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“We have a decent amount of exposure within the smallcap space. This includes a large amount of exposure to consumer-oriented businesses and these may be very small segmentkitchenware, footwear type of businesses, the theatre businesses,” says Vinit Sambre, Head-Equities, DSP Mutual Fund.


Will bad get worse before it gets better or has bad already got worse and now it is time to get better?
From where we were in terms of the valuations a few months ago to now, a lot of froth has got cleared from the market. In terms of the price points for a lot of the sectors, there is much more margin of safety today in terms of the valuations. If one is really taking a three-five year view, I do not want to hazard a guess as to how the next six months are going to be because there is so much news flow and noise.

While most of the negatives are known today, inflation is hurting, interest rates are going to go up, everyone is talking about it. I would rather imagine that those news flows should incrementally not pause now. But it is more to do with the sentiments because so much money has changed the asset class; the flow of money may lead to some bit of panic and can cause more volatility over the next six months.

I am of the view that long-term investors have to respect the valuations.With this correction, there is a good margin of safety across a few sectors. There are sectors like IT where the valuations have come off to pre-Covid levels at least within the largecap IT pack.

There will probably be another 3 or 4% correction and we get to a good valuation zone for them. My view is that they are not as badly impacted as some of the non-profit making tech companies out there in the US which have got impacted much more. I would say overall it is a good time to start nibbling and look for good opportunities with a three to five years view;

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We are now going through a cycle of earnings downgrades. In an earnings downgrade typically a) PE expansion will not happen and b) the market is unlikely to give a big pleasant surprise. How much of this earnings downgrade cycle is something that is already baked in?
I would say that at least this quarter we are not seeing results pointing towards downgrade and maybe in the first quarter, we will see slightly more impact of the increased raw material prices. There will be some bit of margin pressure and maybe there are talks of downgrading, which is taking place in the consumer category as such.
So some bit of demand may get hurt and there could be some effect of that on the earnings starting next quarter. I would say that we are on a journey of reasonable growth as an economy and we are going through a lot of imbalances from all these supply side pressures. These could unwind very quickly as well if some of the global macros start turning around.

Most of the global retailers have stored much higher inventories as far as the number of days of inventories are concerned. This can also lead to the inflation fear lasting much shorter because the demand is also now turning adverse.

As some of the global macros turn more favourable, things can turn quickly and hence one should think of the next three to five years picture where the growth looks okay. Maybe the downgrade season. if any, could be more temporary one of two quarters but beyond that, the outlook should improve.

When you say you like IT, would it be a good idea to go for a sector where the headline movement is not with you? We can argue about Indian IT companies have got nothing in common, if you compare them with Nasdaq related companies. The bottom line is when money is moving out of IT, Indian IT stocks also will be affected.
You are right. It has to do more with the headline and narrative rather than the fundamentals. Fundamentally, the companies have only guided for a very strong growth for FY23 and some of the global trends today, recession and all could hurt the sentiment some bit.

I see these companies are generally looking okay in terms of their business. The rupee depreciation should also benefit these companies. Once people look beyond these narratives and start looking at core fundamentals, the value definitely will emerge as far as the sector is concerned. From that viewpoint, one needs to look beyond the current negatives which are flowing around. Look at the core fundamentals which are on an improving trend.

At a time like this, when the market is looking so iffy, how much exposure should be there in mid and smallcaps? Is this the right dip to buy into those names? Should you be distinguishing between large, mid and smallcaps right now?
With a long-term view, I have always had a positive bias towards the mid and smallcaps because generally these companies tend to grow at a pace higher than the largecap because of the sheer size and through time as the growth actually is taken into consideration the outlook for the mid and smallcap turns out to be better as the long-term price trend really tends to catch up follow the growth metrics.

My skew has been more towards mid and smallcap generally and hence I advise investors to first have a long-term view. Do not look at the short-term volatility. It can be more volatile because these are smallcap segments but on a long-term curve, the volatility reduces and the return profile improves. that is number one.

Number two, in terms of market cap agnostic, I would prefer that strategy where one looks at the pure fundamentals of companies which are large leading companies. Even mid-sized leading companies have the key metric which basically is the competitive advantage which the company enjoys, the ROC, the cash flows. If you have these factors present in companies, I think it is better to own high quality good companies across the market cap range and just be patient with those investments because the external environment can cause volatility. But the core fundamentals will eventually catch up in terms of the outlook.

What within mid and smallcaps, are you recommending right now?
We have a decent amount of exposure within the smallcap space. This includes a large amount of exposure to consumer-oriented businesses and these may be very small segmentkitchenware, footwear type of businesses, the theatre businesses.

A lot of opportunities are available. Expose yourself into some of these names because long term, the consumption trends are going to be positive for India and that in mind, good brands, high quality businesses and managements which are available within these are something which we are highly exposed to.

Next comes the auto, auto ancilaries. As such, I have been talking about the cyclical recovery in auto for a while. It has not happened, it has got delayed but my sense is that auto has been in a very bad cycle and once the recovery starts picking up it could be a very smart recovery over the one or two years after four years of decline as far as the auto sector is concerned.

Beyond that, one could look at speciality chemicals. Agri is a large sector. There are no largecap companies within the agri sector. There are good smallcaps and midcap companies. One can focus on those and with the slightly longer term view, I am also optimistic on the healthcare sector because I feel healthcare demand will continue to grow and these companies have the wherewithal to keep growing at 15-20% over a long period of time. These are a few segments where one should look at with a long-term view.

When you say you are still bullish on healthcare, the long term story is intact. Diagnostic stocks, hospital stocks now provide good entry points?
Yes, across the value chain, starting from the pharmaceutical companies, some of these diagnostic companies as well. Some of these diagnostic companies may see a bit of earnings slowdown going forward, given the high base which they have got over the last two years. My sense is that these are good long-term stories to focus on.

The sense I got from you was that you remained overweight on banks. Within that what are you prferring – private sector banks or public sector banks?
We have a preference for private sector banks and if we look at the results which are getting announced by these private sector pack, it is very clearly showing improvements in terms of the asset quality, Those trends are visible out there and this is as per our expectations as well that the asset quality sort of improves for these banks which is happening. It is now just about the growth. As we see expansion taking place in economic growth, credit growth will also improve for these banks and that should drive profitability.

If we look at the overall profit pool of the Nifty companies, a good amount of improvement in the profit pool is going to be due to the banking sector and the private sector banks particularly. I would say the next two-three years could be a good time to own private sector banks. They are getting liquidated by foreign investors, which is where we have seen the valuations getting de-rated.It provides a good entry point as well. Fundamentally, the outlook has only improved for most of the private sector banks.

If the American consumer is slowing down, that will start impacting exports, manufacturing and other sectors and if energy prices remain stubborn which they are, it will have an impact on the macros. What happens in that kind of a scenario where the world slows down, energy prices remain high and macro remains under pressure?
There are wide probabilities and the external environment can remain stubborn for a period longer than what we anticipate but when we talk of these price points on commodities, let us understand that these price points have led to inflation which is now causing demand scarcity.

The US companies are talking of a slowdown which is hurting them now, which actually means that these price points are not sustainable and are not caused by high growth in demand. These are more because of supply chain bottlenecks. For a normalised setup, the unsustainable commodity prices need to correct. Also, these are not backed by fundamentals.

Back in India we are also not talking of a very hyper growth. We are in a soft growth phase and maybe for a quarter or two, we may see some impact on demand but the longer term picture remains good. Once the commodities start correcting, a very quick correction could take place there because it is not supported by very strong demand and hence the normalised picture to paint would be to look beyond these factors and events. It may get stretched by a quarter or so, but a good idea would be to think with a three to five years view.

From that perspective, once the valuation comes in a palatable zone, that is where the investors need to react and when the first wave of pandemic hit, the markets had corrected and what was actually in favour were the valuations. It was not known when we would come out of this mess and how it is going to impact people but we have come out of that. So most events come and go, but what finally gets respected is valuations and the core fundamentals of the companies.

We came out of the Covid fall or the 2008 fall with the help of central bankers, who supported the economy with liquidity. Now they are against you. That is the biggest limiting factor for markets to bottom out. Where is that support going to come from?
It is a very valid point which you make. In the next six months or so, a lot of uncertainties are there. It is very difficult to call out at what levels we will bottom out but a good margin of safety has started emerging in a few sectors when we look at the valuations. From that standpoint, take a three to five years’ view and not really get bogged down thinking one needs to wait for the bottom to emerge and then start buying.

A good way to look at would be that once you start finding the valuations palatable, start taking entry into those companies or businesses which you like to own and keep building your positions. We would recommend a gradual build up because it is very difficult to call out at what point will we hit the bottom, at what point will the prices be at a peak before we turnaround or make a U-turn.

The only thing which I would like to mention here is that most of the bad news which we are talking of it is a known problem. Markets panic more from the unknown factors. Maybe we have a very severe demand scare which may hit you or the recession is much more severe than what we are seeing today. Those could be the events which can cause more panic

To me, the biggest factor would be the velocity of money because so much money has come and chased the asset class, that some large fund or an institution has to unwind its position. We are seeing the private markets actually getting constrained and that can cause some bit of panic and can lead to volatile outcomes. But beyond that, most of the issues we are talking about are fairly known.

Thanks

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