Take the risk when you are getting rewarded for taking it

The US is still running fiscal deficits of 6 to 7% a year, with close to $8 trillion of maturities happening within the next one year, while central banks once major buyers are de-risking from the dollar and US government debt.

Much of it is just refinancing — raising bonds to pay back bonds that are maturing. And there is a new issuer: the hyperscalers building the large data centers. Interventions only address the symptoms; the root cause is the fiscal deficit.

In the US, large caps were only 65% of total market cap in August 2016 and have gone up to 77%; small caps have reduced from 14% to 8%. On a separate measure, India’s top 20 stocks were about 40% of market cap in 2000, rose to 50%, and have dropped to about 30% — a sharp decline particularly in the last five years.

Is this secular, or are these cycles in the market? Subramaniam leans towards reading it as more cyclical, but offers it as a probability case. If it is cyclical, you have to consider the possibility and the risk of mean reversion.

On trailing PE the Nifty50 is more or less in line with its long-term average; on forward PE about 10% higher than the 16.5 times average. On price to book the picture is very different — about 2.69 times, almost 15% cheaper than its own long-term average, on a return on equity among the highest in more than a decade. Fairly valued and also attractive, but not cheap territory, which would need below 2.5 times.

Midcaps and small caps trade at a higher price to book than large caps — still, in UTI’s opinion, the expensive zone, not even the fair value zone. As a top-down asset allocator the better risk-reward is in large caps, though his own fund managers are seeing more bottom-up opportunities there. In the last one year, against all their expectations, small caps returned 14% and midcaps 12% against 0.4% for large caps; over two years, he says, the three are much closer.