Investors should stay away from the market for the next few trading sessions and not get swayed by the noise, says market veteran Shankar Sharma. In an interview with Moneycontrol, he said that a lot would depend on the new government’s stance on fiscal deficit. “Once fiscal deficits are reduced, GDP growth rates will likely moderate. But stock markets prefer growth, regardless of fiscal discipline,” he said.
Sharma is bullish on small caps and says that quality names in this space are unlikely to fall more than 20-30 percent. “Small caps are the future of equity markets in India. Large caps are too big for the size of the economy,” he said.
Edited excerpts from the interview:
Do you see the market taking some time to adjust to the election results?
The markets will be extremely nervous for a while. Even if the NDA forms the government, it will be a very weakened BJP, which means many expected policies might not happen. Another major issue emerging from these results is the focus on responsible fiscal discipline. Allies of the ruling party will likely question whether to continue the high fiscal deficit policies of recent years or to recalibrate them.
Why does that matter?
Since 2021, we've seen very high fiscal deficits—around 5-6 percent—whereas earlier it was more like 3-3.5 percent. A new government will need to decide whether to maintain these high deficits or reduce them. Our bull markets in the last few years have been driven by high fiscal deficits, which create liquidity and push business growth. Stock markets prefer growth, regardless of fiscal discipline. In fact, I would argue the opposite. The popular narrative is that foreign investors see India positively because of macroeconomic stability and fiscal prudence, especially post-COVID.
Fiscal prudence is a vague term. If it means low fiscal deficit, look at the numbers from 2014-2020: they were moderate, around 3.5-4 percent. Post-COVID, deficits have been 2-3 times higher. We can debate the necessity due to COVID, but running 5-6 percent deficits isn't prudent fiscal policy.
Our debt-to-GDP ratio has risen from 65 percent to about 85-90 percent in the last decade. The new government will need to reassess whether these high deficits are feasible.
By saying this, aren't you undermining the India growth narrative? The narrative suggests that India offers macro stability, which is why this government is preferred.
Off-balance-sheet items before COVID were taken into the balance sheet. I'll give credit for post-COVID policies, but they can't continue indefinitely. Once fiscal deficits are reduced, GDP growth rates will likely moderate. Our GDP growth rates are directly tied to fiscal deficits.
Over the last 35 years, India has been the number two performing market in the world in dollar terms. Foreigners have always loved India since 1993. We haven't had any sustained period of outflows from foreign investors. Nothing has changed from a foreign point of view.
So, going forward, will the equity market performance remain strong? How do you see the impact of the government? You mentioned that fiscal moderation will inevitably impact GDP growth.
My bet is on the country, not on any party. I've been critical of and supported policies from both the Congress Party and the current government, depending on the policies themselves. India will grow irrespective of who is in power. Even past coalition governments have delivered fantastic results in terms of equity market returns, fiscal prudence, and GDP growth. There's no doomsday scenario here.
Given the recent phenomenal run in the mid and small-cap markets, what advice would you give to retail investors focused on these sectors?
Take a bit of a holiday. Markets are meant to give us earnings to take off the table and spend on things we enjoy, like holidays. Don't watch the market today; stay away for the next two or three days.
The bull market in India has been driven by small caps and, to some extent, mid-caps, while large caps have been patchy. I don't see this changing, regardless of which party comes to power. There will be a period of wobbliness, which should be seen as an opportunity. I remain very optimistic about small caps.
Do you think small caps will bear the brunt of market sentiment changes in the coming months?
Absolutely. What gives you maximum pleasure also gives you maximum pain. These stocks have provided great returns over the last two to three years, but they will also cause pain in the coming weeks. However, if you have good visibility in your portfolio, a 20-30 percent fall in an unleveraged company should be the maximum. If you have some cash reserves, this might be a good time to reinvest in strong names at a lower price.
Small caps are the future of equity markets in India. Large caps are too big for the size of the economy. Small caps, despite their volatility, are where the opportunities lie.
What about large caps in the US, like the trillion-dollar companies that continue to perform well? How does that compare?
That's a conversation for another day.
Regarding FII sentiment, do you think foreign investors were waiting out the election risk and will return in the next few weeks?
India is a significant market with a four trillion-dollar economy, and it can't be avoided. India has received a disproportionate share of FII flows in recent years, and I don't see that changing. FIIs don't come to markets like India expecting 100% policy certainty.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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