Next two years will belong to large-cap IT, bank, new-age tech stocks: Hiren Ved

Also, our bet on engineering R&D companies within the tech pack did well. Our stock selection within certain themes and sectors has done well.

What is driving manufacturing stocks, apart from government policy?

First, the kind of spending that India is doing on infrastructure. If you want to build infrastructure, you need cement, you need steel. So manufacturing has to grow.

Secondly, the government has put a lot of emphasis on getting domestic manufacturing going. They have either banned imports or increased tariffs to incentivise local manufacturing. Now capacity utilisation in India is reaching about 70-75 percent, which means existing manufacturers have to build and do expansion of capacity. Beyond that, there is this whole China-plus one, Europe-plus one – it is also incentivising manufacturing in a big way.

Do you see a time-wise correction or the market consolidating?

The market has done very well. People forget that the Nifty was at 12,200 before COVID-19. Now, we are at 20,000. Almost 42 months have gone and the Nifty has gone up by 64 percent.

Now look back. What were the aggregate profits of the top 500 companies in India in March 2020? If I'm not mistaken, the aggregate profit was around Rs 4 lakh crore. As of September-end 2023 annualised, it is around Rs 11-12 lakh crore. That means profits have gone up 2.75 times but the market has gone up only 60 percent since February 2020.

Your one-year forward for the Nifty is 17-and-a-half times, which is exactly your five-year average, or 10-year average. What has gotten a little bit expensive in this market are the small and the mid-caps. They are not very expensive, but relative to large caps, they are expensive.

If this bull market has to continue, then at some point, the large caps have to start picking up. I won't be surprised if the Nifty crosses 21,000-22,000 by the general election next year.

Small and mid-caps may go sideways or there could be a time correction there because they have already moved ahead. But the large caps have not moved ahead. So it is time for the Nifty to do well, and small and mid-caps to go sideways for some time. And then they will catch up if after 2024, let's say, the same government comes back and there is lots of euphoria and a lot of confidence, then small and mid-caps can start doing well again.

The markets have not yet fully caught up with the kind of surge in earnings that we have seen for the broader market. And one difference between 2018 and 2020 was that the market was very narrow at the top, all the earnings growth was focused on a few high-quality companies and the rest were struggling with earnings growth. The real inflection point came after COVID, when the breadth of the market or the breadth of earnings significantly improved in the last two, three years post-COVID. And that's the big difference.

Also, one of the reasons why small and mid-caps have done better than the Nifty could be because the weightage of capital goods, engineering and all these so-called domestic-driven manufacturing industries – their weight in the Nifty or the Sensex is much lower because the Sensex and the Nifty are dominated by financials, big tech, right? Financials and big tech are around 55-60 percent. A large part of auto ancillaries, capital goods, metals, mining, PSUs, they're all part of the next, let's say, BSE 101 to BSE 500, right?

And that is why that end of the market has done very well because those companies have come out of 10-15 years of slumber. And when they break out of such a long consolidation, the leadership will continue for a much longer period of time.

And to that, new sectors have got added. Like there was no EMS 10 years ago. Defence was largely only PSUs – now PSUs plus some of the private guys which are also doing very well. So I think every cycle there is a change in leadership. And I think that is what is happening in our market, that there is a massive change in leadership.

And this shift is very difficult for people to catch because traditionally, the thought process was no, these are cyclical businesses, this is PSU, we don’t invest in, we don't do it. But all that has come back with a big vengeance. So I think, partly we were able to capture the shift in growth, which is coming through many of these companies in automotive, auto ancillary, capital goods, defence, and that is why our strategies have done relatively better.

So from here on, do you see a shift to large caps?

As long as the small and mid-cap party is on, nobody wants to invest in large caps. But these things don't last. And especially if there is a bull market, there is always rotation. So maybe small, mid-caps did well in the last six to eight months, large caps didn't do anything. Now at some point, large caps will break out. I can't time it, though.

The shift will happen sooner or later. Also, one of the reasons is because FIIs have been out of the market. Also, if you see, funnily, for some time, inflows into large-cap funds actually became outflows, and most inflows were coming in small and mid-cap funds. So things were so stacked against large caps. So at some point in time, this will change.

Banks have not performed well. What exactly is hindering the sector, apart from FIIs being bearish on it?

I don't think FIIs are bearish on banks – it's just that FII flows have not come in. FIIs’ maximum exposure is to banks. So even when they come back, the flows to banks will come in. The second thing was that domestically, everybody was already full up in banks. You pick up any multi-cap or large-cap mutual fund scheme, and you will find top banking names reaching 7 percent to 8 percent allocation. Now 10 percent is the limit beyond which FIIs can't invest.

FY23 was the best year that banks could have seen. The highest NIMs (net interest margins), lowest credit cost, and robust growth. Since we can’t have all three at their peaks always, while credit growth is good, credit cost is limited but NIMs have started to compress.

NIMs for banks are like EBITDA margins. I mean the moment NIMs compress, you have an operating leverage going down all the way. So I think there is greater confidence that interest rates have peaked out globally. And now they are talking about the first Fed rate cut as early as Q2 CY24, which means that the Reserve Bank of India can also start cutting rates from maybe May, June. RBI will only start cutting once Fed cuts.

Why?

Because they have to save the rupee. Otherwise, the rupee will go for a toss. If you loosen your monetary policy ahead of the US monetary policy, then the rupee will depreciate. So they will not start before the Fed decides to cut.

Once the Fed decides to cut, then India can cut and once India cuts, then the confidence in NIMs will come back. So, my sense is that FY25 could be a good year again, if credit costs don't pick up in a big way. If the banks are able to hold their NIMs, they can still show 15-17% PAT growth; then I think relative to everything else, they are much cheaper.

Around mid-2024, if this government comes back and the Fed cuts rates, then foreign money will flow to emerging markets. And once the money starts coming in, they have to buy banks because that's the most liquid part of the market. So starting from Q1 or Q2 calendar year next year, you could see banks starting to perform.

New-age companies have started performing financially. Do you see the horizon widening for them?

Next year should be a great year for these new-age companies because you will have a combination – all these companies may turn profitable at a PAT level next year 2024-25. And you will have falling US interest rates. And you have no incremental competition in the sectors they operate.

So it should be a good year for selective new-age companies next year.

You talked about IT having a large weight in the Nifty. And they have been very dull for the past couple of years. How will the sector pan out?

I see a good year for tech in ’24 and ’25. I think there are two things. One is that AI is going to force companies to spend on tech. Because if your competitor has superior AI technology, you don't have a choice but to spend on AI.

But the bigger difference, which will be a big seismic shift for IT companies, is that they will need fewer software engineers to give the same output because of AI. Their labour costs will go down very fast. Over the next two, three years, I wouldn't be surprised if there is no net hiring by IT.

And then they will get into a deflationary phase where customers will also ask for better prices.

So, initially, you will have a little bit of that golden period – 12 to 18 month period – where demand will come back, wage costs might come down a little. That could be next year. However, following this period, customers will also ask for better prices as they know cost is going down for IT companies.

So it's high time we start adding or accumulating IT?

I think so. I think it is time to keep nibbling at large-cap tech.

You see a bright couple of years ahead for IT and banks. And they have a large weight in the Sensex and the Nifty. Will the Sensex hit 100,000 by FY25 or FY26?

Between Diwali and Christmas 2025, it is possible for the Sensex to hit 1 lakh. By the next financial year, they (IT and banks) could take leadership.

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