In conversation with Devang Mehta, Head (Equity Advisory), Centrum Wealth

The art and science would lie in picking good businesses which are market-leading franchisees and emerging market leader, asserts Devang Mehta, Head (Equity Advisory), Centrum Wealth

What is your outlook on the markets?

There are some potentially important events for the Indian equity markets in the next 12-18 months. The state election results, which may swing the mood to the big 2024 showdown, will arguably be the biggest event to watch. But apart from politics, the uncertainty around interest rates, growth in a slowing world, valuations and flows continue to be the biggest factors for equity market sentiment. Inflation data and the resetting of rate expectations is the reason behind the dull equity sentiment currently. Core inflation for the US and India is high and sticky. There’s a reasonably high possibility that the US Federal Reserve and the Reserve Bank of India (RBI) will remain hawkish and raise rates more than expected earlier. However, the market at some point will discount this.

Hence, it is imperative to shift the focus on growth and earnings, especially in India. The most pessimistic guy on the street will also not argue on the growth trajectory that India is getting on to with capital expansion, credit growth and consumption. Corporate profitability along with strong policy continuity ensured by the government and refraining from anything drastically populist in a pre-election year will probably be recognised sooner than later. The key aspect is to look at the timing and quantum of foreign flows. One thing for sure is that, they can’t ignore a growth engine like India for a longer period. Also post correction, the markets look reasonably valued, whether on the PE, PBV or market-cap to GDP fronts.

How should an investor deal with underperforming Small-Cap stocks in the portfolio?

Ideally, in an expansionary phase of the economy, good quality Mid-Caps and small-caps perform really well and reward patient investors handsomely. But of course you can’t generalise it for all small-caps. Any duds in the portfolio should be cleaned up. It does not make any sense to hope against hope and carry a bunch of businesses which are junk and do not qualify to be fundamentally sound. One can replace gruesome small-caps or mid-caps with great quality mid-caps and small-caps. It is advisable to deep dive into the fundamentals of these small-cap businesses and source professional help if required.

As a lot of small-caps wouldn’t have adequate research coverage as well as data available, it is important to be safe than sorry. Some key parameters to watch out for on a qualitative basis are the promoters’ stake, history, integrity and corporate governance. There are a number of good mid and small size companies which qualify as emerging market-leading franchisees. They inherently fit all the parameters like huge size of the opportunity, large and dominant market share and margin of safety. When you buy small-caps, you need to have virtues of patience, conviction and discipline. Market volatility leading to huge fluctuations in quality small-caps should be treated as an opportunity in adversity.

Will the broader markets outperform in 2023?

India seems to be at the cusp of a strong economic revival. In a phase where economic growth along with strong demographic advantages takes centre-stage, the broader markets generally do well.  However, it seems that the first half of calendar year 2023 will be marked with narratives of inflation and interest rates. Once the debate around this settles, India needs FII flows which have dried up since long. The Indian investors have been saviours so far but for the overall market to gain momentum, foreign flows are much needed. Also, all instances of drought in India over the last 20 years have been in El Nino years. We need the rural economy to be in good shape for the government to be able to implement its vision of capital expansion and, thereby, the expected job creation.

Hence, the onset and progress of monsoon will be crucial to watch around June – July. Crude and commodities have to behave well as we are clearly dependent on them for at least our manufacturing sector to prosper. Earnings growth for the next two years seems to be expected around mid-teens. With this ongoing correction, valuations for a number of good businesses have started to look reasonable. There are so many businesses which are not part of the key indices but have the power to grow their revenues and profits along with strong return profiles. Out of the broader markets as well, it would be smart to be selective and pick the best of the lot.

What are you advising your HNI clients right now?

Almost all the HNIs are convinced about India being an epicentre of growth. The only question is how to make the most of it or capitalise on the opportunity. We have been advising our clients to invest money in equities in tranches to take advantage of the ongoing volatility in the markets and also stocks. The art and science would lie in picking good businesses which are market-leading franchisees and emerging market leaders. Even though you can’t time the markets to perfection, slow and steady nibbling in good businesses should be the logical pathway in an environment where the re-pricing of assets is going on.

Some themes like consumption and formalisation, credit growth along with financialisation, capex growth along with fiscal expenditure by government seem interestingly poised for half a decade. On the sector front, BFSI looks extremely attractive and is ready to be a proxy for the next leg of growth. Home improvement, discretionary and some segments of non-discretionary consumption, automobiles, select IT, automation, capital goods, agro and specialty chemicals are other sectors which merit an addition in long-term wealth creation portfolios. Those who try to skip bad years miss out on good years as well. Being in the game is very important. Buying is also called ‘going long’ and therefore you are expected to hold long.