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The stock market rally is backed by fundamental levers, according to Pankaj Pandey, Head – Research, ICICI Direct.

In an interview with Money9, he shared his views on the current euphoria on D-Street and how investors must construct their portfolios in record-high markets.

Edited excerpts:

Q: The rally so far appears quite broad based . Everything seems to be moving up, but for how long will such move sustain ?

Pandey: There are fundamental levers to this rally. First and foremost, our domestic economy has largely witnessed a V shaped recovery post Covid induced disruption, even the recent monthly GST collection at ₹ 1.2 lakh crore for Jan 2021 is encouraging, signalling upbeat momentum.

Secondly, the government has clearly expressed its intent for growth through its recent Union Budget 2021-22 where the focus clearly is on capex, infrastructure development and job creation.

Thirdly and most importantly, we are the cusp of high double digit earnings growth for Corporate India amid worst of the asset quality issues in the banking space behind us. Hence, all these factors amid low interest rate scenario are conducive for equity investments. We are positive on domestic equity markets with our December 2021 Nifty index target placed at 16,300 levels.

Q: How must one look at constructing their portfolio in the current market scenario?

Pandey: In the current market scenario, the focus should be on businesses with are capital efficient in nature or have well defined path to attain sustainable capital efficiency.

Also, currently market is assigning premium to growth hence focus should also be on businesses which have well charted growth trajectory. Given the large caps have led the recent rally, it is also advisable to shift some portion of portfolio allocation from large caps to small and mid-caps.

One should also be aware of the technology changes undertaking in respective industries and hence should avoid spaced which are susceptive to technological disruption.

Q: The banking sector has run up quite sharply in the last fortnight. Would you still bet big on it or will it be prudent to book some profits at this stage?

Pandey: The measures undertaken by government and central bank coupled with faster economic recovery led to stressed accretion at 2.5-3%;  lower than earlier anticipation of 7-8%. Consequently, banking sector witnessed a sharp rally with large private banks being the ones with strong recovery backed by their fundamental strength.

Given adequate provision buffer, banks seems fairly safeguarded from impact of asset quality shocks on earnings. In addition, recent management commentary points towards pedalling of business growth as capex cycle kicks in.

Thus with anticipated revival in capex cycle and continued growth in consumption, banking system needs to play a vital role in supporting economic recovery ahead. So we recommend to stay invested in banking sector, though selectively we  prefer large and fundamentally strong business franchise.

Q: How are you viewing FMCG sector with respect to growth visibility and valuations?

Pandey: FMCG companies are likely to continue the growth momentum in FY22 with sustained government rural spending post pandemic.  There has been acceleration in consumption shift from Unbranded to Branded specifically in packaged foods category. Moreover, renewed focus on Naturals, Healthy & Ayurveda products would continue to benefits selective companies.

We believe some of the discretionary categories like beverages, ice creams, cosmetics & skin care products, which suffered the most in last one year, should also see strong demand given significant increase out of home activity. FMCG companies command premium valuation multiples on account of long term growth visibility. We believe these companies would continue to trade at rich multiples in future as well.

 Q: What is your view on the pharma space? Do you see highest earnings growth coming in the next three to five years?

 Pandey: We remain positive on Pharma  based on some key attributes such as stable earnings visibility, least stressed balance sheets, healthy free cash flows and ability to deliver products in the time of crisis across the globe which was reflected in the 9MFY21 numbers.

The current situation, underpinned by Covid-19 pandemic and its negative impact on most of the sectors further strengthens the argument for investment in pharma. Growing PE interests across sub-segments could be another major lever for upside.

For CDMO / API players we expect significantly higher earnings growth over the next three to five years going by the amount of capex they are deploying based on the visibility in order book.  For others the earnings growth would be driven by significant margin improvement based on cost control measures.

 Q. How do you think the overall crude price trajectory is likely to impact the oil and gas space ?

 Pandey: Oil production cut from Saudi Arabia, harsh weather conditions in US along with expected recovery in oil demand has led to the recent increase in oil prices. Although, oil upstream companies will be the biggest beneficiaries of higher oil prices in the near future in terms of profits (EPS up by 25-30% on an annualized basis); we would still remain neutral on them due to lack of production growth potential and low visibility over sustenance of oil prices over the long term.

For OMCs, higher oil prices will be lead to one-time refining inventory gains. As petrol and diesel prices are currently passed on to the customers, OMCs will continue to maintain stable marketing margins. With regards to the CGD companies, the competitive advantage of CNG and PNG will increase against traditional fuels leading to increased conversions and lead to better growth in volumes. For large gas utility companies, higher oil prices will mean improved realisations of petchem and LPG business, thereby increase in the profitability.