markets: Christy Mathai predicts further market correction, warns of potential pain in small and mid-caps

Firstly, help us with your take on the markets going under the correction mode and do you believe that the bottom could be near, we might be hitting the bottom anytime soon or do you believe that the pain can elongate for a little longer time than now?
Christy Mathai: So, our sense of the markets is let us say from the peak of the market, Sensex would have fallen by about 12% near about and if you look at some of the broader indices, the fall could be much higher. So, if you were to look at the very large universe of the stocks which is listed today, almost 70% of them would have fallen by about 30% or more from their peaks. So, it looks like some correction has gone in in that broader markets but if you were to just look at the valuation standpoint, let us say a midcap index versus largecap index one year forward, so that number is still at a premium of 37%.

Now, one could argue that post COVID we have seen fairly good growth in the mid and small pockets and which is possibly now normalising, but also the flows have been extremely strong in that particular segment and if you were to look at very long-term returns and valuation charts, we can clearly see that these tend to mean revert and our sense is that mean reversion could even sharper if the flows were at risk at some point in time.

So, as a house, we think there is some more correction in the offing, possibly this would be much lower in the largecap because if you look at the largecap universe, financials is a very large component of it and they trade at a fairly reasonable valuations but outside of it, especially the small and mid we think there is still more pain to come through especially driven by flows.

Give us a sense that which sectors do you believe will be more vulnerable to the likely correction.
Christy Mathai: So, if you were to broadly look at the larger sectoral breakup. So if you were to look at, for example, the cap goods space, now they have had a terrific run in the past few years driven by some of the order book growth as well as some of that even translating to revenues, but incrementally the valuations have clearly moved up in that particular pocket and possibly now we are looking at some sort of a slowdown in that segment and that could be one place where this correction could be sharper. I know some part of the correction is already happening. The same is the case with some of the industrial, real estate, more capex-linked themes where again, again they have had their fair bit of growth but the valuation bakes in substantial growth even in the future.

So, those would be some of the pockets where we expect some bit of correction and also, if you look at the whole financial aspect especially, the whole links to the capital markets, so typically as the markets correct, there is a broader sense of larger earnings impact also because in the up cycle they tend to do well but when the markets come down, any of these financial themes be it broking houses, some of the AMCs and so on and so forth, so there are impacts that could be very visible on the earnings and if the valuation in those pockets remain higher, there could be some risk in that pocket.
I believe that in the recent fall, you also have been adding to some of those financials names as well as some of the insurance counters are looking attractive to you. But specifically on the insurance side, what is looking interesting and between the private as well as the public players, between the health and the life insurers, where is the place you are finding value?
Christy Mathai: So, in the insurance space, we have been adding to health insurer in the last probably quarter or so where we think bulk of the impact due to some of the corrections, possibly claim ratios shooting up has kind of normalised and possibly some of these players are taking price hike as a cohort going forward.

So, our sense is the pain would have kind of eased because bulk of the impact is already in the numbers and the valuations across the board have corrected.

So, we have been adding to some of these health insurers. Also, the case would be in the broader insurance space, general insurance, something which we have had for quite some time.

See, if you look at the whole space, when they IPOed some years back, they were price to perfection and we have seen a significant derating since then. Our sense is like the insurance penetration across the board remains fairly low in India and you take whichever life, general, and so on and so forth. So, the runway of growth remains very good.
Our issue all the time was on the valuations and now possibly is the time where that valuations have meaningfully corrected and we remain biased in a sense towards private insurers even in this space.

When we go through your portfolio and some of the sectors where you have the highest allocation, autos is another basket where you have most of the allocations there. Help us understand that how do you see the picture panning out and between the two-wheelers as well as the passenger vehicle, which side is giving you the confidence because for the whole year, there has not been much expectation with respect to the volume growth of passenger vehicles while for two-wheelers, we are seeing the valuation comfort yet again returning. Give us your thoughts on that.
Christy Mathai: So, within the auto space, like if you were to look at our allocation, it used to be substantially higher about a year back, but we have been quite aggressively trimming across the board within the whole auto space. And you are right, the passenger volume looks possibly not so great for this year and our allocation to that segment is a bit possibly through one stock but it is lower, primarily driven by again valuation.

But within the whole space of the PV, the two wheelers, the CV, the tractor, and so on and so forth, we think two wheelers still are comfortably placed especially certain companies who are catering to the mass segment there we think again the growth is slowly coming back after years.

If you look at the volume growth compared to 2019, possibly the two wheeler volumes are lower than what it was during the 2019 period, so that tells you that there is a substantial demand destruction which has happened as a result of inflation and so on and so forth.

But going forward our bet primarily is on the two wheelers and we have possibly perhaps increased our allocation over the course of time to certain companies which cater to the mass segment.

Other than insurance, any other pocket which is looking attractive to you and where you are finding that the valuations are reasonable now?
Christy Mathai: So, as I said, the banking space is extremely attractive for us and that is possibly the largest allocation, so possibly about 25% of our portfolio is geared towards that and within this especially the private sector banks occupy a large chunk of that.

Here our sense is like the credit growth across cycles have been close to about 2.5x to 3x of real GDP if you were to look at long horizon, there are some near-term issues that has cropped up be it deposit challenge, certain risk weight increase that the regulator had done about last year which impacted certain segments, some bit of that is reversing as we speak and also certain asset quality issues have cropped up in certain very pockets.

We do not believe any of these issues are probably lingering issues if you were to look from a three-year or plus horizon and the valuation across this bucket looks extremely attractive, possibly some of them are at decadal lows, so that gives us comfort to increase our allocation towards the private sector banks.