Foreign Investors Recalibrated To Cash In On Small-, Mid-Cap Outperformance: ICICI Securities
Foreign outflows were focussed on large caps, but mid- and small-cap stocks saw buying, said ICICI Securities' Vinod Karki.
Foreign portfolio investors are not bearish on the Indian market as the bulk of selling was focussed on large caps, while mid and small caps were bought, according to ICICI Securities' Vinod Karki.
Overseas investors are not negative overall from the domestic perspective, the head equity-strategy told NDTV Profit. "They are re-calibrating their portfolio towards riskier assets since they are outperforming currently."
In the first half of the financial year, the bulk of selling in the secondary market was focused on large-caps while mid and small-caps were bought, he said in a note last week. "FPI buying was spread across capital-intensive, high-beta and value stocks."
Vinod Karki, head equity-strategy at ICICI Securities. (Source: NDTV Profit)
Sectorally, maximum selling was driven by two quality private banks, consumer staples, oil and gas and information technology stocks, he said. Post Covid countries have seen mega rate upcycle which is the key driver for the fluctuation in the outflows, he said. "But that cycle is more or less ending."
Domestic flows have been so strong that they did not allow the markets to become cheaper even while the volatility in FPI flows was seen, Karki said. "We can see some situations that markets have run ahead of what the fundamentals suggest."
From a macro perspective, India is enjoying the best growth-inflation dynamics globally while the corporate profit cycle continues to expand, thereby making stocks expensive, the note said. "Expensive valuations and rise in global market risk will likely keep FPI flows volatile in the short term."
Watch The Interview Here
Here Are The Excerpts
Vinod, before I get to the crux of what you've written on the note, it's a question that's been coming to my mind every single time people talk about dips in the markets, I would love to understand how you think about it that whether this particular cycle since post Covid is materially different than what's always happened in the past, in that there was a large dominance of global flows, which when turned moved out, were not sticky and brought the market down quite a lot.
And in this case, FII ownership in Indian markets are probably at the lowest that they have been in some time. And the domestic flows of Rs 9,000-10,000 crore of net flows into SIPs make it a very sticky flow that comes into the markets every single time. So, is this time really different?
Vinod Karki: I think the markets, if you see historically, they're never quite different. I mean, it's more or less the same story, but in a different package. So, the clearest comparison can be made from an economic perspective, where the demand is panning out in the economy. We had a similar patch between 2003 and2008, where you name the companies, they were similar in the sense, you know, the capital goods, real estate, utilities, infra, banks so far haven't been participating, which makes them a value in this cycle.
But eventually, there is no investment cycle. So, say if banks don't fund this investment cycle. So, the point is, while the market has already, you know, kind of made it up its mind that there's an investment boom coming. That's why all these sectors are rising. But somehow, the assumption is that there will be no re-leveraging cycle, which, from a macro perspective, cannot happen. You cannot have a full-grown investment cycle without the re-leveraging cycle. So that's the thing.
From an economic perspective, we have seen a similar story play out between 2003 and 2008, where the balance sheet driven companies were really outperforming. Now coming to the flows perspective, see what happens post-Covid, you saw interest rates go to zero and negative in certain countries, which really flared up the valuations. Since then, we have seen a mega interest rate cycle, upcycle in the US, which I think is the key driver for these outflows and the fluctuation in the outflows.
I think that cycle is more or less ending. So, from that perspective, given that India macro story remains intact, and this pressure which is coming up on equity valuation is because interest rates were, you know, rising very swiftly. That will ease. But having said that, the domestic flows have been so strong that they did not give an opportunity for the market to become cheaper, significantly cheaper, even while this volatility in FPI flows was seen. So that's why I think you might get into some kind of situation where the market has run ahead of what the fundamentals suggest, so the market-cap GDP is almost approaching.
Sorry Vinod, which I agree with and the point being, these arguments about steep valuations have been there since 21,500 levels, right? We are circa 25,000 currently and that's precisely my question. Are flows really driving the markets higher or making sure that the markets don't see a significant dip?
I was looking at your note, for example, and why we talk about how mid-caps and small-caps are filled with froth, and yes, a lot of those pockets are. When I look at your own data, if you look at MFs and FPIs, which are the largest contributors, presumably, of flows, while MFs have put in money into mid-caps and small caps, where the FPIs have pulled out, the money is largely from large caps, mid-caps and small-caps haven't seen that. So, therefore, our flows, determining the market mood higher?
Vinod Karki: Yes. So that's what I'm saying, that despite this huge volatility in interest rates and the I mean, we saw volatility in outflows from FPIs, but on balance, the market has not corrected to the extent it should have, given such fluctuations in interest rates as well as FPI flows in between, we have seen. That's because whatever selling came from FPIs was more than soaked up by the domestic investors, and now FPIs because they don't see much issue has started jumping in and what is happening with FPIs, is a classic case of trying to undo some of their portfolio orientation, which is resulting in underperformance.
We have to remember that FPIs, traditionally, have been buyers of what you should say, the high-quality companies in India, which you have seen that are now performing. So if you look at their sectoral flows also YTD, one thing, it is remarkable that the largest outflow is coming only out of two banks, private sector banks, which we know are high-quality assets, basically, and they have, within banks, they have actually bought into the lesser-quality PSU banks have seen inflows during this year, and some other private banks which are not that high quality also, you know, and what are the next sector which they have sold consumer staples, IT and energy and what have they bought?
During the first half of this year, they have been buying all the high beta stocks, basically, so be it real estate, PSU banks and capital-intensive sectors like telecom, utilities, those kinds of things. So, it doesn't give me a sense that FPIs are negative overall from a domestic economic perspective. They are buying smaller-size companies, selling the darlings, which they used to have, the large cap quality companies, which they have been accumulating over several years and so they're more kind of recalibrating their portfolios towards riskier assets, because they are outperforming currently.
Points well noted. You know, the other interesting thing was just to see how mutual funds have bought so much of money into private banks, and yet that's the bucket that hasn't quite done well, and because of the factor that Vinod mentioned, which is that FPIs have been large sellers and predominantly, amongst the two large banks. Now therefore, the question that I have is, to your mind, what is the likely near-term trajectory, considering that flows may turn a little on the global side, on the passive side, if the Fed rate cuts were to come in, and by virtue of the fact that India's weightage in the EM basket is now a lot more than what it was, right? So therefore, do you sense that happening? I remember we were talking about the Fed rate cut led movements a year ago and it finally seems like it is around the corner?
Vinod Karki: I think if there is a 25-50 bps cut, I don't think that’s a surprise because the earning yields are already below 4% and also the bond market is already signalling more than that. So, if it is limited to 25-50 bps, it will actually not be surprising at all. But the point is, if the U.S. avoids a recession and the interest rate rise that we're seeing starts to moderate, and I don't see a massive cut in interest rates, if the US economy continues to be robust.
So, the latest ISM data about services and jobs for July were quite robust. So, I have to remember that the U.S. is at the forefront of the AI Renaissance investments in energy and also you can't write off that country in terms of productivity gain. They are at the forefront of what's going to drive global productivity and the investments there in that. So a lot of value will be created in the economy and the latest data doesn't suggest that even for the short term, we are seeing some kind of I think the US recession calls are at this point, at least speculative, in my view. So you may end up with a scenario where there is no recession, but a slowdown in growth while the interest rate environment moderates, which I think will be a reasonably good environment for equities, you know, but the valuations even in the US.
The US is the only country which is more expensive than India, I think valuations don't have any scope for further expansion. So I think there will be, I mean, a phase of where the stock prices don't go much, but they will go on the positive side, but not high returns. But nevertheless there is some kind of positive returns that’s how I see currently Indian and the US markets.
I wanted to talk about consumer durables industries because FPIs and MFs all have invested, but we have a management of Mazagon Dock ready to talk to. So, I just want to, if I can, before we wrap up, can I just ask you for a very quick view on some of these shipbuilding/defence names, because they've seen tremendous book to bill/build ratios, some concerns in the last couple of days, when the stocks have come off. How do you as a strategist look at some of these names, wherein they might be priced to perfection near term, but the order books are very, very healthy. How do you see them?
Vinod Karki: So, I go by this simple principle, you may be buying a great business of great potential, but if everything or more than what warrants is getting in the price, I don't think they are great investments. So, you have to look if something is at, let's say growing at, let's say it can grow significantly at a rate of around 15–20% over a long period of time. But if the valuations are like 100 P/E and all. So I think that's the key. So the order book and the growth may still be there but if the valuations are something which is out of the realm of reality, I think then you have to go slow on those stocks, without naming the stocks.
