NS Share Market has grown significantly. Is the magnitude justified by the fundamentals?

Several factors contributed to this rally. First, the economic recovery has been faster than initially expected. We are already at pre-covid level in many areas and others are reaching there. We are seeing a pick-up in exports due to the global recovery. Right initiatives of the government- policy measures, focus on infrastructure, thrust on disinvestment, etc. have helped in improving the market sentiment. These things move in the medium to long term and are good for the market.

What about valuations after this big rally?

While the overall economic forecast looks good, valuations have outpaced the historical long-term average. This is a matter of concern. Unbridled valuation is another concern in some areas. Right now, mid- and small-caps are trading at a premium to large-caps, which is not a permanent position, and it cautions us. It is not good for a market to go one-sided for a long time. Since time-to-time corrections bring some rationale, you don’t see sharp improvements in such a scenario. Ideally, there should be a short-term correction and the markets should consolidate. Not happening now is a matter of concern.

What is your portfolio strategy now?

Since valuations are disappointing, we are cautious in the near term. We prefer to remain in large-cap in such a market. Since mid-caps are more expensive in most sectors, I would be happy to buy a large-cap with a lower valuation that can better withstand the shocks of a falling market. We also like stocks that won’t fall as much in the market when Improvement Comes.

Are you entering defensive areas?

No, when I say cautious, I mean following a more balanced portfolio approach. There will be relatively low valuation stocks in each sector and we will buy that. Instead of concentrating the portfolio only in defensive or cyclical sectors, we prefer to maintain a more balanced portfolio with exposure to all sectors.

In which areas are you currently overweight or underweight?

In cyclical sectors we prefer domestic financials. That sector is expected to perform well once credit growth returns. They are also in a better position in terms of valuation. We believe there is some play going on in the capital goods space. We are also overweight on cement. From the defensive sectors, we are happy to play in the IT sector, which has a long runway for growth. Pharma looks interesting because of its recent underperformance. We are selectively underweight in Auto, Metal due to current high prices and consumer names to name a few.

Being a life insurance company, we are focused on the long term and we generally manage a more balanced portfolio. We never bias our portfolios for any one topic or sector and we never over-weight or under-weight in any one area. Even in sectors where we are underweight, we will have exposure to some of the stocks.

With the high valuation of the market, what are the downsides that could result in a correction?

inflation There is a big concern, which is quite a lot all over the world, and investors need to keep a close watch on it. The recent rise in commodity prices has been due to supply constraints and the market considers it transitory. While supply constraints are the main reason, they are not the only reason. While household headline inflation has moderated, core inflation still remains around 5%.

Crude oil is at $85. Is it fleeting?

It is too early to call this transitory, because we are in the midst of an energy transition. Considering the supply side restrictions, different parts of the world will react differently to the situation. It will be a challenge to transition smoothly. While incremental investments in coal and crude oil are low, the corresponding high investments in clean energy sources are not. The market will have to see whether this energy transition will be smooth or rough over the next 5-7 years. If the transition isn’t smooth, some old fuel may go up in the middle.

Will the recession affect the market?

Looking at the signals coming from the US Fed, there could be a tapering during November or December. I’m sure it won’t have a big impact. Simply saying that just writing it down and assuming that it will have no effect is also not correct. Once the Fed starts reducing, it will reduce the incremental money flow and the markets react to that.

What are the other concerns?

The second concern is more fundamental. Over the past 12 months, we’ve seen earnings upgrade cycles come into play; But we didn’t see big earnings growth during the June quarter. If the earnings upgrade does not happen in the September quarter, it would indicate that the earnings upgrade cycle is coming to an end. It will be a bit worrying from the market valuation perspective and one has to be cautious. While it is easy to justify higher valuations in periods of earnings upgrade, this is not possible during periods of steady earnings growth.

Any chances of a fall in earnings?

I don’t see any drop in earnings in the near future. However, investors should watch this closely as margin pressure is becoming more prominent and it can happen in consumer-facing industries.

The market valuation is high in relative terms. How big a concern is this?

The Indian market is trading at a premium to other emerging markets. We are deviating from the long term average and that is a matter of concern. However, now things are a little different. We had several IPOs. Some have started listing and this is causing a lot of inflows. Anecdotal evidence points to the possibility of money transfers from Chinese Internet stocks to Indian Internet stocks. Overall, the Indian market has received a major chunk of the influx. It is not sustainable forever. I don’t know when this will stop. But in the end, the market will be right when this happens.