DAILY VOICE | About two-thirds of the mid-cap stocks are still relatively undervalued: Dr. Joseph Thomas of Emkay Wealth

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Dr. Joseph Thomas, Head of Research, Emkay Wealth Management, believes two-thirds of the mid-cap stocks are still relatively undervalued and are trading closer to their historical averages. Moreover, their earnings have a strong positive correlation with the rate of economic growth. This leads one to the conclusion that they will make much better gains from the economic revival than any other segments or groups of stocks, he added.

With an experience in capital market spanning three decades, he is also a  visiting faculty at numerous management and professional institutes. Prior to Emkay, Thomas was associated with the Aditya Birla Group for almost 12 years.

Thomas has also worked at the Reserve Bank of India as a Currency Specialist and Portfolio Manager in the RBI’s Department of External Investments and Operations.

In an interview with Moneycontrol’s Kshitij Anand, he said high commodity prices and the galloping oil prices may have a negative impact on some sectors of the economy. Here are edited excerpts from that interview:

Q) Indian market seems to be tracking global cues. What would you advise investors?

A) The domestic equity market has been hovering around the peaks. The domestic macro numbers have been on the expected lines, and it gave comfort to the market about the sustainability of the rebound in economic activity.

The GDP number, the PMI, the core sector numbers, all indicate that the economic slowdown is over and that the rebound in economic activity is quite strong.

The Q2 corporate performance was good on account of operational efficiencies, and the Q3 numbers further reaffirmed the improving health of India Inc. In line with the preceding quarter, EBITDA margins showed further improvement in Q3 as well.

The top-line growth, too, reported healthy numbers, indicating an improvement in demand conditions. Most of the Nifty companies beat analyst earnings estimates due to which corporates may witness a round of earnings upgrades, thereby partly allaying the concerns with respect to rich valuations.

However, it is mostly the events from overseas markets that have been having an impact on the domestic market movements. In this connection, it is particularly worth mentioning that the developments in the US market have been a major factor in deciding the course in recent times.

The US Bond Yields have moved up quite sharply. The 10-Year Treasury has touched 1.60%, and this movement is occasioned by the expectations of a higher price level in the US.

As economic recovery is happening at a swift pace, it is highly likely that some amount of inflation would also crop up. This has been confirmed by the Fed Chairman, too.

But, he also hinted that the rise in inflation would be transient. But, the market believes that the moment the price level rises, Fed would start modifying the policy stance. This is causing the current surge in yields.

The question is whether there is going to be inflationary pressures in the domestic economy, too? Domestic inflationary pressures may rise if the fuel prices continue to go up.

Brent is going up and it is expected to go higher, and this may have an adverse impact on the economy as India is a major importer of oil.

Also, the high commodity prices and the galloping oil prices may have a negative impact on some sectors of the economy. This may be aggravated if there is a rise in US yields and consequently if the borrowing costs go up. These are factors to be considered while taking a view of the markets.

Q) What is powering the rally in the small & midcaps space?

A) The small and mid-caps have been favoured mainly on the basis of valuations. This gap in the valuations against the frontline indices was due to the lag in the price movement of mid and smallcaps in the recent past, especially after the pandemic broke out and the markets declined.

The slow catch-up coupled with strong outlook for many mid and small companies also helped. The availability of cheaper credit in view of the RBI policies, and secondly, the targeted repos instituted by the RBI are benefitting businesses in specific segments.

Many businesses, especially in chemicals and specialty chemicals, were also expected to benefit due to the china-substitution factor that was gaining ground.

There is another potent reason why mid and small-cap businesses may start doing better – on an index-to-index comparison, the Nifty Mid Cap 100 and Nifty Small Cap 100 have significantly underperformed Nifty in the last three years.

Almost two-thirds of the mid-cap stocks are still relatively undervalued and trading closer to their historical averages. Moreover, their earnings have a strong positive correlation with the rate of economic growth. This leads one to the conclusion that they will make much better gains from the economic revival than any other segments or groups of stocks.

Q) What is happening with commodities? Do you think we are entering the Commodity supercycle for the first time since 2008?

A) Brent has shot up to the $70 per barrel level, and it looks set to rise further. The recent rise in the prices, in the last few days, has more to do with the attack on the oil facilities in Saudi Arabia by some terrorist groups.

The most prominent factor is the output restrictions by OPEC + members. These output restrictions were further reaffirmed by Saudi.

The fall in the US inventories of crude is also a factor that has caused some nervousness in the market.

According to experts, the demand from countries like India, China, and East Asia is likely to rise in the coming months.

The rising oil prices further fuel inflation in countries like India, which depend heavily on oil imports. This may have some impact on the trajectory of the overall price level, and therefore, central bank policies on base rates. A rise beyond $70, and possibly $80, could upset many economic calculations.

Q) Gold also seems to be inching towards a bear market (a fall of 20% from the highs). What are your views?

A) Gold prices moved up from mid-2019 to 2020-end. Broadly, the range was from $1,430-$2,067. The first and most important fundamental cause for the up move was purchases by global central banks; the other reason being the large inflows into gold exchange-traded funds.

But, the driving force for the rally in gold was the uncertainty created by the outbreak of coronavirus pandemic and the resultant financial distress.

With the development of vaccines and the rebound in the economic activities across the world, the uncertainty created by the pandemic has been arrested significantly. Therefore, gold prices have been declining.

Currently, gold is trading at around $1,690, and it is expected to test lower levels in the coming months. Any break of $1,630 could take the gold prices to further lower levels technically.

The function of gold as a hedge against inflation may get triggered in the face of persistently high inflation. But such a scenario still lies mostly in the realm of speculation.

Q) How do you look at the PSU space amid the privatization buzz?

A) The privatisation move is an earnest attempt to achieve allocational efficiency in the capital. So many public enterprises have been running at a loss for so many years.

There was continuous capitalisation of PSU banks, but the business prospects of many of them remained weak. While making decision on investing in these entities, one needs to be very selective to avoid any value traps.

Disclaimer: The views and investment tips expressed by 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.

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