‘Economic recovery will broaden market rally’

While large-caps appear to be in the fair value range, an economic recovery, led by liquidity and manufacturing revival, will lead to broadening of the market rally, says RAHUL SINGH, Cio-equities, Tata Mutual Fund. In an interview with Ashley Coutinho, he says the movement of the dollar and global crude oil prices will be important factors to watch out for. Edited excerpts:

Indian equities are now trading at all-time highs. Has the market run ahead of fundamentals and are we seeing froth emerging in some parts of the market?

The market rally was driven by a liquidity-driven bounce until July, led by lower rates and bounce back in corporate earnings as cost cuts, tailwinds in certain sectors, such as IT and pharma, and lower-than-expected stress in financials. Corporate earnings have more to go in our view as economic revival gains ground. The Covid crisis has reinforced the view that corporate earnings of the top 200-300 companies did better than others as the brunt of the slowdown was borne by smaller and unorganised players. What impact this has on consumption remains to be seen. Lastly, while large-caps, as indicated by the Nifty forward price-to-earnings ratio of 21x, seem to be in the fair value range, an economic recovery led by liquidity and manufacturing revival will lead to broadening of the rally.

What will be the key triggers to watch out for in the near-to-medium term?

We expect the markets to be volatile, led by various factors. Any risk of a renewed threat from the virus could lead to new restrictions and could continue to exert pressure on the markets. Market participants will keenly follow the announcements made during the Union Budget, as well as the movement of the dollar and global crude oil prices. The inflation trend will be another important factor to watch out for. However, it is difficult to give a directional view in the near term.

What are your views on mid- and small-cap stocks at this juncture?

Mid- and small-caps are trading at relatively average levels with respect to large-cap valuations, making us neutral in terms of evaluating this category. Since it’s therefore likely to be a more stock-specific market from here on, some of the new themes are represented more in the mid and small category. The economic recovery led by good domestic liquidity conditions, reform push, and revival in investment cycle (household, government and private sector) had generally been positive for the mid- and smallcap category in the past.

Which are the sectors or pockets of the market that you like in the aftermath of the pandemic? Which sectors have fallen out of favour?

While IT and pharma did well in the initial stages of the pandemic and had tailwinds, other sectors have recovered well now. Banking, which was one of the worst-affected sectors, has also seen lower Covid stress than what was widely anticipated, leading to multiple drivers of earning upgrades. Impact of cost cuts on the unorganised sector and consumption needs to be watched closely.

Do you expect any shocks in Q3?

There is unlikely to be too many surprises in Q3 because of good consumer demand. The next quarter, however, could be important to judge how various pockets of consumption are holding up and whether there was pent up demand.

What are the learnings for fund managers from the pandemic?

While we are cognizant of lower bond yields and its positive impact on equity valuations, one needs to be careful about not getting carried away. In the end analysis, maximum returns are made when there is an earnings upgrade cycle in an industry or company. There can be some leeway for companies or industries in emerging sectors with 5-10 year runway for growth, but ultimately earnings have to follow.