Ajay Menon, CEO, Broking and Distribution at Motilal Oswal Financial Services Ltd, said that cyclicals are driving earnings at the margin and with a capex boost in the Budget, they could continue to remain in favour in the near term.
Menon, a market veteran, likes stocks from the broader market such as IEX, Varun Beverages, AU Small Finance Bank, Crompton Consumer, L&T Technology, and JK Cement.
Here are the edited excerpts from his interview with Moneycontrol’s Kshitij Anand.
Q) If we look at the micro and macro data from February, the Indian market seems to be in a firm bull market, but weak global cues could be a spoiler in the short-term. What would you advise investors?
A) Strong macro and micro data for February have limited the fall of the Indian equity market vis-à-vis other global markets.
The Nifty50 was the best performing market globally in February 2021 and the robust performance continued in the first week of March as well – overall Nifty is up 10 percent since January end.
Thus strong economic data coupled with steady auto data, electricity data, and ongoing vaccination drive is keeping the positive momentum intact in the equity market.
GDP grew 0.4 percent YoY growth in Q3 FY21 – the first positive after two consecutive quarters of contraction, facilitated by festive season demand and coupled with the reopening of the economy.
Investments were the primary driver of GDP growth, contributing 0.7 percent to the overall GDP growth. Even the PMI Services data expanded for the fifth straight month while the manufacturing PMI data was stable.
The GST collections too crossed the Rs 1 lakh crore mark for the fifth month in a row in February. However, global 10-year bond yields have risen sharply in February 2021 on the back of rising inflation expectations.
Bond yields in India went up around 33bps in February. This has led to huge volatility in the market.
The long-term structure of the market continues to remain positive, though it may face some hurdles in the near term due to concerns over the bond yield, commodity prices, and the risk of an increase in inflation.
The government’s focus on fiscal expansion and capex spending augur well for the revival of the long-anticipated private investment cycle. However, Nifty valuations at 20x FY22 EPS are not inexpensive.
Rising bond yields may cap equity valuations in the near future as the RBI may have to do a fine balancing act to keep bond yields at lower levels while managing the government’s borrowing program.
Thus given the likelihood of huge volatility continuing in the market, long-term investors should adopt a buy on dips strategy while traders should trade cautiously with stock-specific action and book profits at regular intervals.
Q) A lot of beaten-down stocks are beginning to get buyers' attention. Any dark dorses which investors can look at and why?
A) Confluence of economic recovery, containment of COVID-19, earnings beat, and an expansionary Budget have kept the market in good spirits.
With the Budget behind, the focus will be back on corporate earnings, which are witnessing solid momentum, with a broad-based beat and upgrades.
Cyclicals are driving earnings at the margin and with a capex boost in the Budget, it could continue to remain in favor in the near term.
From the broader market, we like ideas such as IEX, Varun Beverages, AU Small Finance Bank, Crompton Consumer, L&T Technology, and JK Cement.
Q) Small & midcaps have been the favourite of the bulls as the segment is turning out to be resilient even on dips as compared to benchmark indices. What is powering the rally in the broader market?
A) Midcaps and smallcaps have shown their resilience even on dips as compared to benchmarks and gained 11%/12% versus Nifty's 7%.
Over the last 12 months, midcaps/smallcaps are up 39%/42% versus a rise of 30% for the Nifty. However, over the last five years, they have underperformed.
Opening up of the economy and strong high-frequency macro data have uplifted sentiment. The vaccination drive has further provided a boost to the Indian market, with much broader participation from mid and small-caps.
The drivers of earnings growth are incrementally shifting towards cyclical sectors. Lower interest rates, the prevalence of abundant liquidity, and broad-basing of economic recovery augur well for mid and small caps.
While we are positive on the mid & small-cap space – we don’t believe that there would be a broad-based outperformance. One needs to be very selective within and look for high-quality management with strong business growth drivers.
Q) Amid the privatization buzz – what should investors do with the PSU space?
A) While the overall market was touching new highs, PSU stocks were sharply underperforming. However, they staged a sharp turnaround and posted strong gains on the back of renewed interest in the sector post the Union Budget – as the government reiterated its commitment toward privatization and singled out several assets for monetization. 22 PSU companies rallied over 25% in February 21, with PSU Banks leading from the front.
The FY22 Disinvestment target has been set at Rs 1.75 Lakh crore. Apart from two PSU banks and one general insurance company, divestments of BPCL, CONCOR, Pawan Hans, and Air India is planned to be completed in FY22.
The government will create a list of new companies for divestment. The much-awaited IPO of LIC is also slated in FY22. All these measures would boost activity in the capital market and help retail investors participate in the growth of these government-owned marque companies.
Despite sharp outperformance in the last month, the majority of the PSU stocks are still trading at a significant discount to private sector peers as also to their own historical valuations. PSU companies have enormous potential.
With the right policies and vision, these companies can play an important part in driving investments in the country and hence creating significant value for all the stakeholders.
However, investors need not be careful while treading the PSU space. Investors should first evaluate the exact measures that can create value in these PSU equities. Among the most preferred PSUs is SBI. SBI recently reported strong performance in its Q3 results, with healthy NII growth and a strong recovery in retail credit.
Its asset quality outlook remains encouraging, with controlled slippages, low restructuring levels and improved Provision coverage.
We believe the earnings normalization cycle for SBI has begun and that the stock has huge upside potential even from current levels.
Q) Where is smart money moving especially in the last few weeks – global setup has changed a bit, and on the domestic front strong micro and macro data does suggest economic and earnings recovery in the offing?
A) Equity markets are currently near their all-time high levels and are still showing resilience on the back of a broad-based economic recovery, a second consecutive quarter of strong earnings, continued FII inflows, India’s vaccine distribution, and favourable policies from the Government as well as the Central Bank.
In fact, the FII stake in Nifty50 has hit a five-year high - rose 170 bps to 27.6% QoQ. Meanwhile, DII holdings in Nifty50 saw a reduction of 30bps to 16%. Even for Nifty500, the FII stake rose by 140bps to 22.6% QoQ.
On a QoQ basis, FIIs have increased weights in Private Banks, NBFCs, Metals, PSU Banks, Capital Goods, Consumer Durables, Real Estate, Cement, and Utilities. While, O&G, Technology, Healthcare, Consumer, Auto, Insurance, and Telecom have seen a reduction.
A) There has been a spike in the US bond yields by 40 to 50 bps in the past 1 month and that has caused weakness in the flows into India. A large part of the rally in India was backed by FII flows and it has slowed down in the past 1 week, so key monitorable would be the bonds yield and the dollar index.
Since the earnings trajectory is strong and we would start getting Q4 previews in a month that again would be a key monitorable for FII flows.
Q) What is happening with commodities? Crude seems to be inching higher, we are seeing some action in metals as well. Do you think we are entering the Commodity supercycle for the first time since 2008?
A) Commodities are in a frenzy since the start of the pandemic. Q1CY2020 led to a fall in most commodities led by lockdowns and pandemic-related closures, but things started to reverse since Q2 where a rebound in Chinese demand led to a surge in select commodities.
China accounts for around 50-55% of all ferrous and non-ferrous metals consumption and their economy was the first to rebound from the pandemic which led to a strong sustained demand, where prices of select metals like copper and nickel almost doubled from March 2020 lows, and minor metals rallied by 50-60%.
There world is now seeing a fundamental switch coming in the form of Electric vehicles + charging stations, 5G technology, solar technology, and a whole new gamut of technological changes along with massive stimulus money which has led to the huge demand for metals.
All this could continue to keep them higher for a brief period of time till new capacities are added and demand substitution kicks in, but 2021 could be the year where metals could continue their bull run.
Crude has had a wild swing from going into the red to sustained gains up to $67 for the WTI, as demand rebounds post lockdowns across the globe, shutting down of a lot of shale producers, production cuts by OPEC + members and weaker future consumption forecasts. Geopolitical tensions and rerating by banks have added to the recent gains.
We believe that a lot of positive fundamentals are already in the prices and it’s time to be a little cautious as sustained higher prices will bring back new production while a massive vaccine drive underway will help reopen transport and travelling once again.
Q) Gold also seems to be inching towards a bear market (a fall of 20% from the highs). What are your views, and what should investors do with the yellow metal – the right time to deploy the money?
A) Gold prices have rallied over 52% in 2019 and 2020, and are now in corrective mode over the last few months down 20% from the peak.
The widespread push of Covid vaccine globally, along with a rebound in economies and reduction in geopolitical stress is weighing on gold prices.
However, soaring debt in major economies and monetary & fiscal lending will lead to an increase in money supply, along with the heightened fear due to the pandemic are few of the top factors for gold’s rise.
There is always a threat of inflation super spike somewhere down the lane, within 24-36 months due to such a high liquidity in the system. The dearth of returns in many other asset classes to drive money towards gold.
Though currencies may be stable against each other, but they will lose their value against gold. A prolonged slowdown impacting the global economy or quick recovery having the spillover effect on the same, both shall have a similar impact on gold, leading market participants to a sell in the dollar as investors dump safe-heaven, and focus on the precious metal.
Apart from Vaccine updates, the recent duty cuts announced by the Government of India has also hammered the prices. The above fundamentals will continue to create a strong floor for the metal.
We suggest to investors that the recent fall is a good opportunity to accumulate for a medium-term perspective targeting new lifetime highs towards $2150. On the domestic front, prices could inch higher towards of Rs.56,000 and higher over the next 12-18 months.
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