Extreme Bull Market: No fear in the market but there’s greed in all sectors except financials, says S Naren

S Naren, ED & CIO, ICICI Prudential AMC, says this bull market started off from March 2023 when equity taxation became extremely attractive and that is the genesis of this bull market. He believes that is the reason for this extreme bull market and finally supply has to catch up with demand. If the Indian government does not do enough disinvestment, this bull market can go on. Naren says initially, they looked at the market foolishly via valuations but it has not worked. Almost six or nine months back, the market was already fully valued but they have been left looking foolish at this point of time.

What is your view on the market? Where is the fear and greed or is there no fear and only greed right now?
S Naren: There is no fear. Maybe there is no greed in banking and financial services, but there is no fear in the market. Every day there are blocks happening in stocks which are loss-making companies and those are going through smoothly. There are QIPs, IPOs, etc. There is greed in all aspects of the market, maybe in financials, there is no greed. But even there, there is no fear, but at least there is no greed also. That is the kind of market we are in at this point of time.

The grain of the truth is that if there is more demand and less supply, markets would move higher. I am referring to liquidity coming from not just DII, but also pension funds, direct retail, and even family offices. Where are the valuations trading above par, but the flow of liquidity will ensure that a downside gets protected?
S Naren: I did a talk recently in Tamil Nadu Investor Association and the topic was this and we looked at earlier bull markets and we found that this bull market resembled the ‘94 bull market, which also had huge liquidity component and in that liquidity bull market, eventually supply did catch up with demand and after that, you did have a crisis in Asian countries which then later created a big fall.

So, at some point of time, supply will catch up with demand because most companies know that the Indian valuations are very high compared to global valuations and I hope sensible multinationals and many other promoters will opt to increase supply at this point of time because they know that valuations in India are much above fair value. We will see a number of multinationals selling in India, a number of multinationals listing in India, and a number of promoters reducing their stake in India and hopefully that will all lead to increased supply and eventually that is the only way in which the liquidity bull market can come down.

This bull market started off from March 2023 when equity taxation became extremely attractive and that is the genesis of this bull market and we believe that that genesis is the reason for this extreme bull market and that is how finally supply has to catch up with demand. If the Indian government does not do enough disinvestment, this bull market can go on. Initially, we tried to look at it foolishly and looked at valuations but it has not worked because if we had looked at valuations almost six months or nine months back, the market was fully valued but we are left looking foolish at this point of time.

It is quite a coincidence that some of your peer sets are indicating the same, that we are not in a very strong value or earnings driven market, we are in a liquidity driven market. Whether it is Kotak AMC or Birla AMC or some other smart old time investors, they are of the view that this is a liquidity driven market and you do not know how far it could extend. Should one not be in a hurry to call the market top now? If this liquidity stays here for another three to six months, then markets could be at different levels?
S Naren: Finally, we have to look at it from the point of view of an investor. What is the point in calling a market top? An investor has to be very careful in deploying additional money and if an investor invested way back, that person can afford to wait to book profits unless that person is invested in extremely aggressive parts of the market. This is what we tell people, how to call the market top.

This is a very tough task at this point of time, but I think the time has already come for people to be careful in deploying new money because if all loss-making companies are able to raise money in QIPs and IPO so easily, the time to deploy money carefully has already come. So, as ICICI Mutual Fund, we are trying our best to tell people, follow asset allocation as the best way to deploy incremental money and do not do any other form of allocation at this point of time.

You started the interaction with financials and you said that they are attractive, they are not cheap. Now, for financials to do well, economy has to do well because financials are always a delta on economy, they are proxy to the economy. So, the fact that you are bullish on financials as a category, does that mean that you are also bullish on the economy?
S Naren: You have to look at the genesis of the financials underperformance. The financials’ underperformance is primarily because of the FIIs being overowned in that segment and what happened was the benchmark for them, which is MSCI, had a very low weightage in financials and they were very overowned.

From 2021 onwards, they have been the only segment which has sold. So, they overowned that segment and thanks to low weightage in financials in their MSCI index, they have been selling. By November, the benchmark weightage in financials would have gone up substantially. The key reason for the selling in financials comes to an end by November. I do not think it was an economy issue. I do not think it was a valuation issue. It was an excess holding by FII issue and that excess holding by FII issue is coming to an end.

So that is one of the reasons we are so positive on financials. The only challenge with financials being your most positive sector is it is not a defensive sector. It would always be good. In 2007, we used to be positive on consumer staples and pharma when the market was very bullish, but those sectors are very defensive. So, to be bullish on those sectors was very easy, whereas to say that you are very positive on financials is a little bit of a problem because everyone knows it is an economy sector, it is a leveraged sector. This time, the real reason for the underperformance is FII selling and nothing else.

I think a disguised correction has kicked in. Most of these so-called policy sensitive stocks are down 15% to even 25% from the recent highs. Do you think the party or the happy hours in some of the policy sensitive stocks, is that over?
S Naren: They were overvalued and they were stocks which we did not own in a big way at all, I would say even in a small way and you looked at those sectors they were all trading at 100 PE and 120 PE and all that. So it did not fit our thought process on valuations at all, so we do not know we have to ask the investors in that segment what they felt when they were buying rather than people like us. It is not that the companies were bad or something like that but we could not understand those sectors actually.

We have stayed away so we have benefited in the last three months but we got hurt in the year before that very badly actually by not owning them.

You have been bullish on domestic facing sectors, autos, cement. Let us talk about autos and cement. They both are parallel to what is happening to the economy. Now for autos, two-wheelers are doing well and four wheelers are taking a back seat. A year ago two wheelers were not doing okay, four wheelers were enjoying all the limelight. What is the right way of looking at auto because two years four wheelers do well, then two years two wheelers do well?
S Naren: These are all cycles which play. So, two-wheelers was a sector which had done very badly from 2019 to 2023. So, it was a ripe for a rally. If you look at entry-level cars, they continue to do badly all the way the last four-five years. So, at some point of time there will be a pickup. Now, people say used cars take care of entry-level cars, but at some point of time they will come back.

Everything is a cycle and in these cycles if you manage to catch the point of maximum pessimism or cheapness in stocks, you will make money and that is our approach and that is how in two wheelers in some of the stocks we actually made good money in our funds and when auto was doing badly we did launch the transportation and logistics fund and the investors in that fund made very good money. But today we are no longer in that cheap zone in auto.

What is your view on this whole theory that private sector capex is not picking up? Industry experts say the private sector is now moving towards semiconductor, manufacturing, automobile, and EV and they are unlikely to be spending a lot in making big buildings, constructing roads, or buying a lot of cement. Is a fresh approach to private sector capex needed?
S Naren: My colleagues tell me if any company wants to do capex today, they do not need to borrow from banks, they do a QIP and do the capex. So, our conventional thesis is that private sector capex has to happen through borrowing from banks and all that has changed. People do now through QIPs. If any company's capacity utilisation is full, they are bound to do capex.

On the power side, there is huge capex happening, in renewables, a huge capex is happening. So, invisible capex will happen. If people want to do capex, they do it, how they fund the capex is also dependent on what is cheap. At this point of time, if for many sectors the price to earnings is 70-80, why would you not raise equity and do the capex, to expect that private sector capex has to happen through bank finance it is not going to happen, it may happen through equities and look at the capital goods price to earnings ratios of most of the companies at this point of time, that itself is telling you that a lot of capex is happening.

It would not happen in areas where there is no growth. It will happen in areas where there is huge growth and that is why I think the way people look at private sector capex you cannot look at it in a wholesale way. You have to look at it sector by sector. Is cement capex happening? Answer is yes. Is auto capex happening? Yes. Is EV capex happening? Yes. Is auto ancillaries focused on specific sector capex? It is happening, yes. Is the entire power and transmission capex happening? Yes. So, it will happen in specific areas and some other area which I am not talking about maybe there would not be any capex happening because there is no growth in those areas. So that is how things will happen.

Telecom was a sector where intense competition broke the back of some of the listed players but eventually rationalisation and logic has come back. Where else do you think there is a lot of mispricing, mispricing on the upside and mispricing on the downside where markets are taking an extreme view?
S Naren: There is a very big bull market. So, you want to get that fear element and getting shares cheap is a tough task. But if you look at cement for example, it is an area where prices have not gone up and there is a fair amount of competition. Paints is an area where a lot of competition is happening and margins are under pressure. If you look at any area where China is the supplier and you are competing with China like steel for example, in all these areas I would say that prices are down, margins are down but share prices are not necessarily down.

So by chance if share prices also come really down, they become fantastic opportunities, otherwise you have to keep thinking are margins going to mean revert and you have to buy it anyway, you have to do it because you are not in that fear element market of 2018 or 19 and 20 that you are going to get shares at mouth-watering prices that you get the combination of fear and prices being cheap. Now you would not get prices being cheap, you are getting lower margins, be happy with whatever the market is giving you as price and be happy because at some point of time margins will mean revert in these sectors.

You have always been a believer of cycles. Over the years we have interacted with you, you have always emphasise that look whether it is equity, bond, real estate, everything follows the cycle. So, if you have to identify some cycles for us, which are the cycles across asset classes currently are still 40% to 50% away from its peak, be it real estate, be it bonds, be it equities, be it metals?
S Naren: Nothing is close to 40% to 50%. To me the equity cycle looked full but I have gone wrong. I mean, that is the reason why we have been recommending asset allocation. We thought that the small and midcap cycle is full, but again we are seeing continued rallies. I think the time has come, we are big believers in mean reversion and based on mean reversion we believe that asset allocation is the way to go, but we have seen that. If you look at consumers, FMCG stocks till 2020 kept outperforming, but in the three-and-a-half years after 2020 they gave huge underperformance.

I believe asset allocation is the best way to invest today and for people who are investing in loss making companies and those kind of things I think they should actually introspect whether they are taking too much risk at this point of time and that is why we are big believers in asset allocation at this point of time because that is a way of limiting risk in investing in equity in these markets and we are big believers in largecap over mid and smallcap at this point of time and we think that this is a time when people have to focus on risk versus return, focus less on return and focus on risk and I think it is a challenge because if every month market goes up on a continuing basis to tell people to focus on risk and not return is thankless actually and we are managers of public money not small amounts of money, so it becomes even more challenging for us at this point of time to explain to people that you have to focus on risk and not return and that is a challenge that we are facing at this point of time.

One of the schemes you manage is a value fund, has got AUM of about Rs 50,000 crore, a CAGR return of 20% 10 years, that makes it grow at 25% for 10 years, you are 10x; you grow 25% for 20 years, you are 100x. So, what happens to a value fund now or a scheme which essentially is centred around value?
S Naren: We have ended up having a lot of banks. If you study the history of the fund, we would have never had as many banks as we have today. If you look at it we have higher cash than we ever had. We have one of the highest amounts of largecaps that we would have ever had and we would have had stocks in that fund which in the past we have not had like some of the mega caps that are there in the fund.

These are some of the things that we have done and if you look at the portfolio today and look at the portfolio four years back, the portfolio has changed drastically because of where the market is today at this point of time and in the history of the fund over the 20 years and 20 years back, people did not think that in a growth market value investing can work, but at ICICI we believed in it and the fund grew from Rs 130 crore to Rs 50,000 crore primarily because if everyone does not believe in value investing, you are in a lonely position and therefore you are in the best position to take the long-term calls like in 2007 not bet on infra and bet on sectors like FMCG and pharma which actually delivered huge returns from 2007 onwards and in 2017 bet on largecaps when midcaps were actually roaring and in 2020 bet on sectors like telecom, metals, PSU and those kind of sectors.

Our belief has been that our value investing will work provided everyone does not become a value investor. Luckily it never happens because value investing in the near term is always a very-very painful activity and like today for example not to believe in micro cap, to believe in banks, to believe in having more cash than before in the fund, these are all things which people find much more difficult than before. So I believe that value investing is very tough in the near term and that is the advantage that we at ICICI have had in running this strategy and we believe that this kind of a strategy also has periods of time when it does not do well like 2006 to 2008, 2016 to 2018 but is good in the long-term because it does what is logical for investment which is buy things cheaper than intrinsic value and we have learned that over a period of time you cannot focus on gruesome sectors, you have to focus on sectors which have quality embedded just like Warren Buffett started to use Charlie Munger's thinking in his value style, we also started to focus much more on quality sectors over a period of time, sectors like pharma.

This year we bought a lot of consumer staple stocks in the fund and a lot of IT stocks in the fund because of this framework. So, we believe that this is a long-term good investing thinking fund which can work with periods of underperformance and that is what we see but the near term is tough because the markets are not cheap at this point of time.