Market rally to continue, to be far more broad-based; private banks, pharma look interesting

Companies in the mid and small-cap space which are governed and run efficiently, are expected to throw up returns disproportionate to what the frontline indices would indicate

We expect the rally in the stock markets to continue and be far more broad-based than it was in 2019. Companies in the mid and small-cap space which are governed and run efficiently are expected to throw up returns disproportionate to what the frontline indices would indicate, said Sachin Shah, Fund Manager at Emkay Global in an interview to Moneycontrol’s Sunil Shankar Matkar.

Q: After a small consolidation, the market gained its momentum and started trading at fresh record highs given government measures to boost the economy and positive global cues. Do you expect the momentum to continue in 2020 and will the Nifty surpass 14,000? What are your thoughts?

A: We expect the rally in the stock markets to continue and be far more broad-based than it was in 2019. Companies in the mid and small-cap space which are governed and run efficiently are expected to throw up returns disproportionate to what the frontline indices would indicate.

We run a proprietary model called “E-QUAL” which is the first of its kind in the country quantifying the governance aspect in ESG effectively. We believe that, if one was to identify such above mentioned winners beyond the frontline stocks, “E-QUAL” model would be the most appropriate tool for the same.

Q: Banking and financial services led the charge in 2019 on the hope of easing NPA worries and likely strong growth going ahead. Do you feel the sector will retain leading charge among others and what are challenges if any?

A: Clearly, banking stocks have done well, particularly the private sector banks. We continue to believe that private banks will benefit from the lower cost of funds, better asset quality and consolidation in the industry. We expect large private banks with strong retail franchisees to deliver better growth and improve their return ratios.

Interestingly, many PSU banks are also much better capitalised at this point in time as compared to last year, many large PSU Banks have reported Tier I capital in the range of 11 per cent-13 per cent at this point in time as compared to 8 per cent-9 per cent twelve months back. They probably no longer have the constraint of capital for lending. In the next few quarters, if they can demonstrate their prudent practices on incremental lending and win back the markets’ confidence then considering the valuations they are trading at, there is a decent potential for returns over there too.

Q: There are lot of wealth creators in 2019 like Bajaj Finance, Bharti Airtel, ICICI Bank, RIL, etc. in Nifty50 and Adani Green Energy, AAVAS Financiers, Reliance Nippon Life Asset Management, HDFC Asset Management Company, CreditAccess Grameen, AstraZeneca Pharma, Manappuram Finance, etc. in BSE 500 index. About 100 out of 500 stocks rallied 20-222 percent during the year. Do you feel there would be more wealth creators in 2020 than 2019 given strong measures and positive global cues?

A: Every year there are winners and losers and from that perspective, I am sure there will be many in 2020. But the market rally in the last two years has been narrower than one would have liked. In these two years, the total market cap change (ex of IPOs) has been negative, and furthermore, barring the TOP 20 stocks, the aggregate market cap, which is positive, the aggregate market cap of stocks below Top 20 has been significantly negative over the last two years. Clearly the valuations of many of these stocks have now reached levels where the margin of safety is decent and some bit of revival in the economic activity can result in interest coming to these stocks from the investors.

Q: Nifty Auto index lost more than 12 per cent so far in 2019. What are your thoughts over auto sector recovery and do you prefer to bet given attractive valuations?

A: Auto stocks have not done well because auto volumes have lost the momentum. Some bit of it can be attributed to structural challenges and some bit is probably cyclical. This year, the monsoon has been quite good and particularly distribution has been wide-spread. That should help the rural economy and aggregate demand from rural areas. From that perspective, some of the demand from the cyclical factors may turn positive and of course, valuations of auto cos are not very high any more.

Q: Most experts believe that the Reserve Bank of India (RBI) will maintain pause in February policy meeting as well. Are you agree, and do you expect the RBI to lower its growth target further from 5 percent now in coming policy meeting?

A: RBI has taken a pause to see the full transmission of the last many cuts to the ground level and also to observe the (positive) effects of the interest rate reduction so far. So, I guess there is room for some more rate cut, keeping the global interest rate scenario in perspective.

Presently most of the high-frequency data points are not showing very encouraging numbers on the front of Gross Domestic Product (GDP) growth. The key is some of the recent actions taken by the government, good monsoons, and a significant amount of liquidity available in the system. How all this will channelize and play out in the next few months will give us some clear direction of growth for 2020. Also, some major reforms like disinvestments and announcements in the Budget may come in to play.

Q: What are major events to look at in 2020 as most experts feel the recovery is expected to happen in earnings as well as economy?

A: The year 2020 can actually be a major reform year. We have already witnessed the first major reform, both in the indirect tax (GST) and Direct Tax – Corporate Tax Rate Cut, and the next big program is Disinvestment of large PSUs and Personal Income Tax – may be DTC. These reforms do have the potential to revive the animal spirits and overall consumption growth in the economy.

Q: What are sectors or themes to play in 2020 and which could give hefty returns than seen in 2019?

A: As investment managers, we look to identify winners using a bottom-up stock picking approach, blending it appropriately with our proprietary model “E-QUAL” as mentioned above. Having said that, some of the sectors we find interesting are:

Private banks: We expect private banks to benefit from the lower cost of funds, better asset quality and consolidation in the industry. Hence, despite the spectre of subdued economic activity, we except large private banks to deliver better growth and improve their return ratios.

Pharma: IPM data has been very encouraging and we believe that domestic pharma companies have settled from GST led inventory disruption. Also, we believe that the USA generic price erosion seems to be settling down. Hence, going forward, price erosion may not be as pronounced as we have seen in the past.

Healthcare: Hospital business is such that there are phases of capacity additions and then long gestation periods to break even, following which there are phases of high growth, improving the profitability of the chain. Currently, we believe that the period of capacity addition is behind the industry and it is currently in a phase of consolidation which will soon be followed by growth. This will help chains gain from operating leverage and deliver improved returns on the invested capital

Q: What are those factors that can spoil or derail the market momentum in 2020?

A: Very recently, we have seen some slowdown in the net inflows to domestic equity mutual funds, although SIP flows have been fairly intact. Hence, there is a high likelihood that the flows will be back to decent levels but just in case the recent trend doesn’t reverse, it may cause some loss of momentum in the market. Also, global ETF flows are fairly dependent on US-China trade war and something wrong on that front can create a Risk-off environment and could create challenges on the front of FII flows too.