2023 could be more like 2013 but not as bad as 2008: Nilesh Shah, Envision Capital

If you are investing from a 1-year perspective, go with largecaps – the Nifty or a bucket of stocks from Nifty. But if you have a 3-year or a 5-year perspective, the advantage lies with midcaps and smallcaps, says Nilesh Shah, MD & CEO, Envision Capital

Shah further says that some of the stocks on the online side, which had gone for IPOs in 2021, five years from now could be hugely profitable companies and they could be a lot more valuable than where they are today. So, it could be a set of stocks which are either hated today or are doing well but are still mid and smallcaps.

They say history does not repeat itself, but it certainly rhymes. Having learnt from the 2008 experience, everybody is worried about 2023 again. Is the tape being replayed?
Yes, I agree in the sense that it is pretty much echoing the same kind of sentiment, the same kind of noises that we saw in 2008. We are hearing something similar. Just that, I do not think it is going to be as drastic as 2008. 2008 was a terrible year where the headline indices probably corrected by 60% or so from the peak to the bottom. I do not think it is going to be as bad as that. And I clearly believe that a lot of the signs, a lot of the kind of playbook is already evolved and it is already out there. So, I do not think the impact is going to be as bad as that.

But having said that, could we be in for some more extended period of consolidation? That is quite possible. We really do not know. The biggest uncertainty is still going to be about what the US Fed does, what is the stance of the US Fed on both liquidity and rates and that is going to decide whether for the rest of the year, we are going to have a risk-on trade or not. That is the key variable. Otherwise, there is not much else to worry about, especially from a point of view of where the markets are today. I do not see there is too much reason to worry.

The subprime crisis started in 2007. When it started, financial market watchers coined a term called decoupling. In 2008, they realised that it is a flat world and everything in a sense is joined at the hip. What are the chances that right now what appears like a storm in a teacup, in hindsight, will be much bigger?
Well, it could be a tad bigger because whatever challenges we have faced, especially what have come to the fore in the course of last maybe three to four weeks, both in the United States and in Europe, could pretty much catapult into something much bigger than than what it is even today. But will it be like 2008? Very unlikely. I probably see it would be more like 2013 which was obviously not a great year. 2013 was actually a terrible year, but not as bad as 2008. I think that 2023 could be more like 2013 and not like 2008.

I think in 2008, we saw a massive global selloff, capitulation and the damage was huge. I mean, we have never seen indices go off by 60%. I do not think we are going to see anything similar in 2023.

Post 2013, we saw a rally in mid and smallcap stocks. Mid and smallcap stocks have done rather poorly in the last two years. If we are in a 2013 kind of a scenario, could the reflation trade be there in some of the mid and smallcap stocks?
Quite possible. We could see some of the midcaps and smallcaps probably gravitating a bit lower from where they are today, especially depending a lot on what the US Fed does in terms of interest rates because that decides whether we are in risk-on or risk-off trade. But assuming that they do correct a bit more from where we are today, I believe that going forward from 2024 onwards, we are going to see a massive reflationary trade happening in midcap and smallcaps.

Valuations have become reasonable; with a bit of more correction, they become even more attractive. The pressures in terms of raw material prices, input prices have started to abate. We are seeing crude going down from $140 to $70 a barrel. Interest rates probably have peaked; at least in India. The Reserve Bank of India has been saying that the inflationary pressures are behind us. In fact, there is a stability report of theirs where they have reaffirmed the growth for FY24.

Fundamentally, we seem to have hit the bottom. If prices were to correct a bit more, especially on the midcaps and smallcaps because of global reasons, we are set for a very strong rally in 2024. The other thing where there may not be a causal effect but is very important nonetheless, is that one year prior to the general election in India is typically not a great year.

2019 was the election year and 2018 was not a great year. Rewind further, 2014 was the election year, 2013 was bad. 2009 was the general election, 2008 was bad. 2004 was the general election, 2003 was bad. Fast forward, 2024 is the election year, we are in 2023. 2023 for now at least is not looking all that great. Investors with a one-year plus horizon and with the conviction in India's potential, will be hugely rewarded 2024 onwards.

What are the chances that in the next six-seven months, by the time global markets recover, Indian underperformance will continue because of the general election cycle?
I would not rule it out. However, I do not believe that India will underperform. In a worst case or a base case scenario, India will probably be in line with global markets or emerging markets. I do not think that India will underperform because things like financial stability, inflation and macros of India are a lot better than where they were in 2013 or 2008.

In 2013 and 2008, we had huge challenges with inflation. Today, at least our inflation rates are not way higher than what it is the world over. If at all, it has been lower and managed reasonably well. Kudos to the government and policymakers. I do not think it is going to be worse than global markets. It probably could be that India would fall or correct or consolidate in line with global markets. And after that, at the end of this year and start of 2024, we are going to see a huge outperformance from India because all the positives will come back, the world will get into a risk-on trade and India is going to be the dark horse.

Let us divide the market in three time phases -- one year, three year, three year plus. What looks good and attractive for one year, three years and five years?
From a one year perspective, largecaps look good. Buy the Nifty or buy a basket of maybe five to six stocks in the Nifty. They all have come off on an average by about 25%, 20% to 30% from their peaks. Maybe there is room for them to fall further 5% to 10% because we can never say where the bottom is. But from a one-year perspective, that pack will do extremely well.

From a three year plus perspective, I believe midcaps and smallcaps are essentially going to beat every asset class globally and in India hands down. I believe from a three year plus horizon, mid to smallcaps look poised for a big outperformance.

Five-year plus?
Hard to say, but I think from a five-year-plus perspective, in a bull market or in an upcycle, midcaps and smallcaps will outperform and this has always happened. When I say mid and smallcaps, it could also mean a bunch of stocks which today are probably hated, are large enough but you cannot call them midcaps and smallcaps because their capitalisation is a bit higher.

For example, some of the stocks on the online side, which had gone for IPOs in 2021, five years from now could be hugely profitable companies and they could be a lot more valuable than where they are today. So, it could be a set of stocks which are either hated today or are doing well but are still mid and smallcaps. From a five year perspective, I think that is the pack which will do very well.


So I go back to the beginning of the question, for one-year perspective, go for five to six largecap stocks. What would be the combination here?
It would be a combination of say Reliance Industries which we own in our PMS. It looks good at this kind of price. From Rs 2,800, it is probably down to Rs 2,200.

It has underperformed even at Rs 2,800. It has underperformed for almost the last two years.
Yes, it has underperformed and is currently underperforming because it has announced a borrowing plan and the Street tends to take all of these with a slight bit of negativity or bit of caution. But it is there pretty much in the price.

The HDFC twins look good and especially post the merger, they should look good. You could even say ICICI Bank or anything like that. Some of the defence names like Bharat Dynamics or Bharat Electronics are the names we own in our PMS. These largecap companies look good from a one-year or even from a 1-3 year perspective.

Some of the insurance, mutual fund and asset management companies also look good. We own HDFC AMC. On Tuesday it was trading at 25 times trailing earnings for a business where the penetration is just about 2%, 3%, 4%. We are going to see more and more people and investors come in and participate in SIPs and a business which does not need capital. On a base case, this business has 10-15% likely earnings growth as well as 25-30% returns on equity. It is a highly capital efficient business which could keep growing for the next 5, 10, 15, 20 years and trading at 25 times trailing earnings. Probably the peak was at 50 times trailing earnings versus that it is 25 times trailing earnings. These kinds of stocks may not create fireworks, but would be a good place to be in from a one year plus perspective.

The anchoring for portfolio is also a function of the macro conditions. If interest rates and commodity prices are low, these are perfect conditions to buy into small and midcap stocks and add a bit of a beta. If inflation is high and interest rates are higher than historical averages, it is time to buy defensives to protect your money. What should be the anchoring of the portfolio?
My view is that at this point of time, it may not be the best place to go into defensives. When I say defensive, we are referring to FMCG kind of pack or maybe the core pharma pack.

Maybe IT also?
It might be IT as well. Maybe the macros in terms of being the worst, have peaked out. Going forward, I would think that the probability of a rate cut is way higher than a rate hike. I honestly do not think this is a great time to be in consumer space yet. There may be one or two names which you like but I do not think FMCG is the place to be in. Their volume growth will at best be 5 to 8%. Today, I would struggle to say that a FMCG business can grow 10% plus in volume terms.

They are actually growing lower than the GDP, to put it very simply.
Yes. So in the consumer pack, outside of FMCG, maybe things like alcoholic beverages, which we have now liked for a long time.

But why were numbers for United Spirits so bad if they are commanding so much market share? The big picture is that in good or bad times, people always consume alcohol.
First, because of industry-related challenges in terms of input prices, cost of freight, cost of packaging, cost of bottles and cost of raw materials.

Second, some of the states have not yet given price hikes and these are two industry related challenges for United Spirits, which is a stock we own. They have challenges in terms of trying to reorient their portfolio and they are trying to get a rejig and that is still a work in progress. It is quite possible that a couple of quarters later, we will start to see the impact of that positively. The company in that space that we like even more is Radico Khaitan.

How come you did not buy a Sula?
We are looking at it. It recently went for an IPO. We are still looking at it. We will probably spend a lot more time, take a harder look and then take a call but the space is interesting. Therefore, Sula is also on our radar. But, we have not yet taken a decision.

It is a season of change in IT. Macro changes, layoffs by big tech and if that was not enough, change of top guard. Infosys has lost talent. TCS has seen Rajesh Gopinathan's exit. Mr Desai from Mastek has decided to pursue different roles in the company. What do you want to start with macro, layoffs or change of guard?
I think the macros and the layoffs’ affects them a lot less. These are steady state like the way we alluded to FMCG companies growing in mid to high single digits. Largecap IT companies will still have that kind of growth.

8-10% growth is here.
I am taking Infosys as a reference point. Even in the best year, which was financial year 2021-2022 for the sector, their earnings growth was only 16%. In your best year, you are going to grow 16%. We have to keep that in mind that they will probably grow in a 10-12% range depending upon how your operating parameters are.

I would still think that the largecaps have played out. We have seen a huge rebound. Last year in 2022 or the start of this calendar year, the IT stocks were on the lower side. We have seen some kind of a rebound rate and we may be done with that. I do not think from here, IT largecaps can outperform in any significant manner.

I still believe that the change and the delta and therefore the alpha will come in from the tier two, tier three names, the midcap and smallcap names. There they have very interesting opportunities. Somebody is getting into a new niche, somebody is getting into new geography, there are client wins, a new CEO, new leadership team.

What do you like?
We own only two stocks currently. We own in fact only one stock which is called LTTS right now and that is about it.

You have sold Tata Elxsi completely?
Yes, we are out of Tata Elxsi and so we are going to be evaluating. I think we are going to take one or two more quarters. In that environment, we will come up with extremely good ideas.

In a name like Tech Mahindra, which is a largecap, there is a change of guard. Somebody with strong credentials is coming in. Plus, it has got the pedigree of the M&M group. The group's view of M&M has been very aspirational and is really driving individual operating companies really hard. There is a change in leadership for Tech Mahindra, the size is great. They have very minimal exposure to BFSI. They are in communications and telecom and all of that.

That is one company where we have not invested yet but we would want to be watchful. We would want to see what the new CEO has in store in terms of his aspiration, strategy and all of that. We will evaluate and maybe take a call there. So that is like one of the names which is part of our prospect list but is not yet in the portfolio.

But this is the lowest positioning in IT in your portfolio as a weightage?
Yes, absolutely.

You are supposed to be the IT guy. It is said, anything in IT, go and ask Nilesh.
In 2021 and early 2022, we had a lot of excesses in IT. Look at the excesses that we saw in names like Tata Elxsi and Persistent.

60 times-70 times.
All of that. The markets had priced in as if the margins that they were reporting and the growth rates that they were reporting will continue for very extended periods of time. I do not think so because our IT companies are services companies. These are not product companies. Again within technology, maybe some of the SaaS companies will work. We do not own any of the SaaS companies yet but some of them also might look very interesting. There has been 50-60-70% a shaved off. Maybe some of them have become very interesting.