Taper down expectations now: Vikas Khemani

We will see accelerated flows coming from FPIs as well as FDIs. I am quite optimistic on both flows and continue to believe that we will be in a decent liquidity scenario for the markets in the medium term to long term, says Vikas Khemani, Founder, Carnelian Capital Advisors. We are looking at a fairly buoyant market fuelled by retail interest as well as liquidity. What advice should be given to investors at a time like this?We have seen strong positive sentiment across the board. The number one thing to do at this point in time is to taper down expectations. In markets like this, expectations run ahead and people start expecting supernormal returns and that is where disappointment lies. Secondly, look only from a medium to long-term perspective because the margin of safety in the shorter term has narrowed down significantly. A lot of positivity has been built in and rightfully so. I am fully convinced about the economic recovery, earning recovery being a long-term story. But the market has its own way of playing that out and that is where the whole greed and fear scenario plays out. I would say that the long-term structural trend is intact but taper down expectations and be careful about the margin of safety. Are there any immediate near-term risk factors? Is it just a sense of topping out or are you also mindful that the market may be vulnerable right now?In the market, it is difficult to predict where the risk will come from. If I were to say that while Q1 earnings will not be anywhere close to Q4 earnings, given that we had a partial lockdown, it will definitely be better than last year’s Q1. So to that extent, a little bit of tepid growth can be expected in Q1 but that is already baked in. But the risk always comes from unexpected factors. It could come from global factors. We have had a rally across the globe and there could be something from the Fed side. So one cannot predict risk but one thing is for sure that there is a euphoria building in the market. The run-ups in penny stocks indicate that people are jumping in because of fear of missing out (FOMO). Valuation and quality both are getting ignored or compromised and these are the typical signs of risk getting built in the market and one has to be very careful. I am not saying that I am bearish on the market. I am very constructive and positive on the overall earnings recovery and economic cycle from a medium to long-term perspective but one has to see what is happening in the short term. Where do you feel valuations are still attractive enough from a longer term perspective? In every sector, there are pockets where you could get conviction more than the valuations. We would like to always state where there can be disappointment on the growth aspect. It will be the single biggest factor and whenever there is disappointment of growth, one will see correction in valuation. So the factor to watch out for is whether there is a negative surprise on the growth factor. But from a valuation comfort perspective, within the financials -- private sector banks are still of reasonable valuation given the great earning cycle ahead of us. Even in some of the structural thematic players on the manufacturing side, there are companies which are getting into a structural growth path over next five-seven years and so there are many pockets of decent risk reward ratios from a growth as well as the valuation perspective available out there. IT services are still attractive. There are a couple of pockets where one could find reasonably good risk reward including the large caps. One has to be very selective but the key vector to watch out for is on the growth side. Valuations correct only when there is disappointment on growth. That is the vector we have been looking for. In some of the sectors like chemicals, three years and even four years’ earnings are baked in. Markets are assuming that it is going to be one way, there would not be any hiccup but things do not work like that. So whenever those hiccups come, you will see corrections happening in pockets. One has to be careful about these hiccups. There are many pockets where over expectation is getting built and whenever there is disappointment around those expectations, the stocks will correct significantly.How big a hiccup could the inflation number turn out to be? Also, how do you think the RBI is going to tackle this big spike in inflation?Inflation in my opinion is spiking because of lots of supply chain disruptions. This is not structural in nature. Of course, you will see some inching up but that cannot be what we have seen in the last five-seven years because we had anaemic economic growth. Some amount of inflation is good and so long as it is within RBI’s target and not structural in nature, I do not think RBI is going to sort of change its stance. We are far far away from that. We have not even seen a decent economic recovery. We are just in an early stage of recovery and I do believe that there are lots of underlying levers of inflation containment, including energy cost coming down and many more. So before the RBI changes its stance, they will see the overheating of the economy and sustainability of the growth are the two important things they will watch out for before changing the accommodative stance. We are quite some time away from that unless some international development forces them to do it. What to do with PSUs including banks because ever since SBI’s numbers came, the entire PSU banking space got rerated. There is no doubt that huge value has been inbuilt in most of the PSBs and PSUs because of deep value. Unfortunately we have not been able to unlock the value through reforms but this government has at least shown the intent to do strategic divestment. Some are already in the pipeline including Concor and BPCL. So if one has to rate the entire PSU basket, the market will watch out for the intent to convert into action. If one or two divestments happen, the entire pack will probably get rerated. There is huge value in PSU banks, They sit on a huge amount of CASA franchise which any private bank would die to create. But they have had a broken asset side which in some sense has got repaired and most of the provisioning is done. Now we will start seeing some amount of growth, which is happening in the case of SBI. We will see that playing out, there is no question. The only thing one has to be worried about. There is one trade which one can play from a valuation breaching perspective but once it gets into a reasonably fair value zone, then one has to worry about whether they can be structural in nature. That answer will not be available at least at this point in time because of the inherent nature of the management, traders and overall structure of the entity on the governance structure. These things have to be played as a trade till the time the valuation gap is breached. I would always say that private sector banks would offer much better risk reward from a sustainably long perspective then some of these banks. What is your secret mantra for getting rich?Work hard. There is no shortcut in life. Also keep a long horizon in mind and do not compare yourself with anyone else. Most people make the mistake of comparing themselves with somebody else. Investing offers a great opportunity for people to get rich and to compound their capital. One can start at any point in time. How are you looking at the high beta pocket in infrastructure and real estate?Real estate is structurally in a great tailwind post RERA implementation and post whatever happened recently on the regulatory front. There has been some consolidation as well. As the market is getting consolidated, bigger and better players will do well.There is no denial that demand for real estate is going to be here and Covid has only accelerated it. Today the affordability ratio is probably close to where it was in 2002-03. We have seen prices correcting and remaining stagnant for long and incomes are going up. We have a significant engine of job creation coming up from IT and manufacturing and in general, all of that will have a very positive impact on real estate. This is one of the core sectors and is very critical for the economy. I have always said that this is where the capital market was, in 1995. Post the formation of Sebi, a lot of cleanup happened and it took off. Real estate over the next 10-15 years will probably create a significant amount of wealth in different ways and hence one should look at real estate from that perspective and not from what can happen over the next six months. I have no doubt in my mind that 10 years down the line, significant wealth will get created from the real estate sector because new business models are getting created and one has to keep an eye on that. What is your take on consumption, discretionary in particular? Do you think things are going to get better for auto? In the short term, we will see Q1 getting impacted but I am reasonably confident that because of the mild lockdowns, we will see sales catching up in Q2, Q3 and Q4 unless we get hit from the third or a fourth Covid wave which nobody knows about. One should keep in mind that India will be in a phase of significant structural change in the per capita income over the next three to five years. And whenever this kind of a structural change happens, consumption in general goes up but discretionary consumption has a little bit more impact. There is premiumisation. People from the lower strata start migrating to the middle class and middle class people migrate to the upper middle class. That pushes consumption and premiumisation and over the next five, seven years, we will see that trend getting accelerated. It has been under play for the last many years but it can only get accelerated with the increase in per capita income. We will be surprised by the number of jobs that will be created in the IT sector and manufacturing. All these will have a very significant positive rub off effect on the consumption so that one has to keep in mind. How do you see the nature of market participation evolving as we go ahead? Currently, there is a huge amount of retail participation and it is not just the FII money that has been coming in. It will only go up. In my 20-25-year career, I have not seen such a confluence of accelerators or growth drivers coming together. This is one of those phases when we are seeing services exports picking up, manufacturing doing well, banking sector getting consolidated, real estate and infrastructure picking up. All these coming together will put India into a reasonably accelerated growth trajectory and that will have a very-very solid impact on corporate earnings. We are in for a great time ahead. The participation of the Indian population in equity is still way below global standards. Given that the alternative avenues in fixed income have been tremendously going down, that also is pushing money towards equities. It is only going to go up according to me. Once people get settled down around Covid and its worries, a much more accelerated flow will come through. Internationally, there is no other market which offers what India offers right now and we will see only accelerated flows coming from FPIs as well as FDIs. I am quite optimistic on both flows and continue to believe that we will be in a decent liquidity scenario for the markets in the medium term to long term.

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