Expert view: Nifty valuation not out of balance; resist reacting to interest rates, elections, says Marcellus co-founder

Expert view: Pramod Gubbi, the co-founder of Marcellus Investment Managers, believes the valuation of Nifty 50 is high but not out of balance. In an interview with Mint, Gubbi discussed the long-term opportunities and the impact of the US Fed rate cut on the Indian stock market.

Edited excerpts:

Does this market lack fresh triggers? What will drive the market in the medium term?

Lately, markets have been more driven by retail flows directly and through mutual funds.

That has helped the market overcome any disappointments, whether from geopolitical events, the election results, the Japanese Yen carry trade unwind, or the somewhat lukewarm earnings season. So, the question is, when do flows abate?

I wouldn’t hazard a guess, but more often than not, the biggest risks tend to be those that no one’s talking about; otherwise, they would be priced in.

Whilst we can't foresee what will cause a reversal in flows, what we know from history is that these things eventually revert to meaning.

Can the market sustain the current valuations? Is it ripe for consolidation?

In our recent newsletter, we talk about market valuations from a cyclically adjusted price-to-earnings (CAPE) perspective.

As of July, Nifty 50 CAPE stood at 37.8 times, roughly the 97th percentile of CAPE values since Jan-2004. Nifty 50 CAPE was roughly 2 standard deviations away from Nifty 50’s historical average CAPE of 25.9 times.

However, the CAPE of the Nifty 500 index, which includes small and midcaps, was even higher at 45.5 times, which was roughly the 99.5 percentile of the Nifty 500 CAPE value since January 2007!

Based on this, Nifty valuations are on the higher side but not terribly out of whack. The broader market (small and midcaps), on the other hand, clearly is trading at all-time high valuations, with specific sectors and stocks way above historical highs and with little fundamental support.

That would leave little upside even if earnings follow-through were to happen, resulting in consolidation for the market with potential downside risks should earnings disappoint.

What are the long-term opportunities? Should we focus more on the domestic theme?

Leaving aside valuations, long-term macroeconomic fundamentals remain intact. Recent policy initiatives to boost employment and consumption should augur well for domestic consumption growth.

Furthermore, early signs of a private sector capex cycle with a healthy banking system to support credit growth should mean well for domestic cyclical.

But current valuations seem to be pricing that in, putting a lid on expected returns from a short—to medium-term perspective. However, longer-term Indian domestic-themed opportunities look strong. 

What is your outlook for the Indian economy and inflation? When should we expect the RBI to cut rates?

Macroeconomic fundamentals remain robust. With global demand, especially the Chinese economy, slowing down, global commodity-driven inflation is likely to remain modest.

With good monsoons, if food inflation remains under control, the recent GDP print, which came in weaker than the previous quarters, and the now widely expected Fed rate cuts later this month might pave the way for the RBI to ease domestic monetary policy in the last quarter of this calendar year.

How could the Fed rate cut impact the Indian stock market?

Meaningful rate cuts by the Fed could result in asset reallocation and the dollar weakening, diverting flows towards risk assets, including emerging market equities, of which India could get a fair share.

Given the relative fundamental strengths of the Indian economy vis-a-vis other EMs (emerging markets), we could see more than a fair share if only our valuations cool off a bit.

How should investors' strategy be for the low rate regime? Should they increase exposure to equities?

Investors should follow an asset allocation-based strategy and use abnormal movements in any asset class to rebalance and take advantage of any drawdowns in one relative to the other.

Given that equities have done well over the past four years, it is likely that equities would have risen as a proportion of the portfolio and, hence, should be rebalanced downwards. Investors should resist acting based on interest rates, elections, etc.

Do you see value in emerging sectors such as renewable energy, electric vehicles, and new-age tech companies?

We are bottom-up investors and sector agnostic. Our investment philosophy involves looking at companies with clean governance, prudent capital allocation and sustainable moats.

If these conditions are met, we are open to investing in any sector. Having said that, valuations in some of the sectors mentioned seem to be running ahead of fundamentals, factoring in high growth till perpetuity with little to no risk of competitive threats in our view, and hence, we would be circumspect.

What might an ideal long-term portfolio look like? What should be the exposure to large, mid and small-caps?

Long-term portfolios should be based on individual financial goals and risk appetite.

Basis that a strategic asset allocation across equities, bonds, real estate and gold should be adhered to with periodic rebalancing to take advantage of dislocations in one asset over the other.

Similarly, within equities, allocations to large, mid and small caps should reflect goals and risk appetite with periodic rebalancing.

Systematic asset allocation with rebalancing not only reduces the volatility through diversification between uncorrelated assets but also improves returns by taking advantage of drawdowns in volatile asset classes such as equities.

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Disclaimer: The views and recommendations above are those of the expert, not Mint. We advise investors to consult certified experts before making any investment decisions.