How was the broader market rally of 2017-18 different from the current one?

Compared to 2017-18, I believe this market cycle is stronger due to robust earnings from midcap and smallcap companies, supported by solid fundamentals. The rally back then seemed more frothy as it was primarily driven by fund flows. This time it is a combination of fund flows and strong fundamentals. Although it is undeniable that multiples have surged notably in certain segments, it is important to note that not everything is perfectly priced, while some other are clearly expensive.

Do you anticipate similar returns for midcaps and small caps in future, or do you expect moderation?

Certain pockets may continue to yield even 20-25% returns, but at an aggregate level, the situation may be different. There could be two or three years where market returns exceed earnings growth substantially. Though, these trends eventually converge over a longer timeframe, typically five years. For example, with earnings growing at 25%, market returns may reach 40-50% due to multiple expansion. However, in subsequent years, as earnings growth moderates, stock returns could decrease to even 5-10%. So as earnings growth slows, multiple expansion may halt or even turn into compression. Looking forward however, there is less reason to expect major corrections.

Do you anticipate a similar trend across sectors like industrials or capital goods?

It’s a common trend that occurs across various sectors. For instance, consider the tech sector, where we’ve seen multiple booms, especially post-covid in 2020 and up to the end of 2021. The surge was driven by factors like increased digital adoption and remote work. However, valuations went from one extreme to another, reaching their peak in 2022 before gradually declining. This pattern is likely to repeat in sectors like industrials as well. Though, it depends on earnings supporting the valuations. Early indicators such as order book builds, and policy changes can offer clues about when a sector may be reaching its peak.

So, in the current scenario, what sectors look appealing to you?

In defence, different segments or sub-sectors need to be viewed separately. These are long-term businesses, where the focus is more on order backlog and future prospects than immediate revenue growth. Preliminary figures from defence companies reported recently seem reasonably healthy and in line with expectations for this quarter. In fact, we have reduced our exposure in certain segments of the industrial basket, while we have increased our exposure in some others such as defence where visibility has further strengthened. We see improved visibility for at least two or three companies, if not all of them, despite the limited number of players in some segments.

What about railway companies like wagon manufacturers? Are you invested in any of them?

We overlooked it, to be honest. Although we recognized the opportunity, we couldn’t identify the right investment vehicle in time. However, some of these companies still hold potential and we are considering revisiting this sector during market corrections and looking at them afresh.

Do you see any dark horses?

The consumption sector appears a dark horse, with lower to middle-income segments struggling while high-end discretionary products thrive. IT companies, too, show promise with substantial deal wins, but execution delays are hampering progress. Despite occasional rallies, the IT sector lacks consistency, positioning it as a grey horse—somewhere in between.

Going by that logic, perhaps healthcare, along with consumer goods and IT, would fall into that category as well?

We have significantly increased our positions in the healthcare sector over the past six months, going meaningfully overweight on the sector. Stocks in the healthcare sector, including both large caps and midcaps, have performed well in the past six months. Despite recent price increases, when viewed from a longer-term perspective of three to five years, they appear reasonably valued. While there may be little upside in the very near term due to recent performance, there’s still potential for further growth over the longer term, considering they haven’t surpassed historical highs on valuations. Pharma, including the healthcare sector, may have room for further returns.

How about financials? They’ve taken quite a hit. Do they appear promising?

We like some pockets in the financials space from a value standpoint. Despite facing challenges over the past 12-18 months due to factors like compressed margins in rising interest rate scenarios and regulatory intervention, they remain attractively priced. Some banks and non-banking financial companies (NBFCs) are even cheaper than their historical valuations. Additionally, some public and private financial institutions still have the potential to compound their book value at a decent rate, making them compelling investments. However, the absence of immediate triggers is a downside.

Are you seeing a pre-election rally?

In 2024, it seems like most of the returns will come in in the first half of the year. The second half might be less eventful, although not necessarily indicating a correction. The momentum of growth is likely to continue, and without the recent regulatory backlash, it could have been even more pronounced. It’s probable that we’ll see a crescendo in the next two months or so, followed by a slowdown until the July budget. After that, other factors like US elections will come into play in the latter part of the year.

What do you make of RBI’s recent policy decision to stay pat?

The outcome was on expected lines. In Q2FY25, inflation is expected to drop below 4%, for the first time in nearly five years. Despite challenges such as high crude prices and food inflation, optimistic comments such as “goal in sight” and “elephant has gone to forest” suggest a dovish stance on inflation. The underlying economic factors remain robust. This outcome does not deviate from expectations of rate cuts in the second half of 2024, aligning with the global trend of rate cuts.