Daily Voice | Definitely see some froth in the market, but can’t be termed a bubble yet: HDFC Securities' Unmesh Sharma

Edited excerpts from the interview follow:

Given the spectacular run in midcaps, smallcaps and microcaps, do you see a bubble kind of scenario in these segments?

Interestingly, we carried out an in-depth analysis on the same topic in our recently released HSIE strategy report, Valuation of Indices. We concluded that the Nifty Smallcap index is trading at a steep premium of 49 percent over its average historical valuation level. This figure is more moderate at 22 percent in the case of the Nifty Midcap index and 14 percent for the Nifty 50. We also highlighted that at the same time, approximately 30 percent of the stocks of these benchmarks are trading at discounts to their historical average valuation levels.

So, we definitely see some froth in the market, but it can’t be termed as a bubble yet. Additionally, this seems largely localised to the small and micro caps. While it may lead to some heartburn, we do not see a dislocation because of this.

Have you seen money gradually shifting to largecaps and large midcaps, from midcaps, smallcaps and microcaps, given the stretched valuations?

We observe that largecaps are witnessing activities led by both FPIs and DIIs, while the small and mid-cap categories are dominated by domestic investors. Hence, currently, the nature of flows is driven by technical factors.

Domestic liquidity is largely trapped within the country (similar to Hong Kong / China in 2005-2008). So, the theme of increased participation in the equity markets is leading to rising flows in the small and mid-cap segments.

Recently, the valuation concerns led to FPIs selling in spurts (as they move to debt or other countries with more reasonable valuations). Furthermore, the extent of current overvaluation is more prominent in small and midcaps while largecaps are only moderately expensive. Hence, a segment of wary investors may opt for safety of capital over appreciation, and accordingly shift some allocations to largecaps from mid, small and micro-cap stocks.

Do you see the definite possibility of a steep fall in equities post the general elections results?

As discussed earlier, there are pockets of froth in the market and that could see some healthy correction. However, at the aggregate level, valuations are expensive and post the December state elections, the election scenario built in signals a stable political environment. In this scenario, investments will chase stocks that deliver earnings.

Hence, in our view, the overall market will remain sideways, and bottom-up stock picking dependent on earnings would be a prudent investment policy.

Globally, some experts see US Fed rate cuts starting in the first half, while some see it beginning in the second half of 2024. What is your take, and do you see the possibility of 'no landing' in the US against a 'soft landing'?

From the market’s perspective, we do not see a dislocation and a sharp and deep recession. We see a more normalised slowdown as the Fed will continue to keep rates at elevated levels in 2024. We see cuts in the second half but in line with the Fed commentary of three cuts this year. Recent inflation prints signal the same. A mild slowdown and a continued fight against inflation remain the base case.

Is this the time to add exposure to FMCG stocks and increase bets on banks?

We expect consumption demand to witness a slight pickup in FY25, and FMCG stocks have moderated in valuations after a subdued performance in the last three quarters. One can start adding exposure to the sector on a selective basis. This view is reflected in our HSIE model portfolio, where we have reduced the extent of being underweight on the FMCG sector.

Furthermore, banks continue to be our preferred sector, where we are positive on large banks (public and private both), as we believe they are most equipped to manoeuvre the current scarce deposit scenario while maintaining healthy credit growth and asset quality.

Do you think much of the future potential is already priced in for the electric vehicle (EV) and semiconductor themes in stock prices?

Our core thesis is that “semiconductor manufacturing in India” and “EVs” both remain long-term promising themes, but the pace of implementation will face certain challenges. These hurdles are adoption of technology, market share gains in favour of India, and rollout of conducive infrastructure.

Also, in the cases of both themes, there is only limited visibility on the direction of the technological evolution trend. We believe that the abovementioned factors are playing out, and hence on both themes, we are seeing a more benign but positive outlook after the initial euphoria.

We remain positive on the longer-term outlook of these themes but there are not many stocks that could be direct, specific plays.

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