MC Exclusive: Prashant Khemka on Geopolitical Risk, China Stimulus, and His Investment Strategy

If global markets correct, India will also see some degree of correction but India-specific macro factors remain strong, said Khemka.

Concerns around China’s stimulus—which could lead foreign investors to shift from Indian equities—and uncertainty over the Iran-Israel conflict are adding stress to an otherwise raging bull market in India.

How do you navigate the current market volatility? Prashant Khema talks about the various risks and his strategy to deal with the current scenario.

What’s your take on the ongoing conflict, especially with Iran entering the fray?

The situation is still quite fluid. Right now, it’s hard to tell if this will escalate further. We’ve seen similar instances before, like a few months back when Iran fired 200-odd missiles, which resulted in no big impact. Just some noise, war of words, and the world moved on.

So, you are saying this is not a big market risk?

Think of the Russia-Ukraine conflict. Russia is a nuclear power, and Ukraine, which we initially thought was weak, has shown it's no pushover, yet the conflict has continued without serious damage to other economies or markets. It’s almost a year since the Hamas-Israel conflict started. You can’t predict these events with certainty. Forget geopolitics or global macros; even India-specific macros are impossible to predict with certainty. The bigger issue is that even if you could predict these events, you can’t predict the market's response to such outcomes.

So, what are you suggesting?

Rewind to the Russia-Ukraine war. Several investors became quite negative on India after the Russia-Ukraine situation began, fearing that India might attract some trouble from the U.S. and Europe due to dealings with Russia. But that scenario didn’t play out, and the markets continued to rise thereafter.

If the market keeps climbing higher, shrugging off concerns, does the probability of a meaningful correction also increase?

It’s hard to tell. Markets going up or down in the short term is only a coin flip. At some point, these things can turn really adverse and pose a serious risk, but as I said, we can’t predict that. Market timing is impossible in my view. The good part is, that these events seem large and cataclysmic at the moment they occur, but many of them come and go, and markets move on.

So, you’re saying do nothing?

Going defensive or taking cash calls by trying to anticipate events does not help. It’s risky for both investors and managers. We remain fully invested at all times. Even now, we are 99% invested.

There’s talk of a “Sell India, Buy China” trade. Do you see that gaining traction?

Till last week, there were stories of the Chinese themselves referring to it as their 'Garbage Time' and so on. Who could have predicted a 35% jump in the market? There’s definitely chatter about reallocating from India to China after this Chineses rally. Some foreign funds are already making this shift, and it could continue.

How big a risk is this to our markets?

Low single-digit risk—not a double-digit risk certainly. Foreign flows are just one part of the equation. Domestic flows remain strong, and there are long-term issues with China.

Also Read | China’s sudden stock rally sucks money from rest of Asia

What kind of long-term issues? Growth? Governance?

The main issue with China is not just the economy—it’s the political environment. The decline in Chinese markets is due to the regression into an indefinite authoritarian regime.

Earlier, China was progressing toward democracy, albeit with an undefined timeline. This has hurt business sentiment because businesses are now under the thumb of one man. A company listing can be stopped overnight, and education companies can be turned non-profit overnight. This can’t happen in a democratic setup like India or the U.S.

Will this deter financial investors from investing in China?

Usually, when markets go up, corporations take notice, and it translates into boardroom conversations. If stock markets continue to rise consistently, sentiment can change—we can’t say for sure. However, the authoritarian shift and lack of property rights are long-term concerns. These factors make investors hesitant, even if short-term economic data improves. The narrative is shifting away from viewing China as a growth powerhouse to seeing it as a riskier market with governance issues.

What kind of correction should investors be prepared for?

If global markets correct, India will also see some degree of correction. But India-specific macro factors remain strong. To the extend money flows are important for the short term, domestic liquidity is robust. While foreign money is important, it’s no longer the only provider of liquidity.

We’re more resilient than before. But war or no war, China or no China, the market can correct 10-15% for any reason. Over shorter periods, there have been steeper falls, so you can’t rule that out.

Are you comfortable with current valuations?

Over the last 10 years, the markets have averaged under a 21x multiple on a 12-month forward basis. We are currently about 5% higher than that level. Our 30-year historic average P/E is 17.5x. Compared to that, we are 20% higher. The historical low P/E is 10x, which was in 2003.

During the Harshad Mehta peak, we were at a 40x P/E. If you ignore the 2003 low and the Harshad Mehta high, the range has been 15x-26x. Right now, we’re at 21.5x, which is in the upper half of the historical range—but this is not extreme.

Do you think Q2 results will disappoint?

They’re likely to be more modest. Until September, nothing very exciting happened; demand was subdued. But everyone is now looking forward to the festival demand, expecting it to be better. On average, results for the quarter just gone by may be slightly worse than expected. However, it’s nothing the market can’t digest.

Which sectors look vulnerable to a correction?

Sectors that have seen massive inflows due to thematic trends, especially those with weaker governance or business models, are at risk. Some have already corrected by 20-30% because churn is happening without investors fully noticing the change. They went ballistic on the way up, so the fall could be just as sharp.

It’s important to be cautious with companies that benefited from thematic rallies but lack strong fundamentals. We are avoiding companies with weak governance and weak business models.

Are there any sectors you’re optimistic about?
All other sectors that haven’t seen excessive inflows or fundraising are business as usual. Technology, IT services, financials and healthcare are amongst sectors that present many opportunities.