Valuations stretched and time or price correction likely, says Ajay Tyagi

Tyagi says private banks, consumer services and consumer discretionary look attractive even as the market has turned expensive across most of the segments

Some of the best-managed banks in India are trading at lower valuations vis-a-vis their long-term averages even as their fundamentals remain strong, says Ajay Tyagi, Head of Equities at UTI AMC. In an interview with Abhishek Kumar, Tyagi says private banks, consumer services and consumer discretionary look attractive for investments even when the market has turned expensive across most of the segments. Edited excerpts: 

The market surprised most analysts in 2023 with a sharp rally. Is there scope for the momentum to continue in 2024?

It looks unlikely. In terms of valuations, we are significantly above the long-term averages as far as mid and smallcaps are concerned. Relatively speaking, largecaps are better but even there, the room for valuation upside is limited. They are trading 15-20 per cent higher than their long-term averages. Logically, a time correction should follow or even a price correction. The future course of the market will be determined by valuation de-rating and earnings growth.

With the rate cut hopes building up in the US, there’s an expectation of strong overseas inflows. The domestic flows have been strengthening each month. How big a support is that for the market?

The cause of strong flows is basically a strong market, as evident from the flows last year. The smallcap and midcap funds have garnered most of the flows because they have done exceedingly well. Will flows remain strong if markets turn sideways or correct? At least, history tells us that’s not the case. For us, fundamentals dictate the stock selection. 

What is your earnings growth expectation for FY24? Can mid and smallcaps deliver significantly higher earnings growth vis-a-vis largecaps to justify current valuations?

The Nifty 50 earnings growth may come in at around 15 per cent or slightly higher. Small and midcaps are trading approximately 40 to 45 per cent higher than their long-term averages. That's a very big premium and it will require very strong earnings growth in coming years to sustain the current levels. Any slight disappointment there would lead to valuations correcting. The quality of earnings should also be looked at. There are many smallcap companies with cash flow issues and balance sheet problems. The expectation in smallcaps is stretched, both in terms of magnitude and quality.

Sectorally, where are you seeing good investment opportunities?

The biggest opportunity we see is in private-sector banks. Some of the best-managed banks in the country today are trading at valuations that are lower than their long-term averages and we don't find any fundamental reason for them to trade at these valuations. 

We are also positive on the consumer services and consumer discretionary part of the market. Here again, because of demand weakness, stocks are trading at attractive valuations. As and when India’s middle-class consumption picks up, there will be a strong demand in these sectors. The information technology (IT) sector is also attractive.

Value as a style has done well in the last two years. Will this continue or growth could make a comeback?

Growth stocks may do better this year. The value index is trading at a significant premium to its last five-year average and valuations are at par with the long-term average. The rally in value stocks came on a low base and was led by re-ratings. Earnings growth will dictate stock prices going forward and growth stocks are better placed to deliver on this front.  

Which sectors may not do well?

Our view is that growth will slow down globally. China is already in a difficult situation. While the US will most likely avoid a recession, it may not see the kind of growth it has enjoyed over the last couple of years. Half of Europe will be in recession. That will have consequences on all global commodities and global cyclicals. The areas where we feel there would be negative surprises are global cyclicals, which include commodities and energy companies.  

Which funds should investors opt for in the current scenario?

Hybrid funds, especially balanced advantage funds and multi-asset funds, are a good option right now when valuations are on the higher side. If the market were to correct, there would be downside protection. Also, the equity allocation will automatically see an increase when the valuations improve. On the pure equity side, we are recommending investors tilt towards largecaps.