Daily Voice | Varun Lohchab of HDFC Securities sees midcap, smallcap opportunities in five sunrise sectors

Will 2023 be better for equity markets than 2022?

Thus far, 2023 is being viewed as the year in which developed markets will face a serious demand slowdown. Higher terminal rates are expected to reduce the marginal propensity to consume, which will inevitably trickle down to equity markets worldwide. While most of this has already been priced in, any incremental negative surprises in macro-economic data worldwide is likely to be met with further selloffs.

Hence, market participants are going into 2023 with palpable caution. While 2022 had its own challenges, India weathered them surprisingly well compared to global peers. Consequently, the Nifty outperformed the Dow, the MSCI global Index, and the MSCI EM index by 413 bps, 1,052 bps, and 1,305 bps, respectively, in Dollar terms.

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If there are to be any negative surprises in 2023, we believe that after an initial market downturn, FIIs could look at Indian equities as a potential risky asset class that can weather the storm and provide high yields.

Most experts feel the Dollar is at its peak now. Do you agree? What are your thoughts on the Fed policy front?

It is apparent that the market is focussing on the increasing possibility of lower rate hikes by the US Federal Reserve (the Fed) going forward — which may be driving the Dollar weakness. That said, the Dollar index could be bumpy as it continues to moderate into 2023.

The market's buy-in into the Fed pivot could be disrupted if the next inflation figure is higher than expected, leading to a strong push back from the Fed against ending the rate hike cycle.

When do you suppose the rate hike will end in India?

Post the December MPC meeting, we expect another 25 bps hike in the first half of 2023, taking the repo rate to 6.5 percent. It is too premature to talk of rate cuts yet. There are too many volatile variables in the markets to be able to gaze into the proverbial crystal ball with any certainty.

As we sail into 2023, what’s your preference — largecap, smallcap, or midcap stocks?

Valuations in pockets of the small and midcap space have moderated compared to the largecap space due to muted returns over the last one year, making them worth a look.

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India has several promising companies in the small and midcap space, which have all that an investor can ask for, viz., capital efficiency, visibility of earnings growth, and moderate leverage. Many of these are found in sunrise sectors such as specialty chemicals, capital markets, household appliances, digital lending, and building materials. These sectors lend themselves well to the mid and smallcap segments.

Having said that, it is important to note that in this domain, bottom up stock selection is key for a favourable outcome. Imitating the index could lead to suboptimal results.

Any thoughts on consumer firms, given the volatility on the raw material front?

So far our stance has been neutral on consumer staples. With commodity inflation seemingly having peaked out, we are slowly getting more optimistic on the sector as earnings visibility improves.

While volumes have been weak this fiscal year, we expect at least the urban demand to improve henceforth. Rural demand is the driver that there is low visibility of and adds an optionality to our numbers. Our coverage universe in the industry is expected to grow their profits at a CAGR of 13 percent over FY22 to FY24.

On the other hand, the consumer discretionary segment is expected to report more normalised earnings hereon post an impressive performance in the last few quarters, as the pent-up demand has nearly played out.

What themes are you betting on now?

We have spotted some long-term structural themes in action in the economy currently, which can throw up investing ideas. Within these, we continue to pick stocks using a bottom up approach.

Driven by sustained growth over the last few years delivered by IT companies and a burgeoning start-up ecosystem, urban disposable income has been rising. It is leading to low-ticket consumer discretionary spend growth such as in food and beverages, apparel, and retail.

Further, rising disposable incomes of IT employees are leading to real estate growth in cities like Pune, Bengaluru, and Hyderabad. This has a multiplier effect on the growth of building materials and household appliances. We are bullish on growth of all these sectors.

We are also bullish on the Indian chemicals story. The industry is witnessing unprecedented levels of capex on the back of global supply chain diversification. Expertise in complex chemical manufacturing, cost advantage, and strong relationships with the global clientele, i.e., large pharmaceutical and agrochemical players, are strong tailwinds which will help propel the chemical industry to greater heights in the coming years.

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