Unmesh Sharma, Head of Institutional Equities, HDFC Securities who is a CFA charter holder and alumni from IIM Lucknow feels that the valuations remain high even if we look through the COVID-related disruption for FY21, and the base case is for muted returns in CY 2021.
In an interview with Moneycontrolâ€™s Kshitij Anand, Sharma who has about two decades of experience in the capital market recommend investors to build a core portfolio of solid stocks and add a small amount of beta (say 10-20%) at the other end of the curve in an unbalanced bar-bell as a strategy to start the year.
Q) The year 2020 which most of us thought could go down as a black year for equity markets, in fact, turned out to be a year of new trends, fresh record highs, and a whole new meaning to life. What are your views for 2021?
A) 2020 was indeed a fascinating yearÂ with Nifty delivering double-digit returns.Â This was the fourth year in a rowÂ in which the market ended withÂ positive returns.
Meanwhile, economic indicators and earnings have started to turn around and the rally has broadened in the last few weeks. Liquidity also remains strong.
All of these point to a strong start of the year 2021. However, if we look at the next 12 months, we expect the dust to settle.
Valuations remain high even if we look through the COVID related disruption for FY21. In this context, our base case is for muted returns in CY 2021.
Our base case is for positive single-digit to mildly negative returns on the market. The resurgence of COVID cases (especially related to the new strains), concerns in inflation towards the back half of the year (leading to expectations of central bank action), and strength of the economic recovery are the key trends we would keep an eye out in 2021. We believe that 2021 will be a stock-pickers market.
Q) How would you define 2020 in a word?
A) “Testing”. 2020 has been a tough year with extreme volatility. Even as we adjusted to the continuously changing environment related to the economy, corporate sector, and geopolitics, this year has been particularly challenging due to changes in the means of communication and practices in our workplace.
Many of our core beliefs regarding the investment process and our own business model were tested this year.
Q) What is your outlook on earnings for the year 2021?
A) The largest negative impact of COVID was spread across the last quarter of FY20 and the first quarter of FY21. As a result, FY21 earnings are expected to be largely flat YoY (albeit off a low base as FY20 ended up with negative earnings growth).
Our Research team now expects 36 percent aggregate PAT growth in FY22. While the headline number may look elevated, it looks reasonable in the context of the base effect from FY20 and FY21.
Risk factors to watch out for would be the sustainability of demand (would it taper off after the spike due to pent up demand?), gross margins (in a scenario of raw material inflation), operating margins (can corporates continue to deliver the cost control in a normalised environment?) and whether interest and effective tax rates would stay low.
Q)Â What are your expectations from Budget 2021?
A) As a house, we believe that the Union Budget has consistently lost relevance over the last few years. This is because of the increasing proportion of spending by the states and the government’s practice of not waiting for the Budget to make major announcements and initiatives.
In this context, we are not pinning our hopes on the Budget to help drive markets in either direction. As with every year, we would see increased discussion on this count over the next few weeks driving up expectations. We would be wary of this as the fiscal space is limited.
We expect continued focus and statements of intent (Atma Nirbhar Bharat) and some incentives (eg. PLI) for the manufacturing sector.
Q) Any new trends in terms of sectors which you are seeing that could last for the next couple of years?
A) Our preferred sectors continue to be IT, Chemicals, Pharma, Telecom, Insurance, large Banks, Cement, Durables and Gas while we remain underweight on Consumption (Staples, Discretionary and Autos).
In the last few weeks, we have increased our focus on the economy-facing ones like Banks, Cement, Infrastructure, Real Estate, Utilities, and Gas, which we believe still have room for re-rating.
Q) Your key learnings from the year 2020? And what would you advise investors to follow in the coming year?
A) Interesting question. I remember listening to an interview by legendary football manager (Arsene Wenger) about 5-6 years back. He made a very simple point – which I paraphrase “When you struggle, go back to basics”.
2020 was the year to apply this advice.
For 2021, our advice would be to hold your nerve. Situations will continue to evolve rapidly. As a house, we believe in buying solid businesses at a reasonable price, bottom-up stock picking with a close eye on cash flows.
Q) Value or beta â€“ what would be more popular in 2021 and why?
A) Unfortunately, there is no simple response to the Value vs Growth argument. If we run a classical value screen, most of the top 10 names seem like value traps to us.
Given that the market valuations are breath-taking and the rally has broadened, intuitively this seems right.
Our Research team usually operates in a framework where we re-define value. In an environment where knowledge-based businesses are gaining prominence, the value cannot be fit into classical Price to Book values. We, therefore, continue to focus on bottom-up stock picking based on delivery and outlook of cash flows.
We believe this strategy will continue to work well. This will be especially true in 2021, where our overall market return expectation is muted.
Globally, central banks have under-written liquidity even as macro indicators improve off a low base. The market is flush with liquidity at this time and we see this continuing for at least two quarters.
We would therefore recommend building a core portfolio of such solid stocks and adding a small amount of beta (say 10-20%) at the other end of the curve (economy facing sectors discussed earlier) in an unbalanced bar-bell as a strategy to start the year. We would progressively move towards quality as the year progresses.
Q) WhatÂ do you prefer largecaps or mid, and smallcaps in the year 2021?
A) We believe that at an aggregate level, the over-valuation atÂ Nifty level is starker than in the midcaps. However, within theÂ Nifty too, we see opportunities.
In this context, the model portfolio by our Research team has no bias based on market cap. We generally look at bottom-up opportunities. As discussed earlier, we continue to see bottom-up opportunities in the market across our favoured sectors.
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