Sensex at 85,000: This fund manager explains how investors can position themselves and make money

The domestic equity markets hit another major milestone as both benchmark indices reached fresh all-time highs. The BSE Sensex surpassed the 85,000 mark for the first time, while the NSE Nifty50 climbed to a record high of 25,981.50 on September 24, 2024. So how much amount investors should put into equities at the current levels and which themes will drive the next rally? In an interaction with Business Today, Amit Premchandani, Senior Vice President and Fund Manager, UTI AMC, shared his insights. Edited excerpts:

With Indian equity market reaching record highs, what is your projection for the future direction?

We do not predict market levels, what we focus on is valuations which are steep. Small and mid-cap are expensive while large cap is relatively better. We have internal model for asset allocation which is used for equity allocation in some of our asset allocation strategies and that model is suggesting less than 50% asset allocation to equity.

Market cap of companies is essentially the discounted cash flow of future earnings. It does not change materially based on short-term events. What changes surely is the narrative, so stocks which were riding on narratives are relatively more at risk than those which are backed by solid underlying growth.

Which sectors appear to be risky in terms of valuations? Are there any that you would consider too expensive to touch?

Real estate is a sector which is clearly expensive. We are in an environment of relatively lower affordability as compared to 3 years back. There is significant increase in launch pipelines in major metros and sharp increase in property prices. The market valuation cycle has moved from significant discount to NAV to significant premium to NAV and moving to EV/EBITDA as metrics to justify valuation. 

Hence, we have turned cautious.

Capital goods sector is another one which is pricing in mid teen growth with high margins to continue for perpetuity. We understand that this sector is cyclical with sharp volatility in earnings when the cycle turns. Order book of capital good space is strong and margins may also remain strong for next few quarters. However, if we take a step back, we see market ignoring any cyclicity in the sector as well as risk of margins reverting to mean. As an example, visibility of thermal power plants coming up beyond 10 years is very low, however market is valuing the near-term order flows to perpetuity for equipment suppliers in that space.

For mutual fund investors who have seen significant gains during the current bull run, would you recommend taking some profits off the table?

In the long-term, equity market returns are linked to underlying earnings growth but in the short-term market could either trade at expensive or relatively cheap valuation depending upon underlying macro-economic environment and emotions of greed and fear of investors. Equity markets have tendency to revert back to mean valuation and SIP is a relatively better approach for long term wealth creation. On top of that, investors may increase allocation to equity during market corrections. More than 30 years’ data analysis suggests that investment in equities at lower valuations have yielded better forward returns.

Which themes do you believe will drive the next market rally? Why?

BFSI as a sector provide valuation comfort as loan growth is in double digits, asset quality is robust, return profile is strong and most banks are adequately capitalised. Market is over focussing on short term/quarterly volatility in net interest margins (NIMs). I would prefer to focus on yearly ROE and ROA numbers, given valuation are cheap on non-earning measure such as P/BV. Deposit growth acceleration is key variable to drive performance in banks.

Cement is another sector which may see revival in terms of investors’ interest. This is one sector which has seen large cap performing relatively better than mid cap. Valuation differential between large and mid-cap is steep. Volume growth has been decent and is expected to pick up as construction cycle picks up while infrastructure related demand continues to be robust. Profitability of the sector has been below cost of capital due to low pricing power, we expect it to improve as consolidation drive rational pricing behaviour.

Power and healthcare indices have surged over 40% year-to-date, what is your outlook for these sectors going forward?

Healthcare as a sector has long runway for growth. Share of healthcare in overall GDP is less than 5%, which is likely to trend up as we age as a society and transition to more organised healthcare. Per capita number of hospital beds are at a fraction of global averages and diagnostics test has low penetration. 

As insurance picks up either through private sector or government policy, we expect greater focus on wellness and quality of healthcare to increase. India is the leader in terms of export of generics to developed markets and we have many well-run companies with cash rich balance sheet and healthy return ratios. Valuation is on the higher side. UTI Value fund has significant allocation to this space.

Power is a sector which is going through transition in terms of move from thermal to renewables. We are in a situation of decent demand growth yet non-renewable supply growth is muted which creates peak power shortage. Growth in renewable is strong but energy storage solution for evening demand is not available at industrial scale. This dynamic has improved pricing power of producers who sell large part of power in the merchant market. As the supply situation improves, this demand-supply mismatch driven pricing power may abate. Stocks are pricing in blue sky scenario which is unlikely to last forever. We are cautious on the sector.

How do you assess the current state and outlook of the defence sector?

The biggest customer of the defence sector is the Government of India which has a stated policy of increasing domestic content of overall defence outlay. This policy has provided visibility of growth as well as stability of growth for the major players in the sector. Stocks have moved up sharply on the back of strong order flows and robust margins. The sector used to trade at less than 15x PE 3 years back to above 35x + now. We think the re-rating is largely done, market has ignored the risks of slowdown in growth and reduction in margins. We are cautious on the sector on account of steep valuations.

Why has the banking sector underperformed compared to the benchmark index so far this year?

Banks as a sector has been subjected to intense scrutiny by the market. Despite reporting robust numbers for last three years, sector has underperformed primarily for the following reason. Firstly, large cap has underperformed than small and mid-cap over last 2 years. Banking is a large cap heavy sector with the largest private bank with high index weight going through merger related transition. 

Secondly, regulation has been tight in terms of increase in risk weights and higher LCR requirements. Thirdly, banks have to invest heavily to develop and upgrade IT systems for digitally native consumers in addition to spending on physical infra. Finally, deposit growth has been a constraint on growth runway which can be overcome with greater infusion of liquidity either through CRR cut or higher money supply growth.