Daily Voice | This investment head expects valuations to ease out in small, midcaps next year

Yogesh Kalwani is the the Head-Investments at InCred Wealth

Yogesh Kalwani, the head of investments at InCred Wealth, expects valuations in the smallcap and midcap segments to rationalise in the coming year, given that a lot of positives seems to have been priced in by the market for an event-heavy year with the Lok Sabha elections and major monetary policy decisions to be taken by the US Fed and the RBI.

This is a good time to take profits from smallcap and midcap investments, given the sharp rise due to liquidity-chasing stocks and reduce allocation to this segment of market, he says in an interview to Moneycontrol.

On the corporate earnings, Kalwani, with more than 20 years of work experience in wealth management and capital markets, expects the earnings momentum to remain strong not only in the current quarter but also through FY24 and FY25. Excerpts from the interview:

Do you expect the valuations in midcap and smallcaps to remain expensive in the coming year too?

Nifty Midcap and Nifty Smallcap have outperformed the Nifty 50 index in CY2023. On a one-year forward P/E basis, the Nifty 50 is trading marginally around its long-period averages (LPA). However, Midcap and Smallcap indices are trading at a premium of 28 percent and 30 percent to their respective LPA.

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Yogesh Kalwani

Head-Investments|InCred Wealth

If one looks back at the past three calendar years i.e. CY21, CY22 and CYTD23, the Smallcap index has doubled, the Midcap index is up 1.8x, while the Nifty 50 index is up around 1.4x. The outperformance delivered by broader markets has been substantial in this period.

We expect some valuation rationalisation in SMID (small-midcap) in the coming year given that a lot of positives seems to be priced-in, apart from CY2024 being event heavy due to Lok Sabha elections and path of monetary policy taken by the US Fed and the RBI. This is a good time to take profits from small and mid cap investments given the sharp rise due to liquidity chasing stocks and reduce allocation to this segment of market.

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Do you see the Fed funds rate cut to be more than the Federal Reserve signalled in the December policy meeting, in the year 2024? Will the rate cuts start in the first quarter of 2024?

US Fed dot plot indicates 75bps of rate cut in CY2024 and rate cuts are expected to start towards the end of Q1CY24. The market seems to be pricing in aggressive rate cuts, however, conflicting remarks by Fed officials can keep the markets guessing and the rates volatile. Whatever the case, interest rates are headed down in CY2024.

Any risk factor that can weaken the market strength in 2024?

We broadly envisage risks to play out on four fronts.

a) Global monetary and fiscal policy

> While the Fed has signalled a pause in rate hikes (for now) and the US economy is showing incredible resilience, a flare-up in geopolitical tensions along with crude oil supply cuts by the OPEC+ could stock inflationary fears, delaying anticipated rate cuts in CY2024.
> Loose fiscal policy ahead of the elections in the US and the UK could stoke inflation concerns, delaying rate cuts.
> Resurgence of recessionary concerns in the US could have a significant bearing on the markets.

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b) Election results

> After favourable state election results, all eyes will be on 2024 general election outcome.
> Announcement of populist measures (cash transfers / subsidies related to fuel, electricity, gas / other freebies may have some impact on investor sentiment.
> A fractured mandate (low probability event) could also be a huge risk to the market sentiment.

c) Geopolitical issues

> Escalation in the ongoing war between Israel and Hamas and the long-drawn war between Russia and Ukraine may potentially disrupt the supply chains leading to re-escalation of global commodity prices (especially crude)
> Small and mid cap valuations could be a cause for concern
> On a one-year forward P/E basis, the Midcap and Smallcap indices are trading at a premium of 28 percent and 30 percent to their respective Long Period Averages.

Do you expect the December quarter earnings season to be strong?

We expect the earnings momentum to remain strong not only in the current quarter but also through FY24 and FY25. In our view, earnings growth would be led by margin improvement primarily due to a durable rise in capital expenditure and benign input / raw material prices.

We expect the growth to be fairly broad based that would be aided by production-linked incentive schemes, stronger exports, capex, infrastructure spend, booming real estate and expectations of continued FDI support.

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Only risk we foresee here is a sharp global slowdown (more towards H2CY24), resurgence in commodities and a General election outcome that alters the current policy and investment set up.

What should be the investment strategy for 2024 if the market participant holds Rs 10 lakh cash for investing?

It’s a good time to revisit equity allocations across investor portfolios. As a steady state allocation within equities, we suggest 60 percent to Large Caps, 25 percent towards Mid Caps and balance 15 percent towards Small Caps as an allocation strategy.

However, given the wide outperformance of SMID segment over Large Cap stocks, and the fact that this segment is trading at 30 percent premium to its average valuations, we think it’s necessary to exert some caution here and hence go marginally underweight in Mid and Small caps. Basis this view, tactically we go overweight Large Caps (70 percent of portfolio) and restrict Mid Caps and Small Caps to 20 percent and 10 percent respectively.

This could be a good time to take profits specially from mid and small cap investments made over past 2 years given the sharp rise in stock prices in these segments of the market. We envisage a possibility of valuation rationalization here during the year.

Invest 50 percent of cash (profits booked) as lumpsum in large cap stocks/ funds (given the relative value there) to benefit from the expected pre-election rally and the much-awaited US Fed pivot to playout in early 2024. Balance 50 percent to be staggered over the next 6 months or on market declines.

For investors who are under allocated towards the mid and small cap segment, it’s prudent to deploy over a 12-month period on staggered basis (within the stated allocation limits above)

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.