Equity markets don’t appear exhausted but do seem frothy: TRUST Mutual Fund’s CIO

According to Mihir Vora, the market is expected to deliver single-digit or lower double-digit returns in 2024, significantly lower than the 20 percent provided by the Indian equity markets in 2023.

The Indian equity markets don't appear exhausted but do seem frothy, especially with higher valuations in mid-caps and small-caps. Despite a positive global sentiment towards India, Mihir Vora, Chief Investment Officer (CIO) at TRUST Mutual Fund, emphasised the importance of closely monitoring consumption growth, which is still perceived as uneven, following a 'K-shaped' trajectory. He expressed keen interest in observing the kick-off of the capital expenditure cycle by the private sector.

According to the CIO's insights, the market is expected to deliver single-digit or lower double-digit returns in 2024, significantly lower than the 20 percent provided by the Indian equity markets in 2023. Additionally, the CIO noted that valuations of select large-caps in information technology (IT), pharma, banks, metals, and certain specialty chemicals still appear appealing.

Vora also highlighted the manufacturing theme in anticipation of potential announcements, particularly in the automotive and electric vehicle (EV) sectors. He believes that the overarching theme of self-reliance (Atmanirbharta) and the Make in India initiative will experience a further boost due to this increased activity. Edited excerpts:

Do you see some exhaustion creeping into the markets after the record run? What is your wall of worries?

As of now, there doesn't seem to be any exhaustion, frankly, while people like us who pay a bit of attention to valuations are cautious, especially in the small and midcap spaces. But the flows, both from FIIs (foreign institutional investors) and domestic institutions, and, of course, the retail segment in the market, don't seem to be letting up at all. So I think the sentiment as we enter the new year continues to be very strong. I continue to recommend that we have to be more and more selective and not compromise on the quality of stocks that we are getting into, because I do see people going down the market cap curve, from large-cap to mid-cap, mid-cap to small cap, micro-cap, and then SME. That's kind of adding to the risk at each level, which is something that we should be careful about at this point. As far as the factors are concerned, I think the global sentiment is definitely in favour of India. I don't see any negatives on that front. However, we need to closely monitor the consumption growth in the country, which I think is still not picking up. It's still a K shape. This uneven recovery is something that I'm a bit worried about. And the capital expenditure cycle that needs to kick off, especially by the private sector, is also something that we are betting on. So already we are positive in the cycle. But that's a variable that will determine the fate of the market this year.

Would you say a victory for the BJP with a thumping majority is already priced into the markets?

I think the market is not expecting any major shocks in the election. I think the default case seems to be that of continuity. I agree with you that a positive result or a continuation of the current regime is already baked into the price.

As far as the equation of valuations versus growth is concerned, for the Nifty, we are still expecting about 15 percent earnings growth for FY25. That's decent growth in profitability. Valuations, of course, are probably one standard deviation above long-term averages. That's a little bit on the expensive side, but we have seen that valuations can tend to overshoot when the markets are in a positive zone or a wild bull run. To that extent, valuations are, as far as large caps are concerned, not that expensive. I mean, it is expensive, but not in the euphoric zone. So, with 15 percent earnings growth and slightly expensive valuations, we should expect high single-digit or low double-digit growth from the markets at the index level. Of course, stock-specific, there is enough scope for stock collection. India is a very diverse market. We do have a lot to choose from in the tail, so to speak. But at the large-cap index level, I would expect single-digit returns.

Speaking of large-caps, all these stocks are quoted at premium valuations. Commodity chemicals, autos, consumer staples, Ultratech, Shree Cement, all are at premium valuations. What's the way forward?

Some of the segments that you mentioned, for example, specialty chemicals, are not trading at premium valuations. In fact, they've seen a sharp correction in the last year because of China coming back into the system. So, valuations have corrected significantly there. But if you look at the large-caps, the biggest sector is financials. In financials, the valuations are not expensive. Almost 30-40 percent of the large-cap index is not trading at a premium valuation. The second-largest sector is, of course, IT, followed by oil and gas. IT is trading at a little bit of a premium valuation. But there, we have seen a correction in the large-caps at least. So, we are probably a little above average in terms of IT valuations. And in the oil and gas space, which is the energy space, valuations are cheap in absolute terms.

I think the three largest sectors are not giving you any discomfort as far as valuations are concerned. The other exciting space where it has not done much in the last three to four years is pharma. Pharma valuations are not expensive. The only expensive space probably would be, as you mentioned, FMCG, where anyway, it's not a big overweight for us. And then capital goods are becoming a bit expensive. But then again, the absolute weight is not very high. So, if you look at the four or five big sectors, it's not a very bad situation to be in. Metals are not expensive. So, I think valuations for large caps can be justified.

Some of the chemicals are being produced in large quantities, and we saw price and margin erosion. And of course, because we were starting 2023 at very high valuations, we saw a sharp correction in many of the specialty chemical stocks. I think now the price dumping is no longer going to happen incrementally. And companies have, or are already executing, the capacities that they announced. So, it will be a volume-growth story in the next two to three years. Some of them are increasing capacity by 40-50 percent or even doubling capacity. So, there's a lot to choose from, given that volume growth will happen. We are not assuming any major increase in margins, plus valuations have corrected significantly.

Your outlook on the metals sector, which is trading at a discounted valuation. What do you like between ferrous and non-ferrous metals?

I think valuations have corrected across the board. For India, I would say that we would stick to companies that are again showing more volume growth or increasing capacities in the next few years. That would be our approach. But in general, I continue to believe that the fate of bulk metals — steel, aluminium, copper, etc. — will still be determined by the growth in China. And there, the situation is not very certain. China's growth is still not picking up. China continues to consume 60-80 percent of most of these bulk metals. So, till China picks up, I would not be structurally positive on metals. For India, I would continue to play companies where we are expecting volume growth.

What themes are you looking at as the Vibrant Gujarat Summit is set to kick off on January 10?

We should see a flurry of activity in manufacturing. As you rightly mentioned, on the auto and EV fronts, a lot of announcements could take place. This theme of Atmanirbharta and Make in India will further gain traction with the Vibrant Gujarat Summit. Land, etc., is a problem. People keep talking about constraints. That's not a problem. I think as long as we have a conducive environment, companies will come in. And you also heard the announcement that they are allowing liquor in GIFT City. All of these ease-of-doing business parameters do matter in the long term.

The hotel, aviation, and travel themes seem to be picking up pace with the Ayodhya Temple opening. How do you see that?

The marriage season is still on. So we should see activity continue until at least January. Beyond that, it's a function of how the traction is. So at least early indications are that we are normalising. The kind of revenge tourism that we saw — that maybe past us — and we may be back to a little more normal. But the problem is that capacities in hotels and airlines are not growing, even at the mild rate it requires. So to that extent, the supply-demand constraints in aviation and hotels will continue at least for one more year.