In an interview with ETMarkets, Kapoor said: “Retail investors should prioritize building a well-rounded portfolio that includes both equity and debt, aligning their investments with their financial goals rather than chasing short-term market trends” Edited excerpts:
The market touched record highs post-budget, followed by a slight dip triggered by global cues. However, the Indian market managed to bounce back, which seems to be due to core economic strength. What are your views on this, especially considering the recent Hindenburg drama?
Sahil Kapoor: Over the last two to three months, the rate of ascent in the market has been slowing down. The market is now spending more time reaching higher highs than it was earlier, indicating a shift in momentum towards consolidation.
The market is still driven by the anticipation of stronger earnings growth, though the factors contributing to this growth are evolving. It’s important to note that economic growth is not the sole reason for the market’s rise. In fact, economic growth is leveling off.
We were accelerating in the previous two financial years, but now we are seeing growth stabilizing and, in some areas, slightly declining. Therefore, the market’s rise is a mix of earnings expectations and runaway investor expectations.
You closely track economic fundamentals, and we’ve seen aggressive moves from central bankers recently, which triggered a knee-jerk reaction in equity markets earlier this month. The RBI decided to hold rates, while the US Fed might cut rates in September. The Bank of Japan also raised rates slightly, causing a risk-off sentiment in equity markets. What are your views on the future trajectory of rates and their impact on equity markets?
Sahil Kapoor: Markets have become more normal now. Previously, bad news was often regarded as good news, as it led to expectations of interest rate cuts, which would drive market rallies. Good economic data also spurred rallies. Now, negative data is viewed as negative. Historically, central banks reduce interest rates during crises.
However, in the past six months, central bankers, including the Fed chair, have indicated that there is no need for large interest rate cuts unless there’s a significant economic decline or crisis.Large rate cuts, typically over 2%, usually occur during times of stress, which equity markets do not favor. It’s crucial to watch the US labor market.The unemployment rate is now rising, indicating that labor market tightness is easing. This, more than anything else, is the most crucial piece of information affecting markets. Most other factors are secondary.
Where should investors focus their investments? Are there any growth businesses to consider, or should they look for undervalued opportunities? A lot of the action has already taken place, meaning many stocks and sectors have experienced significant rallies. Where should investors look now?
Sahil Kapoor: The starting point for investors should be low-risk assets or categories designed to withstand volatility and market corrections.
For instance, I’d prefer to allocate new money to a multi-asset allocation strategy or an equity savings fund with lower equity allocations.
It’s essential to avoid frothy areas, such as microcaps, smallcaps, and midcaps, especially those that follow a momentum style of investing. Instead, focus on quality-oriented styles and portfolios.
Another important strategy is to shift away from the broader market and towards largecaps. Largecap companies currently offer a better relative play, even though they are not cheap.
Therefore, investors should prioritize categories with lower equity exposure, like multi-asset and hybrid funds, and focus on largecap equities.
The new generation of investors, Gen Z, is increasingly entering the market, often through SIPs. Many of these investors are still in college or pursuing post-graduate studies. There’s a lot of money on the sidelines, ready to enter the equity markets. Is now the right time for Gen Z to invest fresh money?
Sahil Kapoor: Unfortunately, our age and inclination to invest have nothing to do with market returns. Whether young or old, it doesn’t determine the returns we’ll get in the market.
New investors are often drawn to the market by recent returns, which is one of the worst reasons to start investing. Bull markets can be the worst time to start investing because they often teach the wrong lessons.
It’s essential for new investors to include equity in their investment mix for the long term. However, they must understand why equities deliver higher returns than debt.
The fundamental reason is that companies can earn more than their weighted average cost of capital, which leads to higher equity returns.
But if you buy investments at high valuations, the possibility of making excess returns diminishes. Therefore, new investors should focus on what they are paying for their investments, as this will serve them better in the long run.
Dhwani (user on Livestream) wanted to understand your outlook on the private banking sector. She’s investing for five to seven years, so I assume she’s a new-age investor who has just entered the market and plans to hold her investments for the long term.
Sahil Kapoor: The private banking sector has average or below-average long-term valuations for a few reasons. Firstly, deposit growth hasn’t kept pace with credit growth, causing stress in the sector. Secondly, there have been regulatory headwinds over the past year. Lastly, many of these stocks have underperformed.
Over the last five years, the Bank Nifty has underperformed the Nifty by a significant margin, almost 4-4.5% CAGR. Despite these challenges, the sector remains attractive.
Banks contribute nearly one-third of all profits in India, making it a crucial sector. Investing in private banks through SIPs and persisting for the next five years would be a good strategy.
You’ve mentioned one sector you’re positive about. Are there any sectors you’re cautious about at this time?
Sahil Kapoor: Several sectors warrant caution. For example, in the industrial sector, top-line growth has been just 10% over the last five years, while profit growth has been 25%.
Free cash flow generation is very high, but it hasn’t been matched by capital expenditure, indicating a lack of visibility for future growth. Therefore, I’d be cautious about industrial companies, particularly those with high valuations.
Similarly, sectors like defense and metals, where valuations have risen significantly, also pose risks. The broader microcap universe, regardless of the sector, is also quite frothy.
Which sectors are you currently overweight on?
Sahil Kapoor: Besides BFSI, which we’ve already discussed, I’m also overweight on the healthcare sector, which includes pharmaceuticals, path labs, and hospitals. There are many opportunities in this sector from a bottom-up perspective.
Additionally, I see potential in the staples sector, though not across the board. There are at least four to five companies in this sector that offer relative investment opportunities. Finally, the two-wheeler auto and auto ancillary space also present several opportunities.
Q) The real estate sector has been in focus, especially after the budget. We’ve seen a decent run-up in this sector over the past few years, followed by some tax changes and rollbacks. What are your views on the long-term potential of this sector, considering it has already seen some gains?
The real estate sector was in a low cycle back in 2022, and it has been re-rated over the last two years.
Sahil Kapoor: The margin of safety that existed two years ago is no longer there in terms of low valuations, but the cycle still appears to have strength for the next few years.
However, I prefer to be more skeptical and focus on a bottom-up approach rather than expecting a broad rally across the sector. There may be four to five companies within the sector that could be good five-year investments, but I wouldn’t bet on the broader sector.
Another important metric to watch is household physical investments in real estate, which peaked in 2011, bottomed in 2020, and made a comeback in the last three to four years.
However, this number has stagnated over the past two to three quarters, which could hold the key to the sector’s future performance.
Can you share your view on the rupee, which recently hit a fresh record low against the US dollar? What is your outlook for the short to medium term?
Sahil Kapoor: It’s difficult to predict a specific number, but I can highlight two important points. First, our foreign exchange reserves have increased significantly, meaning the RBI is likely to prevent any appreciation of the rupee.
This has resulted in a low volatility regime for the rupee, similar to what we saw in 1995. Historically, rupee depreciations happen in steps; there may be years of stability followed by significant depreciation.
Currently, the factors for large rupee depreciation are absent. Our balance of payments remains strong, though the reasons for this are not entirely encouraging, such as FPI flows into the bond market and relatively lower imports.
While the signs aren’t particularly positive, the balance of payments is strong. Therefore, I expect some depreciation over the next year or two, but not a significant one. The caveat, of course, is any unforeseen global event that could alter this outlook.
Retail investors have become a significant force in the market, driving this rally. DIIs are now the new force on D-Street, and we are no longer dependent on FIIs as we were five to ten years ago. Retail investors seem to be fueling the rally, pushing the Sensex towards 80,000 and Nifty 50 towards 25,000. What are your thoughts on this?
Sahil Kapoor: It’s positive that new money is flowing into equities as people recognize it as a good asset class. However, there’s a misconception that flows cause returns. In reality, flows follow returns, not the other way around. If the markets hadn’t rallied, these flows wouldn’t have come.
It’s crucial to understand that the quality of the rally deteriorates as new flows come in. Promoter selling and PE numbers indicate that the selling has been higher than the net inflows from SIPs, mutual funds, or DIIs.
The market moves in the direction of the more aggressive participant, whether buyers or sellers. Currently, buyers are more aggressive, driven by narratives and earnings growth.
My overall advice is to focus entirely on the earnings growth cycle, as it holds the key to equity returns. Everything else, such as flows or liquidity, is secondary.
You’ve mentioned that new investors often misunderstand the relationship between flows and returns. How should retail investors approach this market?
Sahil Kapoor: Retail investors should approach the market with caution, particularly during a bull market. It’s easy to be swayed by recent returns, but it’s important to remember that high valuations reduce the potential for future excess returns.
The key is to focus on the quality of investments and the fundamentals driving earnings growth. Diversification, discipline, and a long-term perspective are essential to navigating market cycles successfully.
Retail investors should prioritize building a well-rounded portfolio that includes both equity and debt, aligning their investments with their financial goals rather than chasing short-term market trends.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
