What should your investing strategy be? Balanced with higher large-cap allocation

Brokerage ICICI Securities' preference is reasonably valued cyclical stocks over expensive defensives with growth concerns.

Brokerage ICICI Securities has advocated a balanced approach to overall investing with higher allocation towards large caps within equities. Its preference is reasonably valued cyclical stocks over expensive defensives with growth concerns.

"Behaviourally, rising gold prices indicate ‘flight to safety’ but it seems that the surge in calendar year 2023 is more of an effect of emerging market central bank demand which may continue. Real estate, as an asset class, is making a cyclical comeback after a decade and has scope to rise further. Within equities, there is significantly less fear towards relatively riskier stocks (mid and small caps) as compared to large caps while credit markets reflect adequate fear despite cyclically low NPAs and the end of the rate hike cycle. In such situations, we advocate a balanced approach to overall investing with higher allocation towards large caps within equities," said Vinod Karki of ICICI Securities. 

 BUY-rated stocks from the ICICI Securities coverage universe with (price/earnings to growth ratio <1.5

 

The brokerage believes the Sustainability of earnings growth of cyclicals emanates from macro trends. Gross fixed capital formation has been leading GDP’s recovery in the post-covid era,  supported by a cyclical recovery in the real estate sector, government thrust on infrastructure spending, conducive government policies towards manufacturing (PLI schemes, make-in-India policy etc.) and the China+1 strategy seen globally. 

"An environment wherein investors are fearful and demand higher ‘risk premium’ for riskier assets is typically conducive for prospective returns. However, the current environment for equities does not provide any such opportunity with relatively ‘riskier equities’ (mid and small caps) providing historically low ‘earnings yield spread’ over risk-free rate although large caps are closer to historical averages. This anomaly reflects investor optimism due to ‘low perceived risk’ towards broader markets on reduced volatility (VIX index), relatively higher returns in the recent past and improving fundamentals. Global risk appetite for India is also at a historical high in terms of low CDS (credit default swap) spreads over US CDS although their holdings are ironically at a decadal low. On the other hand, credit markets show an opposite trend (risk aversion) with high-quality AAA assets having historically low spreads over risk-free rate compared to their riskier peers (BBB and AA)," said Karki. 

Having observed the effect of a sharp rise/fall in the VIX (fear indicator) on one-year ahead returns for the NIFTY50 index, the brokerage said it indicates investor behaviour that is self-defeating during times when there is a complete ‘lack of fear’. 

Investor behaviour is self-defeating for prospective returns – low fear (red zones) or high ‘risk tolerance’ has generally resulted in low prospective returns

Unfortunately, investor behaviour currently has a high risk appetite and lack of fear resulting in historically low ‘earnings yield spread’ over risk-free rate for mid and small caps. However, large caps are closer to the historical average. This anomaly reflects investor optimism led by ‘low perceived risk’ towards broader markets due to reduced volatility (VIX at record lows although it has started to climb lately), relatively higher returns in the recent past and improving fundamentals (GDP upgrades for India and a rising profit cycle), noted the report. 

Global risk tolerance towards India is high in terms of record low CDS spreads and resilient INR

"The risk appetite towards India measured in terms of the CDS spread of India over US CDS is at a historical low. Ironically, this optimism has not yet translated in terms of FPI’s holdings of Indian equities which continue to be at a decadal low of 16.8%. A combination of ‘high risk tolerance’, ‘underinvestment’ due to mega rate hikes over the past two years and improving India fundamentals has the potential to drive FPI inflows going ahead," said Karki. 

Risk appetite in credit markets continues to be low

"Fear in credit markets (risk aversion) is evident with high quality AAA assets having historically low spreads over risk-free rate as compared to their riskier peers (BBB and AA) which have relatively high spreads even though NPA cycle is at a decadal low and prospects of a pivot by DM central banks in CY24," added Karki.