witty: As the capex theme slows down, Mirae’s Vrijesh Kasera identifies 3 other themes to invest in

Edited excerpts from a chat with the fund manager:Do you think it’s the right time to start selectively picking up rail and defense stocks that have seen a lot of corrections in recent weeks?
Despite the correction in recent weeks and expectations of a revival of government capital spending in the second half of FY25 and considering the additional fiscal headroom we may have at the end of FY25, we could see a solid FY26 in terms of government capital expenditure. The strong rally in these stocks and the stretched valuation remain a cause for concern.

The aggregate market capitalization of defense and railway stocks has increased by 56% CAGR (after taking into account the recent correction) from Rs 1.2 trillion in FY 2019 to Rs 14.2 trillion in the present. Thus, the combined market capitalization has increased 11.5 times in the last five years, while the sector’s combined profits have increased only 2.6 times, from Rs 119 billion in FY 2019 to 304 billion rupees in FY24. Consequently, the combined P/E ratio has increased by 5x, from ~10 in FY2019 to ~47 at current prices.

The market capitalization of the two sectors peaked in July 24 at Rp 18.2 trillion. Since then, there has been a 22% correction on an aggregate level, but current valuations still require being very selective in using fresh money, even if the structural case for these names remains strong.Also read | HDFC Bank has more rerating potential than ICICI Bank: Santanu Chakrabarti, BNP Paribas

Investors who were betting on PSUs and rail- and defense-related equity investments are now looking at new emerging themes. Where do you think the disk will be?
We sense a shift in preference towards (i) stocks/sectors with strong earnings visibility, (ii) defensive names and (iii) relatively lower results than last year.

Corporate profits, after four straight years of healthy double-digit growth, are moderating.

We see a greater preference for consumer discretionary, while at the margin, some staples also look good, especially as a hedge against any market correction. With rates lowering in the US, discretionary demand is expected to pick up there, thus providing Indian IT with some tailwinds. health care has consistently delivered healthy earnings growth over the last 4-5 quarters and remains a strong defensive play. Large private banks, after a prolonged period of underperformance, are also emerging as a good option for sector rotation.

The market has been largely concerned about the impact of tensions in West Asia, movement of FII money to China and high valuations. How strong do you think the story of China’s resurgence will be? Is this just a tactical trade or a long-term play?
The recent barrage of monetary and demand measures by China seems tactical in nature to us, as there are several structural challenges yet to be resolved, such as overcapacity in various segments, trade shifting away from China, aging population , the real estate crisis, demand deflation, etc. .

While the initial euphoric response was understandable given the very cheap valuation of the Chinese market at the time (54%/17% discount to MSCI India/MSCI EM), a secular bull run in the Chinese market may not be possible without addressing these structural problems.

Indeed, the initial enthusiasm of the Chinese stock market has died down and after the Golden Week holidays there was disappointment over the NDRC’s fiscal package, which came to CNY 200 billion against some expectations of CNY 3 trillion, which which led to a 7.4% correction in the CSI30 index on the day.

Small caps have had a tough time. Is most of the pain over or do you think there is more foam left on the market?
We believe small-cap companies may underperform large-cap companies. Skilled Small Cap is still trading at a 52% premium to its LTA and a 5% premium to the Nifty 50 (vs. LTA discount of -12%), while some earnings pressure has started to emerge.

The earnings cycle is showing signs of slowing down and we have witnessed a decline in consensus earnings estimates over the last 6 months. Small caps are more vulnerable to any temporary cyclical moderation in economic momentum and may face larger cuts.

Tell us your expectations for the second quarter earnings season. Which sectors are likely to disappoint the most?
Consensus estimates for Nifty are expected to see ~2% YoY growth in 2QFY25 (lowest in 17 quarters). Excluding OMCs, which would be hit by lower refining margins, Nifty’s earnings are still expected to grow 5% year-on-year.

In 2QFY25, overall earnings growth is anticipated to be primarily driven, once again, by BFSIalong with Technologyhealth care, Utilitiesand the best contribution of Telecom YoY.

In contrast, earnings growth is likely to be affected by oil and gas (led by OMCs), along with metals and Cement. Meanwhile, the real estate and retail sectors are expected to deliver strong growth, while capital goods, automobiles and consumer goods are expected to post moderate profit growth.

Given the valuations we’re trading at and the global setup, how bullish are you on gold and silver? Where do you see the two precious metals heading in the rest of FY25? Is it time to increase the allocation?
Gold grew at a CAGR of 27%/15%/10%/12% in 1 year/3 years/5 years/10 years almost at a similar pace as Indian stock markets with Nifty50 rising at a rate annual compound of 30%/13. %/24%/11% in the same period. Historically, gold is considered a hedge against inflation, global volatility, and geopolitical tension.

High inflation and geopolitical tensions caused world currencies to also weaken against the dollar. Furthermore, sanctions and the freezing of foreign assets of warring countries caused global central banks to hoard the precious metal. The share of the US dollar in total central bank reserves has also seen a reduction from 72 percent in 2001 to 58 percent in 2023.

Past returns due to gold price appreciation also attracted consumer demand, despite high gold prices. Silver grew at a CAGR of 11%/13%/19%/10% over 1/3/5/10 year periods, relatively underperforming both gold and the stock markets.

Given the backdrop of elevated broader market valuations, moderating earnings and continued global volatility, we do not see any major erosion in investor interest in gold in the near term. However, with the interest rate cut cycle set to accelerate and stock markets performing relatively similarly in the past, we believe stocks can outperform gold in the medium to long term, provided concerns before mentioned are moderated.

For someone with a moderate risk profile, what would be the best asset allocation strategy you would recommend?
While geopolitical headwinds and earnings moderation remain major concerns; The current festive season, a better-than-expected monsoon between July and September and the consequent expected rebound in rural consumption provide a short-term catalyst for economic activity.

Given the current market structure, earnings moderation and broader markets trading at significant premiums to its own LPA and Nifty50 (NSE Midcap index at 60% premium over Nifty-50 and 146% market cap of GDP), we remain biased towards Large caps.

We remain positive on BFSI, Technology, Healthcare, Consumer Discretionary and underweight on Oil & Gas, Cement and Autos.