Smallcaps, midcaps may shed 4-5%, but no reason to panic: Andrew Holland of Avendus

What's next:   is it still a buy-on-dips market, or does the narrative now change to a sell-on-rise strategy? What's your assessment?

A few weeks ago, it would have been 'buy on dips,' but that has very quickly changed to 'sell on rise.' I think that's how the markets are viewing today's spike — as a relief rally following six days of decline. But I don't think you'll want to hold those positions over the weekend, considering the situation in the Middle East, specifically around Israel and Gaza.

At 5 percent, US treasury yields also contribute to the weak sentiment around equities. Plus, there are geopolitical concerns and soft earnings — do you think the markets have factored all that in? Do you think the Nifty can scale back to the 20,000-22,000 mark, perhaps this year?

Markets have been influenced more by global rather than local factors of late. The Israel situation didn't significantly impact oil prices or impact global markets. However, the 5  percent bond yield did pose a global risk, including for emerging markets, which contributed to FIIs (foreign institutional investors) selling.

At a local level, the disappointing start to the results season, especially in the IT sector, affected the markets. Further, the subsequent commentary regarding the outlook has also remained pessimistic.

Surprisingly, for the banks, the results were somewhat in line with expectations. However, the concerns around net interest margins (NIMs) raise questions about whether this weakness will persist. While some believe it could be a one-quarter issue, the banks didn't instil confidence in this being the case. Therefore, it's possible that the NIM is one of the reasons the banking sector is facing pressure, despite robust economic growth and loan expansion.

These two local factors (earnings and NIMs) have not been favourable for our markets.

When do you suppose the Nifty will reach the 20,000 mark — by the end of the year, or would it take longer? Additionally, what key factors, besides liquidity, do you see as growth drivers in the market?

We feel the Nifty will hit 20,000 by March 2024. This projection is based on a few factors. Firstly, we expect the earnings growth to start picking up in the second half of the fiscal year, between September 2023 to March / April 2024, driven by government and private sector capex, which will have a multiplier effect on the economy. As a result, we expect earnings to improve as we enter 2024.

Secondly, we anticipate a positive impact from the elections. And finally, we anticipate a global decline in interest rates. This might happen in the first quarter of FY24-25,  even as the global economy grapples with the pressure of 5 percent yields in US bonds. This shift is expected to provide momentum to the market.

What are the pockets of strength which will perhaps lead to this earnings growth?

I believe the anticipated market growth will be driven partly by government spending. When infrastructure like bridges and roads are built, it generates new construction activities, particularly in housing, leading to a ripple effect across various industries. I expect this dynamic to become more evident in the second half.

However, it's essential to consider the sectors beneath the index. As we've discussed previously, defence and renewable energy are areas where spending is expected to persist, regardless of global or local considerations, especially given recent events in Israel. These are two sectors with substantial capital commitments and promising growth prospects.

Additionally, you can explore other themes such as consumption, which may differ from fast-moving consumer goods (FMCG). Look at sectors like hospitality and airlines, as people seek more experiential travel and premiumisation in both alcoholic and non-alcoholic beverages. These industries are just beginning to tap into a substantial growth cycle over the next three to five years. These are some of the themes that, I believe, can lead to profitable opportunities, beyond focusing solely on the index.

Over the past month, the one-year valuations for BSE mid-cap stocks have declined from 28.86 to 27 times, and small-cap valuations have also reduced from 24 to about 23.5 times. Do you anticipate further declines? Should investors now invest in large-caps?

That's an excellent question, and I believe it will be the focal point of discussions over the next quarter. The Nifty, the primary index, is currently trading at a PE ratio of 17 times, which, when compared to historical data, is not excessively high. In my view, if a market rally does occur, it is likely to be led by large-cap stocks. I anticipate that mid- and small-cap scrips will now see stock selection, rather than all being painted with the same brush during both upward and downward movements.

For companies with high-quality fundamentals in each of these segments, I expect to witness outperformance. Sectors or companies that were previously overly optimistic may face challenges and experience a decline in valuations. The themes and companies focusing on quality are expected to outperform.

As for small- and mid-cap stocks, I anticipate a potential decline of around 4-5 percent from their current levels.

What gives you the confidence that large-caps could outperform the broader market?

Earnings upgrades in the future are more likely to come from large-cap companies. This is the basis for my confidence. While the Nifty reaching 20,000 by next March-April may not be a staggering jump from where we are, we will see pockets of strength within the Nifty, and I believe the banking sector will be a leader in this regard. The banking sector is the one I expect to see positive surprises from in the near future.

In recent years, foreign institutional investors (FIIs) have been sellers, while domestic institutional investors (DIIs) have stayed invested in India's growth story, with mutual fund systematic investment plans (SIPs) also doing well. Do you expect this to continue, or will geopolitical concerns lead to an erosion of investment? Is there a risk of FIIs withdrawing funds and deploying the same in China if such concerns intensify?

Let's focus on the first part of the situation. If there's an escalation in the Middle East, there’ll be a risk-off scenario and foreign investors are likely to withdraw funds from various emerging markets to secure the same. This may be especially true for India because the index here carries higher valuations compared to other emerging markets, and investors have seen substantial gains compared to other markets. So, India might be among the first places where investors decide to trim their exposure.

As to whether India will attract more investments from FIIs due to issues in China, the dynamics are slowly changing. While I maintain that China has employed a more measured approach to bolster its economy and restore confidence, a raft of policy measures they have implemented is starting to yield positive results, albeit gradually, particularly in areas like consumer confidence and the property market.

This might encourage foreign investors to reconsider China, seeing that things are getting better there, and valuations are more attractive. As a result, they could increase their allocation towards China, not necessarily at the expense of India, but possibly overweighting China in the short term, compared to India.

What’s your recommendation for our readers in a market like this? What should they avoid doing?

Don’t panic. If you've chosen the right companies and have a long-term belief in them, market downturns like this one present an excellent opportunity to acquire more shares. Consider it like an investor's SIP — you're buying at the top, in the middle, and at the bottom. Apply this approach to individual stocks. Instead of panicking and hastily selling, maintain your investments in companies with a promising growth trajectory and effective management. It's better to continue accumulating such stocks rather than divesting just because of some short-term market volatility.