Why have largecap stocks in India like HUL, ITC, Reliance got massively rerated? What explains a 7-8% move in some of these heavyweight stocks? Also, what explains a 10% surge in the market from the recent lows?
There is definitely talk about the short term but if you look at the long term, the wind is blowing in favour of the largecap stocks which basically represent the frontline market leaders in every segment. These market leaders have gained because of two or three simple reasons and it is partly got to do with the environment that we are living in, in a post Covid world, where the big has gotten bigger, the frontline market leaders have been able to not only reach a much larger quantum of customers through their very efficient and widespread distribution reach, but they have also been able to pass on the price increases in various different segments.
We have seen input costs increase both in terms of commodities or even in other areas but it is really the largecap frontline market leaders who have been able to pass on these cost increases to their customers. We have seen this phenomenon even in the services sector. In the case of IT service companies in India, it is really the large frontline companies who are getting the lion’s share of the new orders that are coming in from the western hemisphere.
I would also point out that this is not a phenomenon that is unique to India. We have seen concentrated rallies all across the world, in the rest of Asia and other Asian markets and also in the developed markets in the United States. The FAANG stocks and the top 10 or 20 stocks in the United States have driven a lion’s share of returns. This correlates with what has happened fundamentally on the ground and for all we know, it might continue for some more time.
The other question we are trying to debate and understand is that okay, fair point, future is looking decent, the medium term outlook is strong, flows are strong. But unlike any other bull market when growth was strong, liquidity was strong and we saw a lot of volatility and even in a bull market markets could see a swing of 15-20%. How come there is no back and forth volatility?
That is not exactly true. Some of the other Asian markets like Hong Kong or the Greater China market have been quite volatile and have underperformed over the past three or four months. There are market specific reasons for that as we all know that there are regulatory pressures on quite a few of the Chinese sectors.
Coming back to your original question in the context of India, it is actually a bit surprising. About six weeks ago, we upgraded India back to overweight from an earlier neutral stance. But this massive rally has surprised us also. While we knew that there were quite a few stars aligning for India — a sharp economic recovery, currency remaining quite stable despite some of the Fed governors talking about taper and the taper expectations getting factored into the financial markets. Finally, the delta variant of Covid from which the Indian economic recovery has been sharper than expected. The stars were no doubt getting aligned but even this sort of a straight line rally for the lack of a better word has taken us by surprise.
I am trying to figure out the reasons and the one reason that comes to my mind is the lack of alternative large liquid markets because institutional investors are now forced to think about something outside China. China has about 40-45% weight in MSCI Asia ex Japan. So if an investor has to think of something outside China, he is left with very few choices. It is Korea, maybe some of the Taiwanese tech stocks and India.
In India, there have been some of these new listings of the tech megatrends which investors are fascinated by. It is no coincidence that it is coming at a time when the investors’ focus is moving away from some of those tech megatrends in China. It is a combination of all these factors that have seen the forces coming together for India all at the same time.
But let us wait and see how long this straight line rally continues. The market might take a breather and we might see some short term time correction. Over the long term, things still look quite okay for us.
You are overweight on India. What are your sectoral overweights and underweights right now, given your bullish view on India?
There are three-and-a-half buckets that we are playing in India. The first is financials. It is clearly the most economy sensitive sector as far as India is concerned and within financials, we have a large weight on the private sector banks; we have significant weight on the NBFCs, we are playing only through the real estate or property focussed NBFCs and the mortgage lenders.
We also have the insurance companies and we have recently made a small entry into a public sector bank as well but bigger, larger weight still remains focussed on the private sector banks.
The second large allocation is in favour of the IT companies. The new order wins have taken a new momentum over the past few months and it is really the front line largecap companies which are getting the maximum tailwind. These are the companies that have also demonstrated that they are able to save on costs in the new environment.
Third, there are very selective consumer plays — both consumer discretionary and consumer staples. But we are focussed on the top rung front line largecap companies and at the beginning, these are the beneficiaries of the wide market reach and the consequent ability to pass on the input costs to the customers.
So those are the three main buckets. I would also highlight the sort of half bucket that I talked about and that is telecommunications. For all practical purposes, this sector has become a duopoly and we are playing that through both a leading pure play and a conglomerate and that really sums up our India allocation in our Asian model portfolio.
When you talk about telecom, aren’t you worried about what is currently going on with respect to AGR dues and the battle that the incumbents are having with the government or the Supreme Court with regards to the AGR dues, and of course, the big hurdle of tariffs?
I would say that a bigger determinant for the longer term future of the sector is really the market structure. It used to be a historically very fragmented market. Now it has virtually become a duopoly and the market structure has really become concentrated.
Also, there are future growth opportunities with eventual adoption of 5G and much higher degree of smartphone penetration. The regulatory concerns are valid but as of now, it is really one player which is possibly bearing the brunt of that problem and paradoxically that has turned out to be benefit for the other players in the sector, turning it into a duopoly. Those are really the longer term focus areas that we take into consideration when allocating towards that sector.