Expert View: In the first half of FY25, the mid and small-cap market segments have shown significant outperformance compared to large-cap stocks. However, this trend may not sustain, according to Rahul Baijal, Senior Fund Manager – Equities at HDFC AMC. In an insightful interview, Baijal discusses market valuations, the potential impact of the US Federal Reserve’s rate cuts, and the sectors he is optimistic about. The following are edited excerpts from the discussion:
Market Performance Assessment for FY25
This financial year has witnessed two major events impacting markets, both locally and globally. Domestically, the general elections and the unveiling of the Union Budget for 2024-2025 have contributed to market volatility.
Nonetheless, the recent political stability and coherent policy direction, alongside the budgetary announcements, have positively influenced market sentiment.
On the global front, equity market volatility has surged due to shifts in monetary policy by major players like the Bank of Japan and the US Fed. This may continue to impact FY25, driven by forthcoming economic data releases.
Across market capitalization segments, all three categories—large, mid, and small caps—have recorded positive returns, with mid and small-cap segments leading the pack.
However, looking ahead, it is possible that this outperformance might see a reversal.
Valuations in Small and Mid-Cap Segments
Over the past 18 months, many companies in the mid and small-cap sectors have experienced improved earnings growth, leading to a revaluation reflected in stock performance.
However, several sectors are witnessing prices rise ahead of their underlying fundamentals, resulting in relatively expensive valuations and creating potential market froth.
In contrast, many large-cap stocks have shown reasonable earnings growth yet have faced periods of underperformance.
This scenario has resulted in substantial valuation premiums in the mid and small-cap segments compared to their historical averages and to large caps, suggesting better risk-reward dynamics in large caps in the medium term.
Impact of US Rate Cuts on Indian Markets
The commencement of a rate cut cycle in the US could significantly influence Indian markets. With strong domestic liquidity and increased foreign institutional investor (FII) inflows reported since late June, buoyed by the resolution of electoral and budgetary events, India is positioned for potential benefits from these shifts.
Historically, US Fed rate cut cycles have enhanced dollar inflows into emerging market equities, and this time should be no exception.
India stands to gain from this expected influx due to its relative growth prospects, robust track record of delivering better dollar returns, and a comparatively lighter positioning from FIIs than in previous years.
Given that FII investments in India predominantly target large-cap stocks, expected inflows will likely be concentrated within this segment, potentially leading to a resurgence in large-cap outperformance.
Green Shoots in the IT Sector
While the discussion regarding the potential for a soft landing or hard landing in the US economy remains unresolved, signs point towards a favorable outcome.
Current indicators suggest a soft-landing scenario, reflected by emerging positive feedback, or “green shoots,” within the IT sector.
Nonetheless, the next six months will be crucial in confirming this trend, demanding careful observation of US economic data.
Attractive Sectors to Consider
Broadly, Baijal expresses positivity towards sectors exhibiting strong earnings growth potential alongside reasonable valuations.
Private banks are highlighted as particularly attractive, given their robust balance sheets, healthy credit growth, solid asset quality, and favorable valuations.
Additionally, companies positioned to benefit from India’s capex upcycle, alongside telecom and healthcare sectors, present promising medium to long-term opportunities.
Within healthcare, companies in domestic formulations, US generics, and hospital services are currently thriving.
Furthermore, the power sector’s medium-term prospects are appealing, especially given the ongoing power deficits in the demand-supply landscape.
HDFC Top 100 Fund: Investment Strategy
The HDFC Top 100 Fund adopts a unique investment strategy that blends growth at reasonable price (GARP) principles with value investing.
Its portfolio construction approaches stock selection from a medium to long-term perspective, utilizing a bottom-up strategy enriched by top-down assessments of sector and macroeconomic conditions.
Careful consideration is given to each company’s market positioning, business trends, sector environment, and valuation cycles during stock selection.
Compliance with internal risk management protocols is a priority, ensuring controlled active positions and adherence to regulatory guidelines.
The fund aims to maintain an optimally diversified portfolio, keeping overweight positions in sectors with promising earnings visibility and recovery while being underweight in sectors deemed expensive.
Currently, the fund leans towards financials, healthcare, and communication services, while being cautious in consumer and IT services.
The opinions and recommendations outlined in this article are solely those of the expert and do not represent Mint. We recommend that investors consult certified professionals prior to making any investment decisions.
