across sectors over a NIL base in April-May. It would take a few quarters to reach closer to normal levels, assuming the new cases curve turns downwards soon.
Some sectors will take much longer to reach normal levels. Financials and consumer discretionary are worst-hit in this crisis.
They may take a while to recover given the opacity on numbers due to extended moratorium. Airlines are unlikely to see normalisation anytime soon.
Stocks in consumer discretionary sectors such as auto and durables have bounced sharply but earnings trajectory will take time to recover. Sectors such as pharma, chemicals, small appliances, and agri-related sectors (Tractors) should be better off amidst the current volatile environment.
Q) What is your call on financials, metals, auto, and realty segments that are going through sector-specific troubles. How should investors play them?
A) Indian financials are a secular growth sector, especially the private sector players, and the long-term trajectory has not changed.
Given the leverage model, these are most exposed to the macro environment and in the near term are naturally impacted in times like these. The tail would diminish and larger and stronger players would gain more market share.
Leading private sector banks and NBFCs having robust capital structure and the strong franchise would sail through this crisis with minimum hit and come out stronger with a much larger market share.
These would lead the rally when sustainable recovery sets in. Metal stocks are rebounding from multi-decade trough valuations but metal companies with high leverage would be under pressure in this recessionary environment.
Large-ticket discretionary sectors such as auto will have a rough ride in the medium term, as consumer demand is likely to recover with a lag.
The realty sector already had many challenges pre-COVID and now things have only worsened, with urban demand collapsing. Moreover, increased work from home would dent medium-term demand. Mall operators would also need to rejig their business models. Apart from residential, commercial realty, which was earlier showing signs of recovery, would also come under stress.
Q) Which sectors are likely to lead the next leg of the rally?
A) Despite the opening up of the economy, the outlook would remain uncertain in the medium term. Risks of the second wave, severe than the expected slowdown, and bad-loan cycle persist. In this environment, strong business models with low leverage in sectors such as pharma, chemicals, small appliances, and rural-agri should do well. Private sector banks and select NBFCs may lead the rally once tangible recovery sets in.
Q) The monsoon is off to a stormy start. What is your outlook and which are the stocks and sectors that will benefit the most?
A) The monsoon is expected to be good and agri- economy should benefit. In any case, agri-economy was least impacted due to the COVID-19 crisis as the infections were minimal in rural areas. Agri economy-related sectors such as agrochemicals, fertilisers and tractors should perform well in the near to medium term.
Q) The foremost emotion of investors right now is to preserve capital, especially when the demand has contracted and salaried class stressed over job losses. What should be the strategy of investors?
A) In the current scenario, investors need to have enough buffer to deal with uncertainties. Based on the risk profile, investors need to determine the allocation of this risk asset and invest systematically with a long term view.
Equity, as an asset class, has given reasonably good double-digit returns over the long term but the key is to have at least five-six years of time horizon.
Q) Life after 10,000 on Nifty will change – do you think that increased optimism and liquidity will also lead to a sharp rise in the small and midcaps?
A) The valuation of small and midcaps was attractive even before the COVID outbreak due to their underperformance vis-à-vis large caps over the last two years. This has become even more attractive over the last few months.
We expect outperformance in small and midcaps only when the market enters a bull phase based on sustainable economic recovery.