Risk-Reward Not In Favour Of Big Upmove: HDFC Securities' Unmesh Sharma

Unmesh Sharma: That's the trillion-dollar question right now. There is too much crosswind right now. So, let's start from the top.

If you look at the way in which the fight against inflation has happened globally, I'll try to put it into an Indian context, because not all of what happens in the US is really relevant for us. The biggest issue that we are facing right now is the fact that the fight against inflation quite expectedly has been longer than you think.

If you go back to the 1970s, this is exactly what happened at that time as well. You keep thinking that you're winning. So if you remember, even in this round, there was this whole phase about it being transitory and then there was a pivot backwards.

I think, this word pivot has been used, if I remember correctly, since August 2022. I remember there was an article I had written where we had talked if there is a pivot. So that didn't happen and then there was one earlier this year, maybe December last year.

So what happened was that, at that point in time, the market thought that there would be seven rate cuts, while the Fed said it was three. And the data this morning is that the bond market believes that there will be zero or one rate cut this year.

I don't know if you know this, but in the data if you really go deep, you will find that there is a set of investors, who are actually hedging for even a rate hike. Now, that is a huge move, but the market has not fallen because I think the liquidity has been sloshing around.

We can go into specifically in India, what is happening, but at the same point in time, the risk-reward on risk assets globally and within that, I would say emerging markets and then India being a part of that, definitely the risk-reward is not in favour of a very big upmove from here. So that answers the first part.

Unmesh Sharma: Actually, there are a lot of layers in the question itself. So I'll try to address all of those.

The first is that globally, while liquidity is sloshing around, you can see from the net selling in India itself, that there is some risk. In fact, if you look at last week's data, there is a lot of flow happening into China.

Now, this makes two points. One is that does that mean that people are going away from risk? The answer is probably not. Why would you move from India to China. China, probably the risk is higher at this moment in time, given all that going on over there.

But what's happened is that there is some value bias which is coming in. I don't know if you've seen but across sectors, the valuations of a lot of very good quality Chinese companies is actually in single digits versus India where the whole market itself is over 20.

So what's happening is that there is some reallocation of portfolios happening. So that's at the FPI level and which is why that connects with your second point as to why FPIs are selling. So there is a reason for that to happen. So it's not necessarily a complete risk off but at the same point, because there is enough liquidity but this.

Now then you come to the second point, which is something that is to a large extent unprecedented. Now, this is where you actually compare it to what happened in Hong Kong, China from 2004 to 2008.

Now, what's happened is that this huge wave of financialisation of savings and people participating in the market has started and which is what I think you can see from the SIP flows.

Now there are a lot of layers in that but what's actually effectively happened is that all the bouts of selling which have come from the FPIs is just being completely absorbed by the domestic market.

Now, here what happens is that this is a little scary in a sense. If you look at the aggregate data, I think the FPI stake in India Inc peaked at around 23% and is down 5–6%. Now, maybe I'm too old school but earlier if someone had told me that 5% of India Inc is going to be sold by foreigners and nothing will happen and so the market has actually gone up.

So, you know, it is also somewhere where people like us also have to take a little bit of humble pie because I actually thought the market will fall this year, and that's been the call. Wherever I go, people keep asking me this that you had said that it's going to fall but what's happening now.

But now what I think is happening is that if you compare it with the example of what happened in Hong Kong, China this can go on for a bit.

The only reason why this would stop and that is the second part of, you know, I'm pre empting what you will then say, how does this stop. One is that as of right now, there seems to be not much interest in looking at aggregate valuations.

So if the company is delivering earnings then keep buying. The counter corollary, which supports this thesis is the fact that if you see it even in this earning season you see a small miss and the stocks fall dramatically, which kind of supports my thesis that a lot of this participation can go away if there is disappointment. This is happening globally, not just in India.

The second is that there has to be something else to buy because this liquidity is real, and people have now kind of made money in the market or at least not lost money in the market now for a long period of time. So either real estate, or working capital, or people start deploying money elsewhere, I think this will continue for a bit longer.

Now in this scenario, it's a little tough and honestly, that's exactly what's happened to a lot of market participants including us, thinking that at some stage this will not stop and it has not stopped. I think this will continue for a bit.

Unmesh Sharma: Look, that's the nature of the market. I think, given the fact that it's becoming incrementally more—if I may call it—domestic and retail, this tends to happen for short periods of time. Now, short could mean a year could be two years.

What is happening really is that not having any reason to sell becomes a reason to buy the position. And, you know, there is this mindset—why fix it if ain't broke, you know, that type of mentality. So I think that's what's happening.

But at some point in time, this catches up. And, for people like us who are constructing model portfolios, our research team, we quite struggle with this kind of scenario but that's the nature of the beast at this point in time. Till there is disappointment, we can't see selling happening in the market.

Unmesh Sharma: So you start from the top. I think, the biggest change that we made to our model portfolio, I think, is taking slightly different approaches.

We never go over 5% cash, but we used to be three so it's going to five. So we have 5% cash now. And then, what we've done is that we've added wieght to the utilities. So, the PGInVIT has come in, for example.

Now more than just the fundamentals of that, more importantly is that it's a little bit of protection for your portfolio. So Power Grid InVIT, NTPC these are the types of names that we've added. All of these are overweight now.

So, without going into specific details, broadly what we are doing is that almost 8–10% is like a rock solid, bulletproof kind of portfolio.

In the rest, what's happened is that we had a very, very good run in our model portfolio for three years, taking outsized bets, playing, if I may call it domestic economy and value.

But what's happened is that, you know, value has one issue. It is that if your call is right, then value is no longer value. That's what's happened to our portfolio now.

So what has happened is a lot of convergence has happened. And if you see, when we started to adjust everything together, we came to the point where everything was just getting closer to the index.

For example, we had a huge underweight position on Lever, which was quite unpopular. A lot of pushback from clients. But it really worked.

And we were hugely overweight on ITC. That stock has done phenomenally. I think, we were one of the few fans of that when it was in the hundreds—somewhere between Rs 100 and Rs 200. And we kept adding weight to that.

Now when it came together, what's happened now is that you don't know what to do because it's worked and that is where the difficulty starts. ..

It's not like we have a large-cap bias on the portfolio, but we have naturally gravitated towards the larger caps because of the fact that that's where the value is, relatively better.

Now, this is also linked to my earlier point, which is that the participation has happened more from the domestics, which if you look at the way in which ownership of stocks used to be back in 2006 till even 2020 was dominated by the FPIs. So there was natural bias towards consumers and large-cap banks. But that kind of reversed over the last four (years). But we are kind of now gravitating back towards that.

So we have a very huge bias for that. A lot of things like consumer discretionary, which are just overpriced, we've just taken them off.

Unmesh Sharma: Technically, you know Maruti also is a premiumisation beneficiary in a sense and so is Hindustan Lever.

So they have come closer to the benchmark. But what we've done is some of the discretionaries have gone off. So we're playing discretionaries indirectly now.

So we have real estate in there. So why has real estate come in, even though there is no real estate in the Nifty? Then there are things like media and all that. So we've added a few of these names in there to play that kind of theme.

So what has ended up happening is that the large caps are close to the benchmark and the expensive small caps have gone and got replaced by non-benchmark names. That's broadly how it's got constructed now.

Unmesh Sharma: Look, we've been through this cycle very positive on the domestic capex cycle and I would say equally excited about both the infra and real estate.

I would think at this point in time, given that there is elections coming up, so there has been a little bit of slowdown on that side. We are a little bit more positive on the real estate cycle, so as to speak.

And the best way to play that is not just to own the real estate names, because these are all normally very niche urban players. We are talking about the whole cycle and in that, apart from having some cement names, we have JK Lakshmi in there. But we also have names like Stylam, for example. So we are playing it through that.

In fact, we have a team which actually looks at building materials together. At some stage once the post-election lull is kind of gone and you know, we can expect to see some kind of pickup on the infra side, again, maybe the weight will shift towards cement a little bit more. But as of right now on this entire space, we are quite constructive.

Unmesh Sharma: So there is one big challenge with all the four themes that you mentioned. In fact, one common theme is that it is very difficult to play these themes.

See, I work for institutional equities. So one big benchmark that we have internally—it's a rule of thumb, it's not really a benchmark—is that a meaningful fund house should be able to build a meaningful position in the stock.

So, you know, unlike our retail research team, which has a lot of these under coverage, we don't actually have that.

This is one fascinating thing. Earlier, small caps and mid caps used to be Rs 2,000 crore, Rs 3,000 crore, Rs 4,000 crore. And now, you know, at Rs 15,000 crore, is where you really start operating because the size of the funds is so much.

In fact, some of the new IPOs as well, you know, that's the conversation we have with fund managers that how is this going to matter to me. The amount of work that you have to do to assess a company of Rs 2,000 crore versus 20 is the same.

If I'm not able to put it as half of 1% of my portfolio, where the portfolios have become Rs 25,000 crore now, how do you operate. So, honestly on all of these themes, we have not gone deep.

What I have heard can make an anecdotal comment. It is that a lot of these themes have run ahead of themselves and basis some of the coverage stocks that we have.

What's happened is that low-liquidity stocks also invariably end up doing that. The pendulum swings too far and in some of these, it may have happened.

So I think, we'll wait for some of these to become investable and see what happens.

Unmesh Sharma: Okay. Slightly tough one. So I'll give a slightly more nuanced answer.

The Indian IT services companies will figure it out. But we think that they're hitting an air pocket in the short term. So they will come out of this, but I think in the short term there is a bit of a challenge there. So relative valuation is the only game in town.

We used to have ER&D, but we think we're not comfortable with their values. A lot of these names, we had under coverage. And in the model portfolio, they're off it now.

Unmesh Sharma: So our model portfolio is also very concentrated. We want to play it that way.

If you see our three to four-year kind of long-term Tata Elxsi type names which were there and which we rolled all the way. In fact, we made a name in the market pushing some of these ER&D players.

I think at this point in time we are getting to the point where we are a bit less emotional about them. And I think that on balance, are they good companies? Should you stay invested? The answer is yes, but hold recommendations doesn't make it to the model portfolio.

Don't sell but don't do anything. That is not going to get to the model portfolios. The benchmark is high.

Unmesh Sharma: I think on the metals, with the exception of Tata Steel, we have a huge underweight position. And a lot of it has to do with the imponderables of what is going to happen in China. And till the time we see a little bit more clarity there, I think that and some of these smaller NBFCs.

In fact, even Bajaj Finance we have a huge underweight but that could correct and we still like the business but on the margin, at the NBFC looking at the way the asset cycle will play out over the next two years and the imponderables in China, I think, the metals names with the exception of Tata Steel we think is added to big underweights for us.