Kotak favours mega-caps for reasonable valuations, resilience against uncertainty

Mega-caps have underperformed other large-caps, mid-caps and small-caps over the past 1-3 years

In its outlook report for 2024, brokerage Kotak Securities is bullish the benchmark Nifty index may hit 21,834 mark by December next year, indicating less than a 2 per cent upside against the current level. It sees earnings per share (EPS) of the 50-share index at Rs 964 in FY24, Rs 1,080 in FY25 and Rs 1,213 in FY26. 

The current calendar year has been eventful for the domestic equity market with the Nifty surpassing the 20,000-mark in September for the first time and BSE Sensex surpassing 70,000-mark in December. On a year-to-date basis, the NSE Nifty and BSE Sensex gained around 18 per cent till date. On the other hand, broader indices the Nifty Midcap 150 and Nifty Smallcap 250 indices surged 42 per cent and 46 per cent, respectively,  year to date. 

Sectors that have done well in CY23 include Real Estate, PSU Banks, CPSE, Auto, Pharma, S&P Industrials and FMCG. Kotak now expects automobiles, banks, diversified financials, IT services and oil, gas & consumable fuels to provide the bulk of the profits for Nifty-50 Index in FY2024.

"The up move in Indian markets was exceptional considering the Russia-Ukraine war, Israel-Hamas War, peak global inflation, rising crude prices, peak US 10 year yield and consumption slowdown. The upmove was driven by all classes of investors. While the FPIs set forth their conviction in Indian capital market by infusing Rs 1.14 lakh cr in equities year to date, the retail category (via SIPs) was not behind and invested Rs 16928 crore in October 2023 and Rs 107240 cr in the seven months of the fiscal year 2024," said Jaideep Hansraj MD & CEO, Kotak Securities.

Kotak Securities favours mega-caps for their reasonable valuations and resilience against uncertainties. They categorise Indian markets into three segments:  (1) The mega-caps are in a bear market, with many large-cap stocks delivering modest positive negative or moderate negative returns in the past 2-3 years. 

The large and high-quality midcaps are in a bull market, with weak operating performance in the short term and likely deterioration in fundamentals in the medium term being largely ignored by the market. 

Several low-quality midcaps and small-caps in general are in a bubble market, with the market attaching unrealistic narratives to many stocks.

Kotak believes that the mega-caps and financial stocks are reasonably valued compared to their historical valuations and future prospects.

"The recent sharp correction in stock prices may reflect  growing recognition of short-term (higher-for-longer interest rates, weak domestic consumption) and medium-term (disruption across sectors) challenges or  a ‘natural’ correction in The market from ‘high’ levels. In our view, large-cap stocks offer better reward-risk balance given more reasonable valuations versus lofty valuations of most mid- and small-cap stocks," said Hansraj. 

As per the brokerage, investment stocks have delivered strong returns over the past 6-12 months on expectations of a strong recovery in the domestic capex cycle. Strong government capex in the first six months of fiscal 2024 has supported this narrative. "However, we note two risks with this narrative— possible front-loading of government capex in FY24 and  financing of capital expenditure by large fiscal deficits, which may not be sustainable given high fiscal deficit. Private corporate capex appears to be sluggish given  weakening GFCF/GDP, despite strong government and household capex and tepid recovery in sanctioning of long-term loans for projects," said Hansraj.

The brokerage finds decent value in a few large-cap stocks and the BFSI sector only in light of the rich valuations of most stocks in the consumption, investment and outsourcing sectors. 

"As the broader market valuations are rich, opportunities arising from market correction can be used to add quality stocks (with attractive valuation) from a long-term investment perspective," said Hansraj.

Kotak sees Nifty at 24,260 mark in the bull case scenario and 19,408 in the bear case scenario.

It foresees global and Indian markets being influenced by factors such as interest rates in developed economies in early 2024. 

The brokerage identified several factors in the next few months that would shape the global and Indian markets in the first half of next year. These include the duration and magnitude of peak interest rates in the US and other developed economies, a likely revival in India, potential disruptions in certain consumption sectors like automotive and paint, and the upcoming general elections in mid-2024.

Gold: 

MCX Gold has delivered returns exceeding 10 per cent in 2023. With mounting possibilities of Fed rate cuts in 2024, the outlook for gold appears even more promising, according to Kotak Securities. 

The expectation is that inflation will ease in the coming months, supported by tighter credit conditions, a slowdown in rents, and decreasing prices for gasoline and used cars. A potential Fed pivot could stimulate flows into Exchange-Traded Funds (ETFs), which have thus far been a negative factor for demand growth. 

While interest rates may remain elevated for some time, the likelihood of further hikes appears diminished, given indications of a job market slowdown, tightening credit conditions, and elevated yields.

"Market sentiments are pricing in a full 25 basis points rate cut as early as June 2024, which is anticipated to serve as a significant trigger for gold prices in the upcoming year. Retail jewelry purchases may encounter challenges due to higher domestic prices in India and China. On the other hand, if the current momentum persists, central bank demand could surpass last year’s record. The hesitation of ETF investors and speculative buyers to actively participate thus far presents a growing opportunity for price strength in the fourth quarter. The prevailing geopolitical environment, slowing global growth, and economic uncertainties further enhance the appeal of gold as a safe-haven asset," said Hansraj. 

Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd