'Relevance of earnings releases has reduced over a period of time'

In addition, the current quarter is really a lot more about outlook commentary (leading indicators) rather than results (backward-looking), the analyst says.

"We are witnessing a clear reluctance amongst investors to take large bets at this time. However, in the medium term, we think US elections (like most elections) is attracting too much attention. From a market perspective, barring a few semantic changes, we do not see a massive change in underlying factors," says UNMESH SHARMA, head of institutional equities, HDFC Securities, in interaction with Swati Verma. Edited excerpts.

Your outlook for the market given uncertainties around the Covid vaccine and US Presidential elections.

The market today is driven by a confluence of factors - not all of which are aligned with each other. From India's perspective, the economy has shown some green shoots. Economic data releases are encouraging. More importantly, the outlook commentary from management teams at our recent conferences and earnings calls suggests that the sequential recovery is a bit stronger than our initial expectations.

On the other hand, we have global factors. Global liquidity is underwritten by global central banks. As a result, FPI buying continues and headline valuations are definitely not cheap. They are definitely not building in the possibility of a second wave and subsequent economic impact of Covid, which we are seeing across Europe and more recently in the US. On the US election front, we have a slightly nuanced view. Undoubtedly, we will see some volatility going into the elections, especially if the election is a close one and there is some long-drawn process before a clear winner is identified. We are witnessing a clear reluctance amongst investors to take large bets at this time and hence markets would remain within a tight range till the election results. In the medium term though, we think this event (like most elections) is attracting too much attention. From a market perspective, barring a few semantic changes, we do not see a massive change in underlying factors. Liquidity, fiscal stimulus, geo-politics (specifically impacting India) in the medium term would remain broadly unchanged.

Tell us about your investment strategy.

In this environment, we continue to take a bottom-up view. We generally prefer growth at a reasonable price- stocks with good visibility on cash flows, the strength of the balance sheet to withstand stress, and management quality (basically the ability to adapt to rapidly changing circumstances). While earnings upgrades play a large role in our stock picks, we differentiate between those names which are temporary effects with a one-off upgrade (which are priced in) versus structural beneficiaries, which won't see a plateau post end of the festive season.

Your view on the mid-and small-caps.

From an overall perspective, there is no obvious mispricing of small and mid caps versus the large caps at this time. But as mentioned earlier, we pursue a bottom-up methodology to pick stocks. Our Research team continues to see selective bottom-up investable ideas with favourable risk-reward across all market caps.

However, we are also keeping a close eye on potential catalysts for re-rating of ignored stocks in the economy-facing sectors such as Infra/Industrials, Hotels, Auto Ancillaries and Financials. Interestingly, in some of these sectors, the themes of “big becoming bigger” and “winner takes all” do not hold true, given the fragmented nature of business and niche opportunities. We see multi-year investment ideas for strong small-mid cap business models within these sectors. Probably the only difference here is that in the small, mid cap space, our analysts run a far tighter process in selection with enhanced weight on management quality and the balance sheet's ability to withstand shocks.

Q2 results so far have been good. Your view.

Let me start with a disclaimer. The relevance of earnings releases has reduced over a period of time. Across sectors, companies are now releasing updates with operational details in the first week following the end of the quarter. In addition, the current quarter is really a lot more about outlook commentary (leading indicators) rather than results (backward looking).

Within these contours, so far earnings releases in the second quarter have surprised us positively. Toplines were well-guided and hence in line. However, margins have surprised positively with management initiatives on this count and revenues (due to price inelasticity/ latent demand/ shift to organised segment, etc) having recovered faster than some costs. At this time, we estimate that we are on track for a 5-7 per cent beat on earnings for the quarter. However, I would take this with a big pinch of salt. So far, the sector leaders, larger companies are the ones who have reported, and anecdotally the volatility of earnings releases increases in the back half of earnings season. So the jury is still out on this. but it feels like we are in for a surprise of 5 per cent this quarter.

Auto sales have seen a sharp recovery. Do you think stocks of auto companies are good bets now?

We hosted a channel-check conference in the Auto sector recently and came away quite positive on the Auto names. We are bullish on the theme of rural recovery, the theme of personal mobility, and pick up around the festive season- not least due to the low base from last year. Discounts have reduced and we prefer market leaders across two-wheelers and four-wheelers with a wider product slate and rural/ entry-level presence. While Medium and Heavy Commercial Vehicle (MHCVs) remains lackluster, Light Commercial Vehicles (LCVs) are seeing encouraging trends along with tractors.

Your view on the financial (banks and NBFCs) sector.

We are watching this space closely. At this time, we lack clarity on the emerging asset quality situation. With the recent rally, we don't find comfort in valuations and therefore seek comfort in safety. This space is an Equal-Weight in our model portfolio. We prefer non-lenders- especially Insurance space. Amongst the banks and NBFCs, we prefer the larger private banks with a granular deposit franchise and a track record of delivering on asset quality.

Your overweight and underweight sectors.

We have an overweight position in Chemicals, Pharma (with a focus on consumer-style product slate eg. chronic therapies), non-lending financials, city-gas companies (quasi-consumer, structural theme, resilient to Covid), and Utilities. Further, we remain selective and have some overweight positions amongst large private banks, reasonably priced consumer companies witnessing earnings upgrades, and select IT services and cement companies.

Our underweight sectors are Metals and Mining, Energy (excluding Gas), and expensive consumer names, where we don't see scope for earnings upgrades.

What are the themes that would attract investors now?

The market is not exactly cheap. At this time we focus on secular themes. We think the market will look through the near term volatility and keep adding to these themes as they deliver on earnings and experience upgrades. Some themes include Knowledge-based industries, companies moving up the value chain/ skill upgrades, China + 1 / Atmanirbhar Bharat, the shift from unorganised to organised sector, granularity of deposit franchise, and lifestyle/home upgrades in a WFH scenario. These are reflected in our model portfolio. Premium valuations may be worth paying where we see a high probability of earnings upgrades.