While the markets are riding the bull, the economy is yet to get back to the pre-covid levels. What does the current scenario mean for investors?
Currently, many investors are worried about IPO rush and high valuation in the equity markets. Just as there are market cycles and business cycles, there are valuation cycles as well. At the current juncture, investors must pay special attention to sectoral valuation, as investing in good businesses could also lead to significant investment losses, if they are not correctly valued.
Today, consumer-related sectors like consumer staple, consumer finance, consumer retail, chemicals and recent run up sectors like IT (information technology) and metals, look extremely over-valued. Investors should not invest in funds having exposure to these sectors. They could instead consider investing in domestic-centric businesses linked to the cyclical segments of the market. Through this approach, markets appear reasonably valued and can be positioned attractively.
Where do you see the markets heading from here? What could be the major determinants?
The price to book valuation matrix helps in understanding valuations within sectors, within stocks, between different sectors and stocks. Price to book valuation in conjunction with return on equity can give an understanding of where the market stands. As the earning cycle is picking up massively, Nifty’s price to book valuation could extend to the tune of five to six times in the next five years.
Earnings growth trajectory will be the key determinant in the next five to ten years. Looking at the economy’s & Nifty’s earning growth and the significant up move in Nifty’s profit growth & listed companies profit growth which has started four quarters back makes us positive about the markets.
How do you perceive the current valuation across market segments? Do they hint at any forthcoming corrections?
Rather than looking at the overall market in general, we look into sub-sectors, sub-segments & stocks, and position where the valuation appears reasonably attractive related to the market.
IT, chemical, metal, consumer retail, consumer finance and consumer staple sectors are currently frothy. Besides, digital and technology-related sectors also look extremely over-valued with no earnings to support. When valuations look north towards the sky, we should be very careful about such sectors. Further, ESG, EV and speciality chemicals are certain fads that could melt down materially in the coming years.
Under our investment philosophy ‘MQL’, we look into the margin of safety, quality of business and low leverage which helps in picking and choosing the most appropriate sectors.
Which three sectors appear to be the most promising?
We are currently positive on pharma formulations, auto & auto-ancillary and banking sectors. Banking sectors can be viewed carefully as a lot of mid and small cap banks are trading at cheap valuations which can offer significant upside.
Additionally, since the real estate sector is picking up, consumer goods linked to the home improvement segment look interesting. Valuations of many of these companies are very cheap and available at the same price that they were trading at in 2017.
These are early cyclical sectors and the moment the economy is on the up move, you will see them doing very well.
How should MFDs deal with incremental lumpsum flows? Should they look at recommending equity funds or give higher allocation to debt funds?
As a layman’s principle, 70% could be allocated in equity and balance 30% in debt (dynamic bond fund).
The fund category chosen plays an important role here. Within equity, 20% may be invested in pharma & healthcare, 50% in multi cap funds, 20% in balanced advantage funds and another 10% in small cap funds.
Which mutual fund categories do you currently recommend to hold across different investment horizons?
The earnings growth is picking up which is beneficial for mid cap and small cap segments also. Multi cap funds have defined allocations across market caps, which can be a good play in the next ten years for making reasonably good risk-adjusted returns over the long term.
While investors can start SIP in multi cap funds, investors could also invest in lump sum at the current juncture.
Value, multi cap and balanced advantage funds are the three products where we advise to put lump sum. Whereas, in mid cap and small cap segments, investors can currently register STP or SIP for the next six months for capturing the volatility and participating in the markets.
Debt investors can consider dynamic bond funds for making the most of the interest rate movements.
