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Next leg of correction may start in largecaps: Harsha Upadhyaya

If the main line index starts to correct more than 5%, then there could be another round of fall in mid and smallcaps, Harsha Upadhyaya, CIO-Equity, Kotak AMC, tells ET Now.Edited excerpts: When the year started, the smart guys said in 2018, hunker down your expectations. This is not going to be a repeat of 2017. But I do not think anybody saw this kind of gut-wrenching fall in midcap and smallcap was coming. A fall of 5%, 10%, 15% was what old timers were predicting. But now it is 30% to 50% on an average. Yes, that is right. Whenever the pendulum swings, it swings to the extreme and we have seen complete risk averse in mid and smallcaps. More than two-third of the stocks in the universe have fallen more than 20%. The median fall in the top 1,500 companies is more than 30% year to date. That clearly shows the kind of nervousness that is there in the market and part of it is also because of the fact that in 2017, the returns were very significant especially for midcaps and smallcaps. It was a one-way street without any volatility. A lot of money has flown into mid and small caps which had raised valuations there and with this nervousness, the correction is becoming significant. We really do not know whether the entire correction in the midcaps is over or not. Our belief is maybe there is one more round of correction still out there. You are scaring me. Look at the main indices. Whether it is Nifty or Sensex they have not really shown any kind of fall, 3% to 4% fall is generally a correction in a bull market whereas mid and smallcaps have shown significant correction. So, what if the main line index starts to correct more than 5%, then there could be another round of fall in mid and smallcaps. That is what we fear. How meaningful could the next wave of decline be considering we have already fallen about 26% on the smallcap index from an all-time high? That is a good point. In the last six months, while the largecap index remained more or less stable, we have seen a significant correction in mid and smallcaps. So maybe not to the same extent, but still when the main index falls, we could expect some more correction in mid and smallcaps. But that could be a buying opportunity on a stock specific basis. If you are calling for a correction, I am sure you would like to protect capital. Are you sitting on cash which is much higher than your historical levels and at what level would you be happy to put that cash to work? We generally do not take cash calls because that is a double-edged sword. When the markets move sharply on the other side, you get left out. So, as a policy, we do not hold more than 7.5% in any of our equity schemes. Currently, we are in cash between 3% and 6% in most of the portfolios. Cash generally do not give you resilience in terms of managing the NAV, but it does give you the optionality of entering some of the stocks where there has been significant correction. That is what we are looking at. We would be looking at investing this cash in the next leg of correction. But what would you hunt when that next wave of correction really comes in? I am sure you are deploying this time in the sidelines to chock out that list and pockets which are looking interesting to you? It has been very stock specific. We are looking at two kinds of stocks. One, where there has been some negative news or negative development and the stock has fallen sharply and if that correction has been more than what the fundamentals warrant, then that becomes a buy for us and secondly there are many steady growth companies which were generally trading at let us say for example at around a certain level of price to earnings multiple or price to book multiple that has got elevated in the year 2017 and we saw may be 30-40% higher valuations as compared to average valuations in many cases. If those set of stocks have seen correction, may be those are still giving you a steady set of earnings numbers but the valuations have come back to historical averages so that again becomes good basket to look at. It is going to be very stock specific. We do not have too many names in front of us but I think we will keep watching and see where there is significant correction more than what the fundamentals warrant and try to deploy some money there.Is the run-up in IT slightly over exaggerated? The way TCS and Infosys have got re-rated, it appears that some TMT boom has been unleashed? I tend to agree with your analysis. We also believe that while growth numbers have improved in IT sector, the management commentary has become a little bullish and there is also buyback to support in some cases. Overall, when you look at some of these companies and compare them to some of the domestic names on a three-year or a five-year basis, some of the domestic names can give you more returns than IT sector. At this point of time, given the concerns on the overall market, this seems to be a defensive space to be in. That is where most of the money has moved in in the last couple of months but again there is a risk if some of the growth numbers do not meet the expectations. There are reports that the PMS schemes are suffering. Lots of mom and pop PMS schemes had popped up because it was a bull market where everyone finds that making money is very easy. Do you think a lot of pressure could come in small and midcap stocks from those small PMS or AQFs which had mushroomed up? They are already seeing some amount of pressure from that basket. Cleary the kind of fall that we have seen in smallcaps shows that there has been significant selling from some of these entities. Clearly. most of the PMSes focussed on smallcap and most of the holdings were very concentrated unlike mutual fund schemes, where there is a lot of diversification. In a declining market, the concentration will obviously work negatively and will adversely impact more than what the market is showing. To that extent, there has been a significant erosion in some of the PMSes on the smallcap side. There could be some redemption because of that as well. What according to you would actually recede this correction in the broader markets and lead to a meaningful rebound? Would it have to be something global? Would there have to be enough price and valuation damage or would it just have to be a very genuine across the board earnings recovery that snaps the markets out of this bleak phase? It will be a combination of all of these. I do not know which one is going to happen first. Clearly, there are macro headwinds from a global perspective. The way crude has moved up beyond $75 per barrel on the Brent, the way the currencies have been sliding especially the emerging market currencies, the hikes in interest rates, all these factors have led to some kind of nervous sentiments. If they start to reverse, there will be some positive undertone to the market. Similarly, earnings have not been coming through for the last several years. Every year the analysts expectations have not been met and this year again we are starting with almost 22% earnings growth expectations for Nifty. If those numbers are met or if the market feels that at least in the second half some of those numbers could actually come through, then maybe there will be some positive sentiment to the market. Similarly, if there is a large price erosion from here, that itself will give some support to the market. So, a combination of all of this could really support the market but at the moment we do not see any of that playing out. Do you think this entire corporate governance issue which suddenly has cropped up, is slightly overdone? Yes, there are some bad apples but the way road companies, the construction companies are falling, it is like saying the market feels that the entire basket is rotten. Are you finding opportunity in some of these names where the correction has been slightly unjustified? I do not think one can generalise saying that all the smallcaps or stocks belonging to a particular sector are bad in terms of corporate governance. One has to go deeper and analyse and see how these companies stack up. I would not like to really comment on individual stocks where there have been some issues, our portfolio show where our investments are and I leave it at that.

Source: ET

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