Midcaps and Smallcaps: Expect a muted trend in midcaps and smallcaps for some time: Sampath Reddy

Sampath ReddyFounder & CIO, Azurean Investment Managers, Overall, the strong profit growth of recent quarters is slowing. Overall, this slightly reduces the valuation premium that we previously had compared to most other global markets. So, we could see a subdued market trend for some time, especially in the midcap and smallcap segment.

I suspect that the portfolio doesn’t present a very pretty picture at the moment and if possible one should perhaps refrain from looking at the portfolios today with the kind of weakness that we are seeing. But do you expect this to be just a temporary problem, or will the next few weeks and months be full of turmoil and volatility for individual investors?
Sampath Reddy: Due to the upward movement of the markets in the last few years, valuations are higher overall, especially in the midcap and smallcap segment where valuations are significantly higher. Because of this, there could be subdued sentiment in the overall market in the very short term and even if we were to look at the Q2 numbers, the numbers are slightly below expectations in most other places.

Except for the companies involved in the capital markets, such as asset management companies or brokerage firms or companies involved in asset management etc., profit growth in most other areas has been quite weak. Even the IT industry, which has nothing to do with the domestic demand side, is showing relatively subdued profit growth.

Overall, the strong profit growth of recent quarters is slowing. Overall, this slightly reduces the valuation premium that we previously had compared to most other global markets. So, we could see a subdued market trend for some time, especially in the midcap and smallcap segment.

Did you cover Hyundai India when you tried to analyze the company’s IPO?
Sampath Reddy: No, we didn’t really look at that. We are currently in the middle of fundraising and are busy with these activities. But overall, overall growth rates in terms of valuations are slowing down even in the automotive space, particularly in the passenger car space. The camp structure was quite large. The automotive sector is facing a slight slowdown, which is why the markets are a bit weak.

What would be the trigger for FIIs and these retail and HNIs to come back into the market? Is it just the valuations that need to be corrected and we will have to endure this correction in time, or is it about profits or something else?
Sampath Reddy: Profits will weaken in the second quarter. Except for a few sectors, in most other places. The returns fall short of expectations. In fact, the BFSI space, where returns were expected to be quite robust, was also a slight disappointment. Overall, the results are somewhat disappointing.

On the other hand, the ratings are quite high. It is due to these two factors that we are witnessing this correction and moreover, this period coincides with the large amount of fundraising, be it through the IPOs or through the QIP and FPOs, all of which combine to absorb a lot of liquidity from the market.

All three of these factors combined lead to some sort of correction, and that is exactly what we are witnessing today. This trend can probably continue for a few more quarters. If we could see that earnings have either bottomed out and are rebounding, or if there has been some time correction, this valuation would look better. All these factors combined could lead to a revival in the market towards the end of this financial year.What areas of the market seem safe at this point, considering we’re seeing carnage across the board? As you said, earnings are also disappointing and that is also weighing on the markets. Other than those connected to the markets, is there any other pocket that you think is safe at this point?
Sampath Reddy: In the last two to three year bull market, most sectors participated in the rally. It’s pretty much one of the broadest rallies we’ve seen in recent years. Most sectors trade at fairly high valuations. But there are still a few pockets where you could see value. The private banks have not really grown much in recent years and profits have also increased, book values ​​have increased in recent years and they have probably performed worse.

With the exception of ICICI Bank, most other private sector banks have recorded subdued performance in the last one to two years. Private banks therefore appear relatively more attractive. Apart from that, pharmaceuticals also seem to be quite attractive, especially the generic exporters, where the price pressure is now easing.

Among consumer stocks, the QSR sector has faced significant headwinds in terms of demand growth, but this is a temporary challenge. They have very good long-term growth potential. Even from a very long-term perspective, QSRs look quite attractive. This allows us to find small pockets of value in the market, but by and large most sectors are slightly highly valued.

We have seen strong consolidation in the cement segment. How do you fundamentally see the cement sector as a whole?
Sampath Reddy: In the cement sector and other sectors, we have world-class companies and most manufacturing companies today have significantly less debt. Company fundamentals are quite good across the market. The growth potential is also quite good. It’s just that valuation is a concern for investors.

We just need some timing correction or some of the earnings acceleration that we need to see. Once this happens, we could get back on a good growth path from an earnings perspective. The same applies to the cement sector. The companies are good, the growth potential is quite good. Most companies have significantly less debt. Many companies have liquid assets and a healthy balance sheet. The concern is only on the review side.