JP Morgan today started upgrading some of the China stocks. In fact, JP Morgan also upgraded Europe stocks over the weekend. We saw DCA Research and other global research companies going overweight on global stocks. Do you see merit in a case that perhaps things are getting into a value zone?
I think the story on China stocks is very different. They started falling much ahead of India markets or even Indian technology stocks. They started falling in 2021 or probably late 2020 because of interference of the Chinese government in the technology sector there and so they have their own story. The Indian stocks have corrected. The correction probably started in October-November of 2021 and continued and probably accelerated a bit post the fourth quarter numbers.
We think it is not done. We actually put on an underweight stance on the sector just before the result season started. We have had two great years for technology stocks in India. 2020 and 2021 have been great years. Nifty IT delivered about 50-55% YoY performance in each of these years. The Street had upgraded its numbers pretty substantially in terms of earnings and also the PE multiples were expanded.
PE multiples expanded because earnings growth almost doubled for tier one companies between FY21 and FY25, FY24 versus the FY2015 and FY20 time frame. There is also a very low interest rate regime which led to the PE multiple expansion. Some of these things are unravelling. Interest rates are set to move up fairly significantly in the US and elsewhere too.
We think that earnings are probably going to see a downgrade cycle and we have probably seen the first phase of it where margins have come under pressure and therefore there has been a margin-led earnings cuts. There is going to be a demand-led earnings cut towards the second half of FY23. I do not think it is in the price yet.
So, I would not rush into buying Indian technology stocks right now. Yes there is a digital paradigm, digital transformation services, acceleration that will play out over multiple years but there is going to be a bit of a cyclical speed breaker in the next 12 to 18 months. It will come from US enterprises getting hit because of the margin pressures that they will see and consequently, there is going to be pressure on IT spending. Broadly, that is a take on the IT sector in India and within that, I would probably keep away as much as possible from tier two companies which I think are going to suffer a lot more.
What are your thoughts on comparing the correction which is happening right now to some of the others? Can you draw parallels between the rate hike cycle this time versus the earnings of quality? Is it giving you valuation comfort or not yet?
I do not think I am very comfortable as we speak right now with the way the valuations are and where potentially the correction could go to. I have seen big corrections in the 2001-2002 time frame. That was the time when you saw the shallow recession in the US consequent to the rate hikes that happened prior to that.
Then we saw the GFC crisis deliver fairly bad returns in 2008-2009. Nifty corrected in the calendar year by something like 50-52%. There were mid teens kind of corrections from the top in the numbers. This time, we have seen probably for the first time in the last four decades, very high inflation rates in the US.
The other thing that is probably on the positive side is the fact that domestic money is flowing in. Those are kind of contrasting forces which will lead to probably tightening much more than what we anticipated earlier and that would probably mean that growth is going to come off a lot more than what people anticipated.
The other is the flow of money. While FIIs have been selling, a fair bit of domestic money has been holding up the market but one needs to see how long that can happen. These forces probably mean that there is going to be a correction but it need not be like the correction we saw in 2008.
You have so many companies and sectors under your coverage. What are the pockets of strength where there has been reasonable correction and compared to that risk reward?
I do not want to go and bottom fish right now and so unless you have a three-five year view, you can’t possibly ignore the big correction one is going to see from the top in the market over the next six to 12 months. If you have that 3-5-year view, then probably one can ignore all of this. But if you are an institutional client who does bother about daily NAV and monthly and quarterly performance, then this will be a time not to focus so much on performance.
This is the time to actually focus on capital preservation and I would probably think that the way to approach portfolio construction would be to try to get into quasi cash kind of stocks. Be very defensive and from that standpoint, one should be a bit more overweight on some of the consumer staples and pharma is a space that one can look at. Maybe some of the private sector banks which would probably get hit but may not be hit as much because the valuations have come off quite a bit.
Those are some of the areas where I would probably kind of focus on over the next 6 to 12 months and I would probably be underweight in IT and NBFCs. The neutralish areas will be cement and those kind of areas I mean consumer discretionary space and stuff like that.
What about the midcap, smallcap end of the market? How are you analysing themes there?
We have been largely a midcap, smallcap house and that has been our forte so to speak, but in the next 6 to 12 months, in the kind of market that I potentially foresee, I would probably think that you should be overweight in quality largecaps because that is where the damage is going to be the least within whichever sector you are in.
So if you take a 6 to 12 month view and are very focussed on near term performance, I would say shift to quality largecaps as that would be where you will conserve capital a lot more. But if you take a three to five year view, I am pretty sure that there are a lot of midcap and small cap stocks which will correct quite a bit in this downturn and which will come to levels which would be very very attractive.
I would say that you need to kind of conserve cash to buy into those companies for that kind of a return profile. So as I said, conserve cash right now but if you ask me what the stocks are I would kind of pick a multiple of them. Across the board, if you look at midcaps, consumer discretionary is an area where we can focus on quite a lot on the midcap side. There are a lot of these stocks which we can look at – QSRs, multiplexes, retail companies, even some of the smaller midcap banks.
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