Small, midcaps to outperform largecaps this year as economy pivots to manufacturing: Emkay

The market performance this year will be marked by events such as elections, budget announcements and anticipated rate cuts, with a bulk of returns in the middle of the year and volatility at both ends, Emkay Global head of research and strategist Seshadri Sen has said.

In an interview to Moneycontrol, Sen said he is bullish on the market, with Nifty target of 24,000 for the year, suggesting a 10 percent return. Small and midcap stocks are expected to outperform largecaps, fuelled by a shift towards manufacturing and investment-led growth following the COVID-19 outbreak. Edited excerpts of the interview:

What are your expectations for the rest of the year?

We maintain a Nifty target of 24,000 for the year, implying a 10-11 percent return from the beginning of the year. We anticipate a “dad bod-shaped returns”, with a bulge in the middle driven by election results, the budget, and rate cuts, while the first and fourth quarters may experience volatility. Despite current events, our view remains unchanged. We believe that small and midcap stocks will outperform largecaps in the long term.

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What is the reason behind this optimism?

The economic cycle in India has shifted towards manufacturing and investment-led growth from the consumption and services-led growth previously. The largecap universe is dominated by services and consumption companies. The rise in smallcap and midcap stocks reflect this new economic cycle but any small and midcap rally is volatile, and that is what we are experiencing.

There is still froth and once they correct, they should resume their upward journey. Except the cyclical tightness in domestic liquidity, government balance sheet, corporate balance sheet, bank balance sheets, all are in better shape than the markets have been in for 30 years. I haven't seen the Indian financial system so stable and secure.

So, you think the recent selling in small and midcap stocks is temporary?

The current selling may be attributed to regulatory warnings and the lower capacity of smaller stocks to absorb selling pressure. However, this is a temporary pause in a bull market correction rather than the end of the rally, and we expect a resumption of upward movement later in the year.

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How do you assess the power sector and its investment potential? These stocks have had positive momentum…

Power has certainly emerged as one of the most exciting macro theme over the past three-four years. With enhanced power availability and regulatory measures addressing financial issues and infrastructure development, there are plenty of opportunities in both conventional and green power sources.

What about the defence sector?

The defence sector presents a long-term opportunity as India reinvests in defence, enhances efficiency, and reduces dependence on imports. However, defence projects are lumpy, which can lead to volatility in stock performance. While we don’t cover the segment in detail, valuations appear a little stretched.

How do you view the regulatory actions affecting banking and NBFCs?

We've been underweight on banks since October as the growth and ROE in banks are lower than historical levels. Therefore, a re-rating is warranted. As far as RBI actions are concerned, the larger banks and NBFCs will probably stand stronger because they will be better able to cope with the compliance with stronger systems and governance structures. I think the sector, as a whole, will underperform the broader markets. They will hold up in a falling market but will underperform a rising market.

What other sectors do you find attractive for investment?

We are overweight on consumer discretionary, industrials, materials, logistics and hotels. What we don’t like are financials and IT.

Do you see opportunities in the e-commerce space?

We like that space selectively. I am very bullish. A lot of traditional market analysts had made the mistake of believing that these companies were buying growth (investment) that is not sustainable. But it is sustainable because this is an oligopolistic market. Once a company is established, it doesn't get displaced very quickly, and there is a long runway of growth and operating leverage. Valuations are a challenge but I think now they are not as unreasonable as earlier. But, it is a very high risk sector with a high number of failures – you could go out of business and get wiped out.

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