High starting valuations dampen equity outlook in 2024: Neelesh Surana

Neelesh Surana expresses concerns over the quality of rally in certain smallcap pockets

Banking, consumer discretionary, and healthcare are attractive from a future growth potential and valuation perspective, says NEELESH SURANA, chief investment officer at Mirae Asset Investment Managers (India). In an email interaction with Abhishek Kumar, Surana expresses concerns over the quality of rally in certain smallcap pockets. Edited excerpts:

How are markets positioned at this juncture? Do you think they have gone quite far with optimism around rate cuts? Do you expect any repricing?
 

We maintain a constructive stance, considering a renewed capital expenditure (capex) cycle, a well-capitalised banking system, robust credit growth, an upturn in the housing sector, strong domestic consumption, and growing services exports.

Additionally, the peaking of interest rates and inflation, along with foreign flows due to global bond inclusion, will lead to stability on the currency front.

The International Monetary Fund projects India to contribute 7-8 per cent of the world’s incremental gross domestic product from 2024–2028.

Corporate earnings growth will be anchored around the low teens over the medium term.

Overall, the National Stock Exchange Nifty50’s performance (80 per cent rise in four years) is in line with its earnings growth (21 per cent compound annual growth rate, or CAGR, between 2019-20 and 2023-24 estimates).

What are the key headwinds for this year?
 

At the macroeconomic level, headwinds include global economic and geopolitical uncertainties. Also, the central government’s capex has trebled over the past five years, and incremental growth may be limited from this point. The most significant challenge is high starting valuations in some specific pockets.

You have a higher allocation towards banks compared to most of your peers. What makes you bullish on the banking sector?

Banks are better placed valuation-wise, especially largecaps. The one-year forward price-to-book ratio is well below the 10-year average. Banks also have a superior growth trajectory, with low-teen loan growth. Balance sheets also demonstrate strength as non-performing loan ratios are at historic lows and capitalisation is on the higher side.

Which other sectors are attractive right now?
 

Apart from banking, financial services, and insurance, we have a positive outlook on consumer discretionary and healthcare.

Reports show you are underweight on consumer discretionary. Are you waiting for a correction or any other triggers to raise allocation?
 

We maintain a significant overweight position on consumer names, both durables and discretionary. This is one theme that will benefit significantly from per capita income growth over the next decade.

The valuations are also reasonable right now. The sector is not properly classified yet, and that’s the reason we may appear to be underweight.

One can play the consumer discretionary theme through building materials, food technology, online fashion, and airline travel too, apart from the usual companies.

What do you make of the third-quarter (Q3) results that have come in so far? What is your earnings growth expectation for 2024–25?
 

The Q3 result season is only partially over and now presents a mixed picture, with some signs of softness. Notable trends include confidence in stability in commentary by information technology majors, mixed results in the banking sector with decent loan growth but margin pressure, and subdued consumer trends in fast-moving consumer goods impacted by weak rural sentiment.

Can midcaps and smallcaps deliver at the scale required to sustain present valuations?
 

The midcap and smallcap indices have nearly doubled in the past four years. Historical trends suggest that any segment tends to falter after a 25 per cent five-year CAGR. However, we are cautious only on sub-sectors that have seen massive melt-up during the past six months.

Given that some of these businesses are characterised by high cyclicality, asset heaviness, debt burden, lack of cash flow, low return on equity, and subpar management, there are concerns about the quality of the rally in this segment.

On the other hand, it is essential to recognise that the relevance of the midcap and smallcap segments, as a whole, has improved dramatically over the past five years owing to an increase in the types of businesses due to new listings.