Deep correction unlikely, allocate 5% of the portfolio to defence stocks: Geojit's Vinod Nair

We are not forecasting a major correction rather the possibility of a consolidation in the near-term due to low risk-reward ratio as a result of high valuation, negative earnings growth and weak fundamentals, Vinod Nair, Head of Research at Geojit Financial Services said in an interview to Moneycontrol's Sunil Shankar Matkar.

Q) RBI finally announced one-time loan restructuring after a lot of demand, but with riders. What are your thoughts and will it really solve the NPA problem for the banks?

A) NPA is the biggest problem for the banking industry and post-COVID, this issue has become a bigger pain. Before COVID, the gross NPA of the banking industry was forecasted to reduce to 10 percent by September 2020 which has now increased to 12.5 percent in March 2021, as a baseline. The worst forecast is 14.8 percent if the rate of economic recovery subsides for a longer period, which will be a disaster for the banking system. Hence, restructuring of company loans which are directly impacted by COVID-19 is an essential part of the total plan which is very positive for the economy and banks.

Q) After a rally from mid-May, do you think the market is due for a major correction which can drag the Nifty to 10,000 levels or do you see consolidation going ahead?

Vinod Nair

Head of Research|Geojit Financial Services

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A) We are not forecasting a major correction rather the possibility of a consolidation in the near-term due to low risk-reward ratio as a result of high valuation, negative earnings growth and weak fundamentals. The possibility of a deep correction is low due to high liquidity in the market and hope of a vaccine during the year. This outlook is venerable depending on the pace of vaccine development and implementation.

Q) The broader markets still looked strong given the outperformance to benchmark indices (from March lows as well as year-to-date). Do you think midcaps and smallcaps can beat benchmarks this year, especially after underperformance in the previous two years?

A) Yes, the possibility of mid & smallcaps to outperform the broad market is high. Because of cheap valuation compared to the largecaps and low risk of bankruptcy given supportive measures. In which we can expect a high quality of mid & smallcaps with solid credentials, clean balance sheet and leadership quality to hugely outperform the board market.

Q) The IT index did not see a major impact of lockdown. In fact, work from home helped them a lot in terms of cost-saving. Even the index posted a strong rally YTD and from March lows. Have you increased your exposure to IT?

A) Yes, the IT sector was amongst our best pick during the lockdown period due to stable outlook which we are continuing due to improvement in outlook with digitalisation. Out top picks are TCS where growth is expected to pick-up in the upcoming quarters with recovery in BFSI from Q2 FY21 onwards. Infosys, due to improved optimism in the company's long-term outlook and big deals. HCL Technologies, due to resilience in operation efficiency and solid services & product. In the short-term, concerns are that a good amount of gains is visible in IT largecaps trading at a premium valuation. But on a medium to long-term basis, we feel that this premium valuation and the possibility of further improvement in growth & valuation persists.

Q) Given the sharp fall followed by a sharp rally within a span of just 6 months, what is your advice to investors/traders on this Independence Day?

A) Yes, we are in a peculiar situation due to supremely high valuation increasing the risk of underperformance in the short-term. At the same time, business sentiment is building up inching the long-term outlook of the equity market. We suggest accumulation is the best strategy with a decent amount of exposure in mid & smallcaps. Some sectors like pharma, chemical and IT are likely to do well while value buying can be done in the Banking sector.

Q) Pharma (with participation by every stock) remained the leading sector in the current rally. Would you still recommend taking exposure to this sector?

A) Pharma was amongst our top pick during the lockdown period. And we expect this outperformance to continue in the short to long-term basis. COVID has helped the sector to regain its lost attention, in terms of its R&D, production and technology abilities to the world. Indian pharma sector was underperforming since 2015-16 and this change in trajectory could be a start to revamp its long-term outlook, in-terms of re-rate in investment, financial benefit and valuation.

Q) An embargo was imposed by the government on the imports of 101 defence items under the Atma Nirbhar Bharat program. Are you a buyer in defence stocks given the sharp focus of the government on the 'Make in India' programme and what is your advice to investors?

A) This is a very positive development for the domestic defence companies. At the same time, we should also accept the reality of the defence sector as an inelastic segment in the short to medium-term due to long approval period with bureaucratic and capacity constraints. Importantly, the fiscal position of the central government is very essential which currently is weak. So don't expect a revamp in the financial performance of such companies very soon. But it does provide an idea to consider such stocks from a long-term perspective due to high cashflow & visibility. One may give a 5 percent weightage to defence stocks in their portfolio.