Wait and watch for next 3-4

months; small & midcaps

may see multiple deratings:
Rahul Chadha
economictimes.indiatimes.com

Synopsis

“There is no need to hurry to buy into

this market or one can be on a wait and
watch mode for the next three to four
months.”
From a three-year perspective, we would be very positive on metals.
But in the near term, this is a sector which is vulnerable to some profit
taking. It can easily correct 10-20% over the next three to six months,
says Rahul Chadha, CIO, Mirae Asset Global Investments.

From the prism of market breadth, the last four-five days

have been very brutal but the index is sitting at an all-time
high. Why are we looking at such a divergence?
We have to rewind and see what has happened in the market over the
last 12 to 18 months. Some of these midcaps -- in real estate, metals --
and other mid and small caps have gone 3-4x from the lows and all
these moves have been more pronounced in the last three-four
months.
Everybody in the market was worried how some of these smallcaps
with not so great fundamentals had performed over the last three-
four months. There was a fair bit of excess. Initially, there was a fear
of missing out and that is getting cleansed out. The reason for the
cleansing is again what we saw over the last one week. The strong
payroll numbers from the US, and the fear of tapering by the US Fed
which means liquidity gets reduced. It was a rising tide of liquidity
which had lifted all boats over the last 12-18 months. Markets are
going to be far more discerning now as we are going into the second
phase. Companies which are able to show earnings growth will give
net positive returns.

Did you Know?

Stock score of Reliance Industries Ltd moved up by 1 in a week on

a 10-point scale.

View Latest Stock Report »

In general, Indian markets have done very well and we are

the second best performing market this year after Saudi
Arabia which is an irrelevant market and rose because of
Aramco. Despite the underlying bent of the economy, is
one better off taking some chips off the table rather than
remain fully invested?
It may not be a bad idea to just be on the sidelines for the next three
to four months. One has to see how things play out globally and that
is in terms of rise of bond yields and in terms of flows to various
sectors which have done well. There is no need to hurry to buy into
this market or one can be on a wait and watch mode for the next
three to four months. You will get good entry points from a medium
term perspective for investors. If you got a 12-18 months’ perspective,
markets are going to be higher from where we are. But there is a bit
of uncertainty on how it plays out over the next three to four months.
Any concerns with respect to the valuations because there
is a pocket of the market that is pointing towards that?
Also, do you have any concerns about those mid and small
caps where you think the valuations have run up way
ahead of what they deserve?
The simple way is to just look at the valuations of these companies for
10-15 years and see where they are today compared to their historical
valuations. There are a lot of thematic stories and bullishness in the
market. That gets corrected in coming quarters as the earnings failed
to live up to the hype. Already in this quarter’s earnings, we have seen
that the gross margin pressure has been somewhat mitigated by the
savings on SG&A. The gross margin pressure continues but I am not
sure whether companies can cut back on as much SG&A as they have
with the economy opening up. We will see margin pressure coming
through and there are parts of the market where companies are
upping up the capex and that is going to come through with a higher
interest burden etc. The frothiness will get corrected over the next
three to four months.

Which are the pockets where you see the most correction
kick in?
I would answer this question in a different way. I will say the pockets
of attractiveness today would continue to be banks. The financials
have not really participated in the rally; insurance has but the banks
have not participated. So a bit of inflation is good for them. They will
see a pick up in credit and the incidence on credit cost because of the
second wave is not as bad as we feel. That should be a space one can
go to and that would do well even if the market corrects.

Names which can get corrected will include some of the consumer
discretionary names where there is still some optimism and where
people are hoping for a strong recovery. That is where we can see
multiple deratings happen and earnings growth commensurate
enough for the multiple deratings.
For smallcaps and midcaps, the time of easy liquidity is over. We will
see money now going back into the economy rather than markets.
That is where some of these small midcaps may see multiple
deratings.

The US House of Representatives, the Senate voted to

approve the $1 trillion infrastructure bill which is now
likely to provide the country’s biggest investment in roads,
bridges, airports, waterways etc. The Dow Jones US Iron
and Steel Index has notched up almost 7.5% gain.
Yesterday again it was up 4.5%. What does it spell for
global stocks? Are we looking at a super cycle?
From a three-year perspective, we would be very positive on metals.
Apart from the US infra spends which would come at about six-nine
months from now, China is looking to cut steel and aluminium
capacities to control their carbon footprint. For metals, the
uncertainty is in the next two-three months. As the easy liquidity
moves out, one may see metal price correction. These stocks have
been strong performers. They have been three-four baggers in the last
nine months. In the near term, this is a sector which is vulnerable to
some profit taking. I would be more positive on the sector post the
20% correction. The sector can easily correct 10-20% over the next
three to six months.

What are you making of the pharma pack considering the

US generic pricing seems to be coming under pressure?
I think pharma is a tough sector to make money in. The overall
headwinds are intense in terms of pricing pressure coming through in
the US. So one has to focus on companies which have got a good
specialty business in the US and where there are meaningful, stock
specific and new approval or specific molecule ramping up triggers.
But just to buy a basket because of the generic story is behind us.

In that space, we have liked hospitals for a while. A couple of them

have done well on the telemedicine story but outside that, there are
number of other plays -- Narayana, Fortis which still look attractive
and as the economy opens up, people go to get their much needed,
much awaited surgeries done and elasticity of demand plays out over
there.

Where is it that you would be wary in the market right

now, you did highlight your views on the broader universe
that is the small and midcap spaces but any sectors which
are looking over heated to you at this juncture?
Metals clearly stand out and that is something which is a bit over
heated. Real estate has done well and can be vulnerable to a pull back
though I must say that we are very bullish at that sector from a two-
three year perspective. Outside that, markets are broadly okay. The
consumer discretionary names are a bit expensive and can correct by
10-15% but then again they become attractive. So markets are broadly
okay but there would be sectors like financials which may be up 5-7%
over next six months. There would be other sectors that would be
down 10-15%. So there is a swing of 20% within sectors which we
see over next six months.

Besides metals, a strong big rally is taking place in agri

commodities like sugar. The Indian government’s focus on
ethanol blending has augured very well for the entire
sugar industry and for Praj Industries, as well. Where
within agri commodity, do you find comfort?
Honestly we have not done much work over there so would not be
able to comment on these smaller names. What we continue to like is
some of the tractor plays just coming from the same thought process
that agri commodities are going to be buoyant and with the buoyant
agri commodities, the semi-urban, rural ecosystem perform very well.

Siemens is massively overvalued but again that is an

exception. But the one thing that is not an exception is the
kind of commentary they have given and they have reached
pre Covid levels when it comes to their order book. Do you
think that we could see potential for the capital goods
sector because this has been a space which has been very
slow in terms of its performance?
Absolutely and this is something we have been watching very closely.
There are big debates in the team on this but if we get the investment
cycle going, the growth or the whole India story gets a good escape
velocity. In the last 10-12 years, we saw the government giving
handouts that led to consumption growth but obviously the wage
growth was limited. A strong investment cycle that creates jobs, that
has higher wages and which is a virtuous cycle also eventually
benefits consumption. This is something we are exceptionally positive
on.

We have got exposure to a number of companies and would be looking

to increase exposure to this space despite high valuations because we
believe we are just in the year one of the cycle. The capex intents
have picked up significantly over the last six months. The metal
companies which want to invest;
Reliance
NSE -0.32 % wants to do investments in batteries, solar etc; chemical
companies are also looking to invest. Plus the data centre investments
are very positive for the economy. So from a global perspective, if you
see capex in India and more importantly if capex is picking up in the
US, that is a big positive for this recovery to be a multi-year recovery
basically.

A lot of these companies are investing in new energy. What

is the best way to play that? When you say new energy, it
is not just solar, wind and power. We have hydrogen cells
and many other new concepts.
Rahul Chadha: In India we do not have any clean play but outside
India in the regional funds which we have, we are playing some of
these leading battery names in Korea. We are playing it through the
solar names, the solar chains, some of the companies which supply
material like lithium etc in China. So there are good plays outside
India. The hope is if in the next two years, Reliance shows something
on execution, we can get a good play within India also. But at this
point of time, one would be wary of going into these solar companies.
Honestly speaking, there are not many new energy companies in
India or whatever is there are still biased towards conventional fossil
fuels.

Who do you think stands to benefit from the EV play?

Would you say it is too soon to judge Indian companies
with the EV canvas?
We are watching the companies which have clear transition strategies
to EVs. In the last six months, companies are also coming out and
confidently talking about migration strategies towards EVs. There are
some select plays in auto ancillary. We have had some new listings in
auto ancillary companies which have exposure to EVs and are
ramping up that exposure. It may not be a bad idea to play it through
auto ancillaries here and then see within EVs, which one -- be it
tractors, utilities or cars -- which has a path to migrate toward EVs.

The other part of the market which got extremely excited

about three odd months back was the PSU pack. The
government revived its privatisation drive and those
stocks jumped up. If the privatisation process goes
through, would you be an investor?
We have seen sound bites from the government on privatisation. They
have made the intent loud and clear that they want to privatise the
non strategic assets. But the process is taking longer than expected.
From our side, we would look at businesses on their pure merit,
companies which are deepening their mode, enhancing their
competitiveness and good strong managements. One would buy those
businesses where there is a margin of safety. Purely buying for
privatisation may not be the best strategy. The idea is to buy a
business on a fundamental basis and then privatisation adds a 20-
30% kick above it.
