What are you making of midcaps melting away small caps? Do you think this will make the market healthy?
Midcaps have moved up a lot in the last few months: the small amount of correction taking place. But if you recall, overall this entire rally in the markets was pretty much driven by the Fed and fiscal stimulus by the various governments. That is what has actually kept the market moving up in such a rapid way. Similarly, now if you were to look for big correction in the markets, I think again it will be driven by the Fed and liquidity.
These are the things which will one really has to be watchful for. Go back and see historically, for example the 2000’s technology bubble or during the 2007-2009 pre-Lehman era; whenever the correction was in news. By the taking away the liquidity backed by the Fed, we have quite a long time to go. In 2000, probably after hiking the rates by about six-seven time, that is when really the market started correcting and it was same thing in the 2007-2008 also.
That is when usually when markets started correcting. We are talking about just the tapering somewhere in October, November, December; the first rate hike in six-seven months, even more than that. So, we have a long way to go in terms of if the correction were to be again Fed induced or liquidity tightening. From that perspective, we have a long way to go.
I think this is a small correction. Having said that, yes the valuations have been on the higher side, but that is how it has been. Even those two instances of market peaks driven by the liquidity. In that sense, I think we have some time to go before the market corrects. Midcaps especially in the last few months have rallied a lot. There is a correction taking place.
If someone is taking a three-year view, do you see an average portfolio from current levels in a positive territory in three years from now?
Even in a very bearish market, even markets where there is a substantial correction, few stocks will always do better. Now what is driving this rally in the past two-three years may not be the same ones that will probably drive for the next two-three years. It is very much possible that some of these very well-performed stocks or sectors may take a breather.
Some of the ones which have been laggards may come into the rally. So, a well-constructed portfolio along with some value stocks, with some cyclical stocks, I think from a three to five-year perspective could construct a good portfolio which will give decent positive returns.
What are your thoughts on steel, metals, and financials, especially private sector banks and a few large NBFCs?
Let us look at metals first. Most of the aluminium, steel and all of the commodity prices have moved up quite substantially in the last six months. Based on the current prices, the free cash flows to most of the commodity companies have been exceptionally high. From here on, steel or aluminium prices need not go up further for the metal stocks to give a good positive return. Even if the steel and aluminium prices were to remain here for let us say two-three quarters more, I would still think that these commodity stocks can give a very good return from current levels because at these prices almost about 25-35% market cap is generated as free cash by these companies.
If the prices were to just remain where they are, you would still easily get upwards of 10-20% returns. That is how the commodity prices are today. Some of it is driven by the Chinese side of it. The Chinese government curbing the excess production because of the pollution-related issues is also helping the overall market. And even if you look at today for example, the steel prices in the US and Europe are substantially higher than what it is there today – almost $400-500 higher prices in these developed markets.
And not only that, most of the global players, airlines, if you look at it in terms of where the spending is going to be, the US seems to be spending in a significant way on the infrastructure side. So, if that were to happen, I think the demand for the commodities led by the infrastructure spending by the developed countries will continue to be there. All we need to do is that steel prices or aluminium prices should stay here for some more time – maybe two-three quarters, so that the prices will continue to go up. That is why we still like this sector at this juncture.
Among all other sectors, probably the banks are somewhat valuations-wise close to their historical mean, whereas most other sectors if you look are substantially higher than the historical mean. It is just that in the last quarter there have been slightly higher slippages than the anticipated levels because of which the banking sector has been not performing so well for the last three to four months. But we still like the top four-five private sector banks. They are very well positioned and their capital adequacy is exceptionally good. They have very strong management teams and most of them are embracing technology. There is a lot of opportunity in the top private sector banks is what I think.
Which area of the market in your view in the new environment offers the best margin of safety?
Given the way the midcaps have risen in the last few months at this juncture, we believe that large caps are slightly better positioned from a risk-reward point of view. Most of the large private sector banks we have talked about, even the commodities are also pretty much largecap names. I mean at this level of markets, I would bet more on the larger cap segment than the midcap because market is not close to historical mean valuation. It is much higher than the historical mean valuation. It is very much possible that some corrections could happen soon. In that backdrop, there is a better risk-reward in the larger caps.