you are here: HomeNewsOpinion

Decoding Uday Kotak’s warning signals: Is it a time to worry for markets?

Headlines across the media screamed about how the fundamental concerns in the stock markets were aptly highlighted by Uday Kotak. Stock Market participants on the other hand went about their business nonchalantly and markets once again hit a new high.

January 16, 2018 / 12:43 PM IST

Manoj Nagpal

Yesterday morning, a delighted well-known “Big-Bear” forwarded me the link of Uday Kotak’s interview in Indian Express, saying “The message is clear. Finally, a big voice has raised the red flag”.

Headlines across the media screamed about how the fundamental concerns in the stock markets were aptly highlighted by Uday Kotak. Stock Market participants on the other hand went about their business nonchalantly and markets once again hit a new high.

Will the market react once they read him in greater detail or will they market’s continue their upward journey . Let’s decode the five warning signals that were highlighted by Uday Kotak and see how you can translate them into specific actions steps in your investment portfolio.

Warning 1: Money is moving to a small pipe of a few hundred stocks


The Price-Earnings ratio of the market has moved into an inverse curve for quite some time. Though the Sensex still trades at a historic PE of 25.84 (which itself is at around 2 standard deviations from the long term mean), the BSE MidCap Index is at a PE of 40 and the BSE Small Cap Index is currently at a whopping PE 119 times.

Though the market has been rotating the leaders over the last 3 years, the liquidity chasing the mid and small cap stocks at these valuations is clearly an area of concern that Uday Kotak highlights.  

Also, the quality and governance issues he highlights are now being demonstrated with some stocks with questionable management pedigree doing a 5x-7x in the last 18 months. If you are running a mid and small cap portfolio, after such a fantastic rise this could be the time to re-evaluate the downside risk in view of this warning. Taking profits and cutting small caps is a clear signal here.

Warning 2: High Foreign Ownership of Indian Stock Markets needs to change

Uday Kotak gives the example of HDFC with ~80% foreign ownership and Private Banks having a majority foreign ownership and the need to shift this ownership structure.

Though this is the shift he would want, but on a broad market basis it is already happening. In Dec 2015, foreign ownership of Indian markets was at ~27.5% of the total market cap.  This has now reduced to ~25.7% of total market cap showing a significant change in a rapidly rising market.

This shift is getting accelerated with higher inflows to mutual funds and increasing exposure of EPFO. Both Mutual Funds and EPFO put together now own ~5.9% of the market cap from ~4% two years back. Insurance Cos on the other hand have been at the same level of around 6.5% of total market cap showing the reducing incremental flows to insurance as an investment vehicle in India.

The challenge in this transfer of foreign ownership to domestic ownership is however happening at elevated levels of the market and the domestic flows are unabated. Will these be strong domestic hands to weather a down cycle is the key to watch out for.  However the upside headroom for the market to absorb this trend change is huge and the trend can continue for some time if the markets continue to support the trend.

Warning 3: Interest rate dropping cycle is over. Rates won’t drop from here

Watch out for interest rate sensitive sectors here. Though Uday Kotak has firmly stated that the interest rate downcycle is over, he stops shy of saying when the interest rates will start moving up.  Clearly with inflation now moving above the RBI target band, many analysts have started putting out forecasts that RBI will be forced to increase interest rates very soon. Even if that is not what happens immediately but the market rotation from interest rate sensitives will start before the rate increase cycle begins. And even though the markets may continue to rise the leadership will change considerably to sectors which will not be impacted by the hardening of interest rates.   

Warning 4: Micros better but Macro headwinds have started

In 2013, India’s macros were at the lowest point. The current market rally started from this low point when India, due to the macro turbulence, was made a part of the “Fragile Five”. The last four years saw an amazing strengthening of Indian macros aided by the tumbling oil price.

However, with these strengthening macros there was a non-matching increase in profitability of the broad indices and companies due to sectoral weaknesses in PSU Banks and then across sectors like IT, Telecom, Pharma due to a variety of reasons. Uday Kotak now warns against the headwinds in macros especially in the banking sector and also across market sectors.

However, he also highlights the micros getting better which would translate into an increase in profitability in select sectors and stocks which will not be impacted by the changing scenario of increased oil prices, fiscal deficit and the hardening of interest rates.

Warning 5: Don’t miss the three mega trend changes in the Banking sector

Uday Kotak highlights three major mega trends shaping the financial sector which are underway currently.  Firstly, the big shift from public sector to private sector banks specially in the incremental asset book building which will the NIMs of the PSU and private sector banks.

With retail assets already with private sector banks, if the Corporate side of the assets also shifts significantly towards the private sector banks, then the PSU Banks will struggle in the next 5-10 years. The second trend he highlights is the formalisation of finance along with a shift from real assets to financial assets.

These two legs of this structural change will lead to significant change in the banking with large parts shifting from traditional banking to other asset players which would mean significant growth of mutual funds and insurance companies in the overall market cap of the markets.  

Thirdly, he highlights, that digital mega trend coupled with Aadhaar will be a massive game changer for all financial players. Though he does not go into the details of the pros and cons but clearly the trend points to the significant increased penetration and players which will be able to leverage on the digital footprint rather than a physical footprint will own the game.

Manoj Nagpal is Consulting Editor with Moneycontrol.
Manoj Nagpal
first published: Jan 16, 2018 12:43 pm

stay updated

Get Daily News on your Browser
ISO 27001 - BSI Assurance Mark