Have low expectations, Samvat 2081 may be far more challenging for Indian stock market: Shankar Sharma explains why

Stock market today: Samvat 2081 may be far more challenging for investors than anticipated. After four strong years of a bull market, markets often slow down or take a breather in years five to six, potentially bringing only moderate returns, says Shankar Sharma, ace investor and the founder of GQuant, an AI-tech company. In an exclusive interview with Mint's Nishant Kumar, Sharma shares insights on key topics likely on every investor's mind, from the outlook for the Indian stock market to the impact of US elections on India and the prospects for Chinese markets.

Edited excerpts:

How would you assess the performance of the Indian market this Samvat? Did it align with, exceed, or fall short of your expectations?

India's performance in the last year has been exceptional, to say the least, and frankly, a little beyond my expectations—not that I'm complaining! But then, that is the way markets are: they never perform as per expectations. They are either over or under!

What are your expectations for Samvat 2081? Are there reasons to be optimistic, or do you foresee any significant challenges on the horizon?

I think the coming year will be far more challenging than investors are prepared to accept.

For one, we have had four amazing years of a bull market and usually bull markets tire or retire between five and six years.

That is a very good reason why the stock market animal is a bull or a bear: both are very heavy animals, are not very agile, and are meant to run very fast but for short distances. Unlike a horse, which is lean and meant to run very fast for very long distances. Bulls need to take breathers, and they usually do that between year four and year six of a bull market.

It does not necessarily mean a bear market. All it can mean is a year of moderate to negligible returns.

The problem is always the perception. When you get used to 30 per cent annualized returns over each year of four years, and then we run into a year in which we make only 5 per cent, it looks like a bear market!

I am keeping my expectations very realistic and low for the coming year, and hence, at least for me, the disappointment may not be much.

Still, I am not sure that is the way the large body of Indian investors is going to look at the markets for the next 12 months because expectations are very high and probably unrealistic.

What investment strategy would you recommend for the current market environment? How can investors identify opportunities in the large, mid and small-cap?

For me, the large-cap segment holds no interest whatsoever because those are companies that have already become extremely big relative to the size of the economy, and the headroom available for large growth is vastly limited.

Pick, for example, HDFC Bank, Asian Paints, or similar companies, and in all of them, you have seen moderate growth over the last few years.

Trees simply cannot grow to the skies, and these companies are now contributing a huge part to the profit pool of the market.

There are limits to how much they can grow in the next 12 or 24 months.

These kinds of stocks are meant only for mutual fund managers who want to protect their jobs because nobody gets fired for buying Asian Paints or HDFC Bank.

That used to be the case with IBM a few decades ago, and we all know how IBM ended.

For me, it is small caps and even smaller caps, and I'm prepared to take the risk and significant losses that come with small-cap investing.

However, I'm a professional investor, and I have experienced losses in my investing career that have been gut-wrenching.

It is precisely because of such experiences that I have become a more resilient investor since I've seen such cycles for 35 years now.

Therefore, when I lose money in a small cap, I have no problem mentally or emotionally because I take it as part of the investing risk.

Investing is all about risk because if you're not prepared for the risk, then put your money under the mattress and hope that your spouse is not around to steal it.

Therefore, my investing strategy remains unchanged for the next 12 months, which is to buy a basket of 25 to 50 small and very small market cap companies.

I do know that even in the worst of markets, I'm going to get at least five stocks that deliver massive returns and which will more than make up for any losses that I make in the bad ones.

I will get bad ones because one can never be too sure about the governance and the quality of accounting in small-cap investing.

As long as you are clear about what you are getting into, you should have no problem in dealing with losses because the profits more than adequately make up for such losses.

After the recent correction, do current valuations offer sufficient comfort? Or would it be prudent to wait for further corrections before making fresh investments?

Over the 30 years that I have seen them, Indian valuations have always been much higher than those of most emerging markets.

There is usually a good reason for this, which is that Indian companies make a far higher return on capital than most emerging market companies.

However, one must say that in the current bull market, valuations have gone to crazy levels for even extremely unsound businesses. For example, solar and other renewables are in deeper markets elsewhere in the world but are booming in India.

Whether this stock price boom will be sustained two years from now is a big question mark, especially given the nature of the business and crazy valuations.

Of course, my investing experience has also taught me that making a market judgment call based on valuation can be very, very dangerous because valuations can expand much beyond what the mind is prepared to accept.

What I also do know is that many of these stocks will become "reverse compounders," as I call them, which are stocks that keep compounding 50 per cent on the way down!

I am fine with some degree of overvaluation, but when things become crazily valued, I'm better off remaining with fixed deposits.

How much weight should investors place on macroeconomic events, such as Fed rate cuts and elections, when shaping their strategies?

Elections don't matter to markets except around election time, whether in America or India, because most political parties have converged on the same or similar economic policies over time.

It is mostly rhetoric that drives election campaigns, but once somebody gets elected, the policies become more conventional, which pretty much agrees with most people.

However, interest rate policies of the US Federal Reserve matter a huge deal to markets globally because, in large part, it also directs the movement of the US dollar, and the US dollar drives equity market returns much more than people understand.

In fact, if you can predict the direction of the US dollar, you can predict most equity market returns!

At this point, are you also considering the Chinese markets as a potential investment opportunity?

I have been bullish on China for the last three months and have been rewarded handsomely.

I continue to be positioned in China because that suits my style of investing, which is to put a decent amount of capital into stocks or sectors or countries which are shunned by people in general, which is what I call my " 4 AM Strategy".

The 4 AM strategy is not for everybody, and it is definitely not for the faint-hearted! You can go severely wrong in the 4 AM strategy, but when you get them right, you make out like a rabbit!

China is one such bit of a market because it has underperformed for a very long time. I do believe it is at an inflexion point, and the returns from China for the next few years can be far ahead of the returns from India.

Of course, I still have a lot of India in my global portfolio, so I'm happy if both do well!

With Q1 FY25 earnings showing weakness and Q2 results coming in even softer, is it time to approach the market with increased caution?

Absolutely! And we also should be cautious about GDP growth numbers because I do believe we are in for a moderation in GDP growth numbers as the government capex slows down, and this I predicted even two years ago because the government will necessarily need to reduce physical deficit.

The only way they can reduce it is by cutting back on capex, and government capex is the bullet that has driven this bull market train. But the bullet itself is running out of gunpowder, which will dramatically reduce the speed of this train.

Which sectors do you see holding strong growth potential over the next one to two years?

My approach is not at all sectoral. My approach is all about diversified small-cap holdings, and then from there on, it becomes a statistical game with probabilistic outcomes in which at least 20 per cent of a well-chosen 25-stock portfolio will be up two or three times the market returns and the middle of the back will be slightly ahead of market returns, and then they will be 20-25 per cent of the portfolio that will lose between 25 and 50 per cent.

Once investors understand that investing is nothing but a game of statistical outcomes and not a game of certainty by any stretch, they are already on their way to becoming very, very successful investors.

It took me time to understand this very simple logic about investing, but since the time I understood it, my investing journey has become smoother silk with no bumps, no hiccups, no emotional pain and no sleepless nights because it is when you understand what this game is all about that you have acceptance of losses which are inevitable in the investing journey.

However, the way we are taught investing in India is that every single thing has very predictable outcomes, and nothing could be a bigger lie in investing because nobody can predict, especially about the future!

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