Should you go for value stocks now?

We are starting to get into a phase where the leverage stocks, the PSU stocks, have started doing well. I get a feeling that there is potential for this to be the big one, says Manish Gunwani, CIO-Equity Investments, Nippon India MF.

How much of the market is a function of liquidity according to you?
Liquidity is very important. It is very difficult to quantify but not only has liquidity directly played a role in the market but in case of leverage companies also, liquidity has been very helpful. So, we are seeing deals in real estate and infrastructure, where a lot of leverage companies are able to divest their assets at good valuations.

In fact, we are seeing a flurry of deals recently and that is changing the perception of asset quality for banks as well. So liquidity from various angles, has been the key to this recovery. It is very difficult to imagine that six months back, after an once-in-a-hundred-year health crisis, we could be back so soon. But it is also playing out in the real world.

Six months back, it would have been difficult to predict that real estate sales, order sales would come back so strongly. So, it is both fundamental and liquidity driven. How much is each is obviously very difficult to split, but yes things are looking all around right now.

When news is bad, prices are good and when news is good, prices are bad. Now news is good, but are prices bad?
Not really. Prices are probably bad from March lows. But from 2018 January, a lot of stocks in the cyclical sectors are still lower. The interest rates are lower versus Jan 2018. You could argue that the PEs need to be higher to factor in the lower interest rates. The interest rates are lower and you could argue that the outlook for next three years and earnings growth is better right now. The prices are bad versus March in a lot of cases but a normalised cycle may be fair value right now.

Would you go back to the original leaders which is IT and pharma which has started outperforming or is it time to stay with the current leg of outperformers which is cyclicals and industrials, cement and steel?
I would place my bet that value will outperform. If you see what has happened over the last 8-10 years, every time the economy normalises -- the global economy as well as the domestic economy as it did for one and one-and-a-half years -- we have a shock. In 2013, we had the Fed taper tantrum shock. In 2015, we had a China debt problem and the yuan devaluation shock. And in 2018, we had the US-China trade war combined with the NBFC crisis. Now the big question is a very accelerated cycle. From March, it has been a very traditional cycle where first pharma, IT did well which obviously have better balance sheets. The retail banks did well which are a bit more cyclical but still have decent balance sheets.

Now we are starting to get into the third phase where the leverage stocks, the PSU stocks, have started doing well. But I just get a feeling that there is potential for this to be the big one if we do not get a shock for a few quarters or maybe a couple of years as well because with each of these cycles, these stocks have got cheaper and cheaper.

The starting point is very low and so you do not need much. You just need no shocks to happen to a lot of these stocks to do well and given that we have had so many shocks, it does look like there is a good chance that we may see a lot of these value stocks outperform. It is global as well. We need to be nimble. We need to see globally whether FAANG stocks are dominating. It does look like the momentum is behind value stocks and given the normalised valuations, the bigger upside is in this category.

If one were to just go a little deeper into materials, you would probably look for quality picks?
You are not going to get great quality in the traditional term but you still have very few companies and CVs, steel, industrials, real estate, utilities are trading way below 2018 levels with dividend yields of 8%-10% at 0.5 book-0.3 time book value. In that particular sector, there are enough opportunities so that if the 10-year average valuation were to come back or if dividend yields fall from 10% to 5%, the stock can do very well. Across segments in metals, commercial vehicles, energy, industrials, real estate and cement, a lot of the midcaps are quite cheap.

ET Now: As attention turns away from the index, when can the broader markets expect to catch up? Do you see the rotational aspect picking up pace now?
Manish Gunwani: If value has to outperform, it has to be very sudden and not very prolonged. In a business cycle, at some point, the interest rates and commodities become a drag for the high quality consumption or staple sectors. If that can be called a half-way of the bull market, we are already there. Basically, the total market cap of the economy cannot go beyond a point because if steel and crude go up, then the consumption sector starts getting hit after a point.

My view is we are probably not very far off from that point we had reached in the 2003-2008 cycle; 2006 was the mid point where the value stocks started outperforming and the consumption stocks did not do anything till the financial crisis. We probably are closer to that point now and if the economy from both the global and domestic sense does not get a shock, it is quite possible that we may see the commodities value style work. If it works, since this seems to be a very accelerated cycle,it will pay out quite fast.

When it comes to the PSU pack, the CPSE ETF has surged about 13% in the last 14 days. As the government’s disinvestment plans seem to be gathering steam, the PSU index is showing a staggering 20% uptick in the last one month alone!
There’s a lot of value out there but not very often we ascribe domestic factors to all this. But I just feel that the way Indian markets were, the sectors with a lot of correlation to global happenings did well. All this started when FAANG stocks started underperforming prominently since the November first week when the presidential election and vaccination data came out. What the NASDAQ is doing versus Dow will probably give us a direction of value versus growth. We are coming to CPSE or PSUs as a stock picker. It is better to play select stocks within the PSU bucket. Also, one should avoid any kind of disrupted sector but even if you exclude that, there are a lot of secular growth stories which are trading very, very cheap.

Do you think there is merit in looking at the PSU banking space in particular?
We are looking only at the largest one. There is a cyclical component which can help all PSU banks but if one looks around the globe, a lot of market cap has migrated so fintech and so technology is going to be a big factor in the banking space which is the most structural factor. There is a conflict here with the small PSU banks. The economy is picking up, asset quality concerns are receding and the valuations are very cheap.

Anything which helps asset quality can result in a lot of value enhancement but at the same time, there is a structural component about technology becoming bigger and bigger. The top three-four private banks across cycles -- pre-Covid or post Covid -- show advances growth materially above PSU banks. The market is accelerating quite fast, taking away share not only from PSU banks but even from some of the NBFCs and smaller private banks. A bit of consolidation is going on in banking which is why I feel that going beyond the largest is not something I would favour at this point of time.