With the significant outperformance, it is prudent to cut some exposure in midcaps and smallcaps and take some profits home as the relative risk adjusted returns for largecaps look good, says Jitendra Gohil, the chief investment strategist at Kotak Alternate Asset Managers, during an interview to Moneycontrol.
On the sectors, he believes the outlook for the consumption space is weak, Additionally, the valuation isn’t cheap, even after the recent underperformance.
Gohil, backed by around two decades of experience in equity strategy and business development, favours domestically focused interest-rate-sensitive sectors such as banks and NBFCs. He believes that interest rates in India have most likely peaked and will gradually decline over the next 12-18 months. Excerpts from the interview:
Do you think the relative risk-reward looks favourable for largecaps as against midcaps and smallcaps in the near term?
Some pockets of midcaps and smallcaps are trading at unusually high valuations, especially for companies where there is low free-float. Midcaps and smallcaps are performing really well, however, they are also more susceptible to a sharp correction during the periods of risk aversion.
Therefore, after this significant outperformance, it is prudent to cut some exposure and take some profit home as the relative risk adjusted returns for largecaps look good.
Which are the three sectors that one must look at for investment in Diwali 2023?
We favour domestically focused interest rate-sensitive sectors such as banks and NBFCs. We believe that interest rates in India have most likely peaked and will gradually decline over the next 12-18 months.
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We also like the real estate sector where the inventory is falling to multi-year lows and demand momentum remains very strong.
Within defensives and exports, our preferred pick is the pharmaceuticals sector, which also provides some comfort in case global recession worries resurfaces.
Are you super bullish on the pharma space?
The pharma sector is emerging from a period of consolidation and is well-positioned to benefit from higher inflationary pressures in developed countries. We believe that price erosion will be lower in this sector.
Indian domestic healthcare and pharmaceutical companies have significant structural growth opportunities, but investors should monitor the evolving regulatory landscape and changing policies.
Within the sector, we don’t like sectors with lower moats, such as the diagnostic chains. Hospital chains are in focus, but investors should be aware that this segment offers lower return on invested capital (ROIC) and lower free cash flow potential due to high fixed costs and capex intensity.
Do you expect the large volatility in FII flow to continue in the coming quarters?
India's weight in the MSCI Emerging Markets (EM) Index has doubled from pre-Covid levels to mid-teen levels, making it more sensitive to the movement in the overall global EM flows. These EM ETF flows tend to largely fluctuate with dollar strength and weakness.
FPI flows will also depend on how China stimulates its economic growth. If it bounces back, we might see some reallocation of foreign capital back to China as the market is very cheap at present.
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Over the medium to long term, as the depth and breadth of the Indian equity market improve, we believe that India will attract a significant portion of foreign investor portfolios.
Are you still bearish on the export-oriented sectors?
India is slowly gaining the market share in global exports, but we are concerned about the weak global growth outlook and slowdown in China. These factors, along with the weak yuan, are making the export market increasingly competitive, leading to weak topline growth and lower margins.
However, inventory corrections appear to be nearing completion for several export-oriented sectors, and once Chinese growth stabilises, we believe that sectors such as chemicals could rebound.
The PLI (production linked incentives) scheme will benefit these sectors in the long run, but the sector is already trading at an exorbitant valuation, so the return potential in the next one year seems limited.
Have you made changes to your full-year earnings estimates, especially after the September quarter earnings season?
Overall, the earnings downgrades could be limited for India, we believe. However, the quality of the overall earnings quarter is weak in the September. Topline was not only impacted by lower commodity prices year-on-year but also due to lower volumes.
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The earnings were supported largely due to margin expansion, which we believe could be challenging next year.
What do you make out of management commentaries after the September quarter earnings?
Sectors that are in momentum such as travel, tourism, and hotels, continue to instill confidence. The FMCG and QSRs (quick services restaurants) sectors are facing stiff competition from newly emerging brands and local players. This could lead to higher advertisement expenses next year limiting their margin expansion potential.
However, on the other hand, this spending could benefit media companies. The IT sector is tricky: deal-win momentum has been very strong but they have also resorted to headcount reduction, this might be an indication that new deals were bid very aggressively. However, the IT sector has demonstrated good margin performance in difficult times in the past, and we shall monitor this trend closely.
Do you expect revival in the consumption space, given the likely spending ahead of general elections next year?
India sees faster economic growth but with higher youth unemployment. Household financial savings rate has depleted to multi-year lows, while household leverage is rising rapidly. For listed consumption-oriented companies, the competitive intensity is also rising.
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The outlook for the consumption space is weak, but some bounce could be seen ahead of the elections if the government announces policies to revive consumption. It seems unlikely as the announcement so far is targeting food and higher fertiliser subsidies, which won’t move the needle much to prop-up overall consumption. Additionally, the valuation isn’t cheap, even after recent underperformance.
Do you think the ongoing geopolitical tension is a significant concern for the global economic growth?
Global geopolitics is highly unpredictable, especially with the upcoming elections in Taiwan and the US next year. Unless geopolitical tensions escalate to a point of causing energy and food shortages and shocks, we do not believe that these tensions will have a material impact on global growth, barring a few economies.
The US-China trade war is a bigger problem for economies that depend on China, as it is leading to uncertainty in supply chain management, a push for localization, capital reallocation, higher inflation and interest rates, and other challenges. However, to some extent, this has benefited a few countries, including India.
In the medium to long term, the ongoing geopolitical tensions have also resulted in higher inflation and wage growth in developed markets. This could lead to more outsourcing business opportunities for India, with its large English-speaking young population. One example is the growth of global capability centres (GCCs) in India. Additionally, the service export sector is surprisingly strong despite weakness in IT.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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