DAILY VOICE | Market has not priced in possibility of second wave of coronavirus cases: Unmesh Sharma of HDFC Securities

A) The assessment is right. Confidence in this rally is low. The last leg of the rally (say 600-800 NIFTY points) has been quite narrow led by a select few- notably IT and some private banks.

We believe that the consistent theme in all rallies in the last 3 years has been the loss of conviction in the last leg. Yet again, the market is in consolidation mode with 'low conviction coinciding with strong liquidity'. This makes the market narrow and the index level meaningless.

A) The equity investments of the domestic individual investor is currently going through a phase which is impacted by a cross-play of factors- related to fees, performance, and market timing.

The search for outperformance by increasingly well-informed individuals, which can be driven by lower fees (selection between ETFs and active funds) or by alpha generation (selection between fund houses and schemes).

To add to this, a new phenomenon has emerged- the availability of time and bandwidth in the lock-down for individuals to manage equity holdings oneself.

All this coincided with a breathless rally, blurring the lines between skill and beginner's luck. The market also looks a bit expensive so overall investments by individuals across products may see a slowdown.

Eventually, my personal view is that some investments into direct stocks by individuals will move back to managed funds- the mix between ETFs and active funds is a bit tougher to call. Honestly, we believe the dust is yet to settle on this.

Q) What are your expectations from the September quarter earnings? IT sectors hit the ground running, and the initial commentary from India Inc. suggests that we are on a much stable wicket? Which sectors which you think could turn out to be a dark horse?

A) Over a period of time, the relevance of earnings releases has been reducing. Companies across sectors now release operational updates in the first week following the end of the quarter.

This improves the outlook on the top lines. In any case, we are in a phase where investors are looking at the leading indicators (outlook commentary) rather than results (backward-looking data).

To give credit to company management teams, they have been quite open in talking about the situation on the ground- which we saw at our recent conferences as well. So we are not really expecting any major surprises.

Having said this, we believe the IT, Pharma and Consumer stories are well recognised. We may see some financials surprise on margins and asset quality.

However, we believe stock price movements will continue to look beyond current quarter results and into the earnings outlook for FY22 and beyond

Q) Did your criteria for picking stocks changed or you added more parameters especially after the COVID breakout which has more or less shifted India Inc. as well as the economy to a new normal?

A) Our fundamental criteria for stock picking remains consistent across cycles. Our Research team generally prefers Growth at Reasonable price- stocks with good visibility on Cash flows, balance sheet strength, and management quality.

Needless to say, the weights and tactical moves are being incorporated into our stock picks. In the near term, the key criteria where we have increased our weight are management quality (with a focus on adaptability to rapidly changing circumstances); strength of balance sheet (does it stand scrutiny and our stress tests); higher visibility of cash flows.

We also differentiate between temporary beneficiaries of the pandemic- these benefits are priced in in our view. While there are no distinct parallels in markets, observations in the general economy post the Spanish flu pandemic a century ago suggest that some effects will last for years if not decades.

We try to spot these themes such as lifestyle/home upgrades in a WFH scenario, the granularity of deposit franchise, moving up the value chain/ skill upgrades, shift from unorganised to organised sector, China + 1, and Atmanirbhar Bharat.

We continue to believe that certain stocks in the IT, Pharma, Chemicals, select Financials, Consumer Durables sectors are likely to emerge as beneficiaries and the premium valuations may be worth paying where we see high probability of earnings upgrades.

Q) With money chasing few stocks even defensives have become expensive. Is valuation methodology getting challenged post COVID as stocks market valuation is at the upper end while fundamentals seem to be catching up?

A) We do agree that there are some pockets of over-valuation in the market. Multiple have run ahead of earnings delivery. However, our Research team's approach to stock selection has more weight on a bottom-up approach rather than index valuations.

While select  IT, Pharma and Consumer stocks have risen above our comfort zone, the last leg of the rally has been narrow and we can still see opportunities to invest.

We can see the earnings upgrade cycle playing out in select Private Banks, select IT names, Pharma and Chemicals, and some domestic cyclical like Autos, Cement, and Durables.

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