Mid, Small-Cap Volatility Could Rise Amid Market Correction, Says Kotak Mahindra AMC

Mid and small-cap stocks are still trading at much higher multiples as compared with large-cap stocks. As compared with their own historical valuations, these mid and small-cap stocks are currently at fairly higher level, according to Harsha Upadhyaya, chief investment officer, equity, president at Kotak Mahindra AMC.

The volatility in mid and small-cap stocks could be higher in case of a market correction, or if corporate earnings do not meet the market's expectations, he told BQ Prime's Niraj Shah.

"So, that's the risk that any investor would probably face if he's putting lump sum investments into mid and small caps at these valuations," he said.

In terms of commodity pricing, with all the stimulus that may come through, global growth is going to remain subdued as compared with the trends witnessed in the past, according to Upadhyaya.

"I don't think there is going to be a positive trigger for the commodity pricing as such," he said. "We are definitely surprised the way crude has moved up without any real fundamental change in terms of demand."

All this can be attributed to geopolitical issues and OPEC's decision to limit production, the CIO said. "None of the commodities seem to be showing any great strength in terms of pricing."

In the consumption basket, caution is advised at this point of time, he said. There was an anticipation that the second half of the fiscal could see improvements, given that it's a pre-election year, with various rural initiatives planned. The hope was that these initiatives would aid in revitalising trends in rural consumption and related sectors, said Upadhyaya.

"However, given a deficient monsoon, even if there is a pre-election spend in the rural areas, we don't know how much of that will actually translate into higher consumption. So, that's a bucket which will probably see a muted demand trend," he said.

The information and technology services sector is currently experiencing slow business momentum and it may take a couple of quarters, at least, to witness a significant recovery in terms of discretionary spending on IT services, according to Upadhyaya.

However, engineering, research and development appear to be performing well. This segment is expected to continue delivering strong growth, he said. "And to that extent, within IT services, we'll continue to get better valuations in."

According to Upadhyaya, if there is a comparison between the current situation to previous peak cycles, "we are nowhere close to that peak cycle".

"Even if you compare it to 2011-12 probably, we are not there because that was a period where corporate capex was really high."

It doesn't seem like there is a very robust investment cycle, he said. However, it's important to note that there is typically a delay between corporate announcements of capacity expansions and their actual implementation. This lag period is usually around 18 to 24 months, according to the CIO.

"If you look at just the trend of announcements starting from financial year 2021 onwards, we have seen quite a bit of an increase and similarly, the implementation is also going up," he said.

The current investment cycle might not reach the levels seen in previous cycles. However, the expectation is that over the next 12-8 months, many of the announcements that have been made will move into the implementation stage, Upadhyaya said. "So, to that extent we are not really negative on the investment cycle per se."

The recent decision and comments made by the Federal Reserve have provided relief to the markets and eased concerns, and it's unlikely to see very low interest rates in the near future, according to him.

There was a fear that due to the increase in crude oil prices and yields, the Fed might raise rates further, he noted.

The U.S. Federal Reserve held its key interest rate steady, in line with expectations, as it kept the door open for another hike this year to cool inflation.

The Federal Open Market Committee decided to hold its key interest rate at 5.25-5.5% in November in a unanimous decision, according to its statement on Wednesday night. The central bank had hiked the rates by 25 basis points in July, which took the benchmark rate to its highest in 22 years. In September, it maintained the status quo.