Mr Market is in no mood to cease to surprise, of course, pleasantly, believes an upbeat Vikas Gupta, the chief executive and chief investment strategist at OmniScience Capital.

Mr Market looks slightly more pessimistic than the situation calls for and, hence, when things turn out better than expected, both in terms of the numerator, or earnings and cash flows, and the denominator, or rate cuts, the DCF (discounted cash flow) model would surprise on the upside, Gupta says in an interview to Moneycontrol.

The ace finance strategist, seasoned for over 20 years in capital markets, says one cannot ignore any of the spaces – be it large-caps or mid-caps or small-caps. “On a forward earnings basis all are similarly priced.” Excerpts from the interview:

Do you think the macro environment indicates the interest rates will remain higher for longer?

The headline US CPI and PCE are close to 3 percent. The core CPI, excluding food and energy, is 4.7 percent and core PCE, which is what the Fed looks at, is at 4.1 percent. While this is not at 2 percent, which is the Fed’s mandate, it is dropping at a reasonably fast pace. This gives the Fed breathing space to slow down on the rate hikes and wait for the previous rate hikes to work through the system.

From now on, the Fed will hike further only if it sees the inflation rates, especially, the core PCE year-on-year going the other way consistently. Yes, a couple of hikes are still possible; even the Fed doesn’t know for sure. It looks unlikely that the Fed can retain such high interest rates for too long. As the core inflation starts dropping consistently, it will be more and more likely that the Fed will start cutting the rates in tandem.

The unemployment rate is still at a near-50-year low, and the number of jobs available are millions more than the count of unemployed who are participating in the job market. Also, the US GDP has come out significantly high at 2.4 percent for Q2 2023. While we anticipated a significantly strong US economy despite the rate hikes, most analysts were surprised and are likely to be surprised further. This was also much higher than the Fed dot plot at the beginning of the year.

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The strong job market and GDP could give the Fed more ammunition for rate hikes. However, it also needs to watch out for the impact of the previous hikes. Our opinion is that the Fed would not be in a hurry to hike rates or cut rates. However, if the core PCE goes to 3 percent, then we expect rate cuts from the Fed.

The RBI is definitely not in a hurry to hike since the Indian inflation is not that severe. In fact, given a choice, the RBI would like to support growth since there is a high risk of inflation in India. What has tied the hands of the RBI is the Fed inclination towards rate hikes which makes it risky for the RBI to cut rates since that would depreciate the rupee.

For India, we think the overall bias is for an early rate cut, albeit a small one to begin with, at the first chance the RBI gets.

Are you surprised by the strength in the small-cap space this year? Does the space look overvalued?

We are not surprised since we expected the Fed rate hikes that would translate into strong FII inflows. With money flowing in, it is no surprise that small-caps have also rallied. While the FII capital flows to large-caps, the rally in the US markets led the retail investors and DII fund managers to focus more on the small-caps since the small-caps had become significantly undervalued. However, the general undervaluation is now over. But there are several pockets of mispricing in the small-cap space which is what one should be looking at.

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More surprisingly, even the large-cap space is in Mr Market’s blind spot. This includes some of the largest stocks in Nifty50 too. So that clearly shows that the markets are far away from overvaluation. In fact, we are finding a lot of stocks in all three spaces, large, mid and small caps space.

Do you expect returns in the mid-cap space to beat that in the large caps?

Mid-caps are, of course, attractively placed. But, we think there are significant opportunities in large-caps as well. Given the current situation we cannot ignore any of the space, large, mid or small-caps. On a forward earnings basis, all are similarly priced. It is surprising that despite the FII flows, the well-known large companies are still significantly mispriced. This is especially true for banks and IT.

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Your take on the SME segment as we see a rush for fundraising through the IPO route…

We think that it is great that the SMEs are getting capital from the IPO markets. This bodes well for the Indian economy and entrepreneurs.

In a few years, this should make for a very rich space of small and microcaps from which good investors and fund managers can fish for future moat companies.

Do you think the markets may remain range-bound in the short-term, given lack of drivers going forward?

Au contraire, we expect that markets might continue surprising upwards. At least that is how we think the situation is biased. Mr Market is slightly more pessimistic than the situation demands and hence when things turnout better than expected, both in terms of the numerator, i.e. earnings and cash flows and the denominator, i.e. faster or earlier rate cuts, the DCF model would surprise on the upside. Of course, no one can predict what will happen. But our view is optimistic.

Your take on the banks’ provisions which have increased in the June quarter…

It is a reflection of preparation for the expected loss model that the RBI is going to mandate soon. It makes sense to start making those provisions, the earlier the better, as long as the capital adequacy permits and it can be balanced with growth opportunities. The banking space is significantly undervalued in our opinion and we think this is a rare opportunity where the balance sheets are becoming quite clean and the markets are still mispricing them significantly. What is being missed is the large growth opportunities and the chances of increasing RoEs (return on equity). Also the capital adequacy is sufficient to support growth.

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