This HSBC Strategist Says 2018-Style Correction Not Happening In Small And Mid Caps

Amit Sachdeva: Sure. I think it's easy to reflect going back to what we said in the past and I would start with the same thought. I have reiterated it again and again, that the Indian market has a certain Goldilocks scenario. Once that sets in, it's very difficult to go. If I were to think about it in current context, this was decisively set last year. We've seen a major bull run, and we've argued that once the momentum sets in, it doesn't go over that easily. 

In fact, investors use small phases of consolidation to buy into, you know, this consolidation mode and what you're seeing is basically reflection of that dynamic. Why this is happening is, because India's internal construct is very positive with macro earnings, even valuation, I would argue. One can bear excesses and they are tolerable valuations and this earnings and obviously this dynamic of risk tolerance in the market continues with it which reflects in small caps and mid caps majorly outperforming last year. But small bit of panic, for example, a correction happens and then people start to sort of write obituary of that small and mid-cap space as well. 

We've always cautioned that one must stay cautious on the overarching mid and small-cap construct because they have run way ahead of this bull market scenario and one has to maintain a bit of caution. 

But we also said in this note that we are not in a 2018-style correction in mid caps. In 2018, when the correction set in, mid caps and small caps corrected basically 30% and market also was down 7-8%. So it was a major bearish phase. But at the same time, the context then was very, very negative. We even had IL&Fs crisis in that year, US bond yields were rising, growth was slowing down, there was a major earnings downgrade happening. If you put the current context, none of that is in the picture. 

So, although the expensiveness debate will continue, my sense is that we are in a decisively positive phase. That is the reason that you see these small phases of consolidation but market rebound very quickly. And I think, that phase will persist for a decent length of time as well. That's the reason we continue to be very positive on Indian market.

Amit Sachdeva: That’s what we have been also advocating since last few months. Large cap as a space last year was a major laggard. And you know, for example, mid-cap space and small-cap space outperformed the market majorly, and large-cap space relatively lagged. So there's a relative pocket of value and how much that is let me just phrase it. 

Typically, in bull runs, we've seen that small and mid-cap spaces typically 1.4x the market run. This time it was 2x the market run, way ahead of fundamentals. We also noticed that peak valuation of mid-cap space over the market is about 35-40% and there's very less tolerance of that premium holding at that level. So it comes down. Now if you see that when the year began, we had seen small and mid-cap corrections and we've seen that premium come down to about 17%. Market breadth for mid caps also 73. So they became much more tolerable. 

So, what we've been saying is that large-cap space relative to mid-cap space in the market as an average basket tends to offer certain superior pockets of value, while one has to be increasingly cautious buying into momentum in certain small and mid caps to avoid large-scale corrections. Say for example, there's a major global risk or some other event happens, crude touches $100 or and bond yields continue to stay very high, there's a whole lot of negative context..., then you could see that some corrections could be very stark. So one has to also brace up for those uncertainties, if I may say so. 

On balance, our view is that small and mid caps are not in that 2018-style of correction… Large cap offers slightly better value but also not to forget that FII flows became negative at the beginning of the year. If FII flows come back, we'll also see that it has a tilt towards large caps. So that also we should keep in mind.

Amit Sachdeva: I assume that you're referring to our mid-cap style note which we put together some of the ideas in the mid-cap space. So I would refrain from definitely discussing any individual names. We are not allowed. 

Our view is that deep corrections in mid caps are unlikely and some of the names in our mid caps are long-range themes or multi-year themes. And then what happens in this scenario is when the market is in risk-taking mode, market tends to identify those opportunities, which are multi-decade stories, multi-year stories and these corrections become a good point to buy into it. 

So, the market is looking for next mid-cap idea or nest large-cap idea and that is the quest that continues to go on and on. So, reflecting that thought with some of the ideas that you see in that list, qualify for that pocket as well. That's the reason you'll see that diverse range of ideas, but it has a certain guiding principle.

Amit Sachdeva: As I said that I would reserve my comments at a very broad level, but if you come and think of it and if I reflect on the last piece we published… , we noticed that banks or the largely financial space has definitely seen dynamics turning negative, investors being more pessimistic, there was a selloff and all the rest of it. The sector has sort of accumulated some apathy, if I may say. 

That is the reason the sector has moved to a quadrant that we define as a risk-on quadrant. What does that tell us is, this risk-on quadrant is where the investors are already pessimistic and business dynamics continues to be negative. So in the end, that quadrant is very interesting. For example, if the market wants to buy risk with a two-year view, in that sense the market then starts to value those opportunities which are small improvements in outputs, etc. 

So, my sense is that it is a very interesting bucket to watch out for and hence banks and financials as well. As the market's tolerance for risk rises, I would say at some stage that makes a case for some sort of preference for those as well. 

But given the market is sort of mixed, one has to play all the opportunities as a blend of all opportunities. For example, a risk-on bucket could also be a momentum bucket and could also be a structurally winning bucket.

So, I would probably have a balanced risk view in the current market, rather than just go all out and buy all the risks or go out and buy all the momentum. I think the prudent strategy for us has been in the way we have selected our top ideas is to manage that sort of quantum of risk. Hence banks, although have sort of slipped to a risk-on bucket, one has to take a slightly longer view, not a shorter term view. But still it could be part of the risk thinking here.

Amit Sachdeva: I think, our preference is clear in the way our stock picks have been. I think, our bank analysts would be the best to comment on specific ideas, but clearly we are positive on some of the large-cap names.

Amit Sachdeva: Our view is that it's still in that bucket that is stuck in that zone, where one has to, you know, take a bit of a risk-on position there. So I think, we stick to financials. Within the financial bucket, our preference is for larger bank space. 

Amit Sachdeva: Look, I think that's a great question and everybody has that question in their mind that consumption clearly has shown two spectrums, one part of consumption doing really well and one part of consumption is very weak. If you recall, we had portion on FMCG style consumption a while ago. That piece seems quite not well-placed and stocks have corrected as well. 

My sense is that the demand situation continues to be a little tepid. As such from staples or as a general basket, I think near-term recovery is still questionable and we had several pockets of consumption. For example, QSRs and if you look at even apparel and few other even discretionary consumption at the mass end is also impacted. 

So, our view has been that, for example, retailers are a good way to play some of these periods of tepid consumption where there is a structural code, ... where the business models are winning. I'm not specifically guiding for any particular stock. What I was trying to say is that our view that growth is almost very structural, growth is easy to come by, growth doesn't seem undeterred and that kind of dynamic is needed for performing in the current context. 

For example, obviously, rural areas have been an issue and sometimes urban demand has been an issue as well. So it's a mixed thing. So our view is that there's a large opportunity, where there's structural growth, where there's a winning business model, and where we see demonstrated consistent performance, that's the kind of stocks we have picked. We have stayed away from largely staples, you know, in the current cycle, but at the same time, you know, once there's a larger correction there, and there's a demand that takes a turn, which we think that may happen next year, but it's too early to call that out. 

So, I feel that the consumption basket seems very interesting, market would value structural delivery of growth, where the growth remains consistent, growth remains above average. Market would really value that.

Amit Sachdeva: I think the global picture continues to be slightly uncertain. Some demand scenarios and the way several pockets of economies are still grappling under fears of recessions and all those things. So, that picture remains mixed. 

That's the reason actually if you look at the one thing to watch out for actually from a global scenario is, rather than global growth, I would probably think that there are global risks we need to watch out for. What's happening with crude or what's happening with the US bond yields would have a larger overlay on the Indian market as well. 

In the coming months say for example, expectations of rate cuts in the Fed but happens in the second half. For example, if the geopolitical situation and how it evolves for example, in the Middle East. How crude sort of behaves that would also weigh. 

I think these are also larger global macro factors we need to watch out for. There is some obvious growth in external sectors. These are various pockets of it. Pharma could be another and you know IT could be another and there are different drivers for it. But at the same time, you know, I would probably think that for global macro context, we need to worry about these two aspects as well.

Amit Sachdeva: We like manufacturing-led themes in India and you know, some of the names that we mentioned in our top ideas are also linked with those themes. And at the same time, there's an overarching context also, we need to account for.