Keep off momentum trade, balance consumer & cyclicals

Taher Badshah, CIO (Equities), Invesco Mutual Fund, tells ET Now that middle of the midcaps will probably do a little better than the upper and the lowest parts.Edited excerpts: When do you think semblance and stability will come back to the markets? Whatever has transpired in the last two-three months, especially in the midcap and the broader market, was partly self inflicted as we had gone overboard during the upside. Therefore, to me it is still cyclical or a bit of a correction or a reversion. We did extend the valuations, especially in the midcap space, beyond a particular level and to that extent, the pain in the shorter run looks relatively severe compared to what it should have been otherwise. But when we look at that space compared to what we were probably doing towards the end of calendar year 2017, we find there is a little more optimism, a little more constructive approach in terms of the larger midcaps.There are opportunities in the 100-200 stocks beyond the top 100 stocks. The valuations are relatively reasonable. They are not exactly cheap but they are at a level where they can be investigated and probably even bought into. I would say they are getting into that zone. But this does not hold true for the entire midcap and smallcap basket. So, you have to probably dissect it a little bit. The set where we can find scattered opportunities is getting a little wider than what it was six months ago. They may not prove to be profitable within next six months. But if you can hold them for next year and a half, then money can be made. This morning there is a lot of enthusiasm around IT. Currency clearly seems to be favouring them. Globally, things are looking up. Yesterday, Accenture upped the revenue guidance. How long would IT continue to be strong? Is it time to partially book profits in IT? The best time for IT was a year ago when there were contra ideas and compelling valuations. The growth trajectory since then probably has not altered significantly. Accenture has consistently outperformed and upped their guidance over the last two-three quarters but the mix is considerably different. Even within digital, it is more of the new digital compared to the old digital. As borne out by Accenture’s results, North America is picking up and that should partly help Indian IT companies also to move up from that 5%-6% growth that they have seen in North America over the last few quarters. Meanwhile, rupee remains favourable. Our analysis tells us that valuations are not cheap anymore but they are not expensive either. But can they significantly outperform from here on? Probably yes. The market is turning a little defensive and it is not as juicy as it used to be six months or 12 months ago. When do you think markets will start differentiating between good stocks and bad stocks? 2017 was a rising tide when everything midcap and smallcap went up. Now the reverse is happening. People are selling off mid and smallcap stocks without looking at balance sheet, valuations, earnings or PE multiples. 2017 was insane on the greed side. Can we say this year is insane on the fear side? Absolutely. This is the year in which I would expect the grain to be separated from the chaff and you will probably see a lot more rationality. This is not going to be a year in which you can easily ride momentum. You have to be far more considerate about valuations -- what you are paying for what kind of companies. That is when I said that the middle of the midcap will probably do a little better than the upper and the lowest part of the midcap. If you were to stack them in terms of quality of businesses, gravitation will separate the men from the boy. That will be the scene not just for midcaps, but even for largecaps. You will be a lot more stock selective in your approach, but one has to be careful about not buying a lot of momentum trade this year. If you buy something at 30 PE multiple, don’t expect that to be easily sold at 40-45 PE multiples. You have to be a lot more reasonable in buying in the valuations that you pay and that will probably allow you lesser downside. Protection towards the downside will allow you a certain degree of alpha even this year. Consumption is where valuations are not stretched. You can expect reasonable growth and frankly the volume dispatch numbers from Dabur and HUL have surprised us. But on the other side, you have got cyclicals which are cheap but the earnings are yet to pick up. What is a better strategy? Go for something where you know that there is visibility or align with the hope trade?It is important to strike a balance between the two. You cannot position yourself too heavily towards only growth-oriented stories and then end up paying heavy valuations for them as well. You have to balance your portfolio. On the cyclical component side you have to be careful about the quality of the companies that you buy. That will be probably more important than the quality of the companies that you buy on the consumption side. This is because the pain can be probably a little more and the time horizon could be a little longer. You do not want to end up with a situation where even if cyclical recovery comes about, it bypasses the investments that you have. So, as and when the cyclical recovery comes about, your investments need to be at the centre of that cyclical recovery and benefit out of it. You have to be really selective in that regard in cyclicals.You do not have a choice as a portfolio manager but to balance both the legs of the story and in the last six months while the markets seem to be suggesting something else, I have a feeling that in the short run sentiments are running way ahead of market realities. To that extent, the ground level situation does not seem to be as bad as what is probably getting reflected in stocks.It is still not that stage where you can completely dismiss the fact that cyclical recovery will not happen. We have built a few building blocks last year. We have put behind some of those issues like DeMo, GST behind us and even in corporate NPA related issues, a lot of ground has been covered in the last one or two years. You cannot bet against a cyclical recovery either in the next one-two years. It can still happen. So, from a portfolio perspective, you have to have a certain amount of logical positioning there as well. In order to buy the fear and sell the greed, what can you do tactically? What should you be buying and what should you avoid within mid and smallcaps? At a broader level, even in the mid and smallcap space, a greater number of cyclical midcaps have taken a bigger beating compared to the consumption or non-cyclical midcaps. Therefore, the same rule applies that you have a combination of both the sides of the story. You want to play consumption with a certain amount of reasonableness to valuations. You do not want to overpay and at the same time we also want to buy a few things which you believe have a fair chance of coming back. We have not been part of the global growth curve in the last one, one-and-a-half years. Some of it was missed by us in this whole confusion on GST. It looks like a fairly decent global growth cycle even now to us and therefore India should partake of that as well in the next 12-18 months. The growth opportunity is still available and that should also reflect on some of the midcap bets in the market. So, all is not lost. You have to learn to differentiate. Probably over the next six months, the market itself will differentiate in spaces where there was earnings delivery versus those where earnings delivery was misplaced. Should someone who is buying equities and has a genuine three-year view, expect double digit returns? We have a general election and we are on cusp of earnings recovery. If I put all these three factors together, can an average equity diversified scheme potentially give even a low double digit returns? Can we expect a CAGR of 10% plus? I wish I could assure the return but if you look at three-year cut, then remember that in 2013, a little before 2014, midcaps were not doing well but even if you were to account for the carnage of the last six months, even midcap and smallcap oriented products on a three, three-and-a-half year basis have done reasonably well and there have been 10% plus returns on the table.So that is possible. If you choose right midcap stocks, then you have a better chance of hitting 12% or 15% return number over a three-year period. I would agree that over three years, we still are in the fray for double digit returns and may be even more than that. This one year may be we will see a little more volatility and we need to be a little more watchful. Post that, we should be on course to deliver that return picture.

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