Why HDFC Securities favours value stocks and midcap, smallcaps for 20214 min read . Updated: 31 Dec 2020, 04:19 PM IST
Post US elections and vaccine news flow to Emerging Markets have exploded in Nov-20, equity inflows into Asian markets have risen to a record high. India saw $17.7 billion inflow in 12 months to Nov-20, including $8.3 billion in the same month
Indian markets saw a sharp fall in Mar-20 and a gradual recovery which has brought us to all-time highs. Despite this, in the past two years, Indian equity markets have underperformed their global peers against the background of perennially expensive valuations.
Post US elections and vaccine news flow to Emerging Markets (EM) have exploded in Nov-20, equity inflows into Asian markets have risen to a record high. India saw $17.7 bn inflow in 12 months to Nov-20, including $8.3 bn in the same month. Nifty EPS has seen the first upgrade after 23 quarters of a downgrade. 182 of BSE-200 constituents gained in Nov-20, with 116 stocks posting >10% gains MoM, leading to a broad-based rally.
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The pandemic has created massive opportunities for some businesses. It has created enormous opportunities for pharmaceutical and chemical companies, the technology industry, for IT offshoring, remotely operating industries.
Overall, the EM are going to do better in the coming year. To that extent, India, being part of the EM pack, would also benefit.
The 50-stock index is currently trading at a one-year forward price-to-earnings multiple of ~27 times compared with its 10-year average of 17.3 times. The Nifty 50 is also trading two standard deviations above its historical average. MSCI AC World –12-month forward PE is now close to 20, 3SD above average of 14.1. India's market cap to GDP ratio is at 91+ vs the average of 75.
Bulls tend to argue that P/E may not be the right valuation measure in current times. However, historically, it has been able to forecast the subsequent one-year and five-year returns. High current P/E typically leads to subnormal returns in the subsequent one-year or five-years. This is true for the S&P 500 and will be equally applicable for Nifty.
Bulls feel that the coming growth cycle is not fully priced in. A better-than-expected Q2FY21 fuelled market optimism, wherein maximum companies benefitted from low raw material costs and better operating leverage. Also, management commentaries were optimistic of demand prospects and retaining some part of operating leverage gains.
Lower interest rates should support higher-than-median valuations. However, current equity valuations have run up, factoring in robust growth.
We believe a large portion of the Nifty run-up is over and, from now on, its rise (if substantial) would be gradual and measured. In the interim, we may see bouts of correction, especially if FPI flows dry up for a couple of days/weeks. Stock-wise moves could continue to take place even as institutions continue to take higher exposure out of their erstwhile preferred 50-80 stocks.
The continuation of low or zero interest rates globally can keep pushing valuations higher for the world as well as for India. But this ride has to be taken keeping in mind the possibility of sudden and sharp reversal.
Asset allocation review may be required to bring down the value of equities to desired levels over the next few weeks.
Indians have a choice to invest anywhere in the world under the LRS. The country's market cap is around 2-3% of global market cap. Indian investors need to seriously consider putting a small portion of their investible surplus by diversification and investing in stocks listed abroad.
With many broad market indexes already surpassing pre-pandemic highs in 2020, many investors are asking whether it's too late to buy. Tactically, we still think there is plenty of opportunities, both in catch-up plays and in structural winners, to continue reaching new highs. In times of uncertainty, investors should take advantage of volatility to enter markets after assessing their risk exposures.
We believe that small and midcap space will be back in favour in 2021. One of the most distinguishing characteristics of companies in this segment is higher growth rates than larger peers. Investors have always flocked to this category in anticipation of higher returns, given their potential to report increased profitability and gains in market share.
The Nifty Midcap 100 index shows an extremely high correlation with GDP growth. As compared to the Nifty, the Midcap index has higher weights in Autos & Auto components, Consumer, Real Estate, Chemicals & Pharma and Utilities, all of which have structural tailwinds favouring them for the next 18-24 months.
Growth hungry midcaps flourish in low-interest-rate regimes. Data shows a high correlation between repo rate and the ratio of MidCap index to Nifty 50, again suggesting a likelihood of outperformance over the Nifty in the coming year if interest rates continue to remain low.
The current disruption has forced companies (especially midcaps) to rework their business models right from sourcing to manufacturing to distribution. Many smaller companies have adapted and embarked on prudent cost-cutting and reduced debt to clean up balance sheets.
Smaller companies run lean compared to large companies and tend to do well in times of rapid growth in the economy and high inflation. Over the next six months, as vaccines roll out, the market could continue to broaden and favour small caps and value stocks.
Dhiraj Relli, MD & CEO, HDFC Securities