We are in the last leg of consolidation

Fixed income investors seek yield while protecting the downside, and India’s yield gap over US Treasuries has narrowed to 190 basis points — under 2%, against roughly 7% ten years ago. With the rupee depreciating around 3% against the dollar over the long run even before volatility, that is not a profitable trade; he thinks that while the gap stays this narrow India will not attract fixed income investors.

Equity investors look at underlying growth, so the pickup of the last two quarters should bring interest back and, hopefully, turn weak foreign flows positive — if, he adds, the economy keeps showing growth and earnings visibility. And he says this with US yields at 5 to 6%, which over 30 to 40 years is the average: investors anchoring on 2010 to 2022 are misreading today’s yields, because that phase was abnormal.

Averaged across multiple 10-year rolling periods over roughly 20 years, large cap revenue growth is highest at 11% against 10% and 9% for mid and small; midcap operating profit growth runs about 1% above large cap while small caps are much lower; small cap net profit growth has been the weakest. That, he thinks, is probably why mid caps have given 1 to 2% better returns than large caps over long periods — but he says small cap return expectations should be kept below large cap.

Rolling returns over the same multiple 10-year periods nonetheless show mid and small ahead of large, which he attributes to the valuation level small caps trade at. Large caps are at 18 times against a 17 times average, a 5% premium, with mean reversion already done. Mid caps have also reverted a good deal but are still at 24 against 18, about 30% above. Small caps carry a premium of almost 60% and have not mean reverted — which is why UTI’s view is that they will be the weakest performing segment over the next two to three years.

India’s mega caps have done the opposite of the US, where the top 10 carried the market. Here the top 10 have undershot, with returns below their own averages, which he says makes them attractive: the BSE 100 is near its average and its top 25 stocks are below the long-term average. The same reversion applies by sector — PSUs, capital goods, power and metals sit well above their averages, while IT, FMCG, consumer, consumer durables and banking sit below. Banking, IT and FMCG are already close to their bottom levels over a full cycle, one reason UTI wants to take a contrarian call on them; UTI thinks those sectors should do well over the next three to five years.

On 25 years of Nifty 500 data, 2000 to 2003 delivered minus 26% and then 500 to 550% over four years; the financial crisis took markets down about 60%, followed by roughly 140% in two. He reads today as closest to 2010 to 2013 — three years of no returns before the rally from mid-2013. This phase is two years old and he says it is hard to say when markets turn, possibly another three to nine months, but that we are in the last leg of consolidation.