Small Is Big: The action lies in high quality smallcaps now

Aishvarya Dadheech

The year 2023 is turning out to be a historic one for Indian equity markets. The BSE Sensex recently scaled an all-time high amid a breath-taking rally that began in March, which saw participation from the broader markets as well.

Sound domestic macros, return of foreign investors, and a promising quarterly show from India Inc are some of the drivers for this upmove. Will the momentum continue? Which themes should you be betting on now? In an interaction with Moneycontrol, market expert Aishvarya Dadheech says he expects capital goods, auto,  and FMCG to do well in the coming quarters. Edited excerpts:

The market was expecting the US Federal Reserve (the Fed) to hike rates by another 25 basis points (bps) in July. But given the commentary from Fed Chairman Jerome Powell, it seems like we could factor in two more hikes. Your thoughts?

If you’ve seen the UK inflation data, and the way the European banks and the Bank of Canada have raised rates, there is a very strong likelihood of another rate hike in July.

But we are obviously closing in towards the last leg of the rate hike cycle. Last month, inflation — both in the  US as well as in other major economies, including India, was healthy, and unlikely to shoot up anytime soon.

In that context, they (US) have little or no need to raise rates further. And that has led to the kind of jump we have seen in the US market over the last couple of months, as well as in other emerging markets, including India.

So it's just a little more pain before we see an accommodative policy coming our way. India has already maintained status quo in rates. While we have seen a very comfortable CPI (consumer price index) inflation of 4.25 percent recently, our core inflation remains high. But we believe the inflation downtrend looks pretty strong for RBI to hold on to the rates. So, all said and done, we are surely in the last leg of this interest rate hike cycle.

It has been a breathtaking rally since March this year. Do you expect this dream run to continue? Which are the sectors that could outperform in the coming earnings season?

We have seen a very strong rally both in India as well as in emerging markets like Taiwan, Korea, and even in developed countries like the US.

Coming to India, we believe this rally still has legs. We can say this confidently considering the valuation. If you look at the rally we witnessed in December 2021 or even in the latter part of 2022, the valuations then were higher. As of now, the Nifty’s trailing PE is around 22X, compared to 25X and 23X in 2021 and 2022, respectively.

What is more important this time around is that the rally is more broad-based. If you see, the Nifty has moved 10 percent in the last three months, but mid- and small-caps have jumped almost 19-20 percent. The extent of the rally tells us that given the strong economic momentum we are witnessing, the favourable CAD (current account deficit), the positive inflation data, the comfortable crude prices, there are still legs to this rally.

Having said that, we believe the opportunity lies more in high quality small-caps now. Mid-caps are trading at a premium to large caps. But small-caps are still trading at a 20 percent discount to large-caps and almost 25 percent discount to mid-caps. That is where businesses which continue to show good earnings momentum will see a lot of movement in stock prices in the coming months.

Last, but not the least, a lot of people are waiting on the sidelines in this rally. So a lot of people have not participated in this rally so far. We believe we will see greater participation once we see that quarterly results continue to be positive.

I think this is the third consecutive year where we have seen double-digit earnings growth in Nifty. I don’t think this has happened in the last 15-20 years. And even the expectation for next year is very healthy, in the range of 13-14 percent.

In Q1 the growth will continue to come from BFSI because the tailwinds in this space are very strong from a credit growth as well as cost perspective. Other sectors like industrials, capital goods, auto & auto ancillaries, and FMCG will also see good earnings momentum in the coming quarter.

What about the pharma pack? Do you think we will see a revival of interest in this pocket with sector rotation at play?

Pharma looks interesting. It has massively underperformed, but if you look at the last six to seven months, we have received just a couple of USFDA OAI (official action indicated) notices (added) compared to over 20 that we got in 2021-22.

So I would say that interest is coming back. But I would focus on businesses which have lesser presence in the US and possibly a higher presence in formulations. Some of the API players who have been not doing well over the last two, three years may also provide a good opportunity. An investor with a two to three year timeframe could include some of the leading pharma / API players in  their portfolio.

The government's initiative on manufacturing will also see growth revive in this sector.