Expert view: Nifty 50 may correct moderately; focus on THESE sectors for 2-3 years, says Aditya Birla Sun Life AMC CIO

Expert view: Mahesh Patil, the CIO of Aditya Birla Sun Life AMC, is positive about the long-term prospects of the Indian stock market and suggests investors should focus on consumer discretionary, financial services, industrials and IT for the next two to three years. In an interview with Mint, he says any correction is expected to be moderate, possibly not more than 10 per cent in the Nifty 50 index, as it will lead to FIIs buying who have been waiting for some correction to enter our markets.

Edited excerpts:

What is your assessment of the current market trend? Do you expect a significant over 5 per cent correction in Nifty 50?

Despite the concerns following recent election results and budget announcements on capital gain tax, the markets have continued to rally, primarily driven by strong domestic liquidity.

Over the past few months, record inflows of around ₹30,000 crore monthly have bolstered market confidence.

Globally, fears of a US recession, which initially weighed on sentiment, have diminished.

Although the economic growth in the US is expected to slow, the likelihood of a recession remains low.

Additionally, anticipated interest rate cuts by the US Federal Reserve, potentially three within this calendar year, contribute to a more favourable outlook.

However, the momentum in corporate earnings is now slowing compared to the robust 20 per cent+ growth seen during the last two years.

Given the recent market run-up, consolidation appears likely. Potential global events and upcoming state elections could lead to volatility and a possible market correction.

However, any correction is expected to be moderate, possibly not more than 10 per cent in the Nifty index, as it will lead to FIIs buying who have been waiting for some correction to enter our markets.

FIIs underweight in India is now at a decadal low. In this context, while short-term volatility is possible, the long-term bullish trend remains intact.

Investors are advised to view any correction as a buying opportunity rather than a cause for concern.

How do you see the valuation of mid and smallcap segments? What should be our strategy for them?

Over the past three years, the mid and small-cap segments have notably outperformed large caps, driven by a combination of earnings growth and P/E expansion.

Approximately 50 per cent of the returns in these segments can be attributed to actual earnings growth, while the other 50 per cent stems from rising P/E ratios.

This has led to valuations that are now trading at about two standard deviations above the long-term average, indicating that prices have moved ahead of fundamentals.

While small and midcaps, which are more tied to the domestic economy, may continue to show slightly better growth than large caps, the high valuations reduce the margin of safety.

Given this backdrop, a cautious strategy is advisable.

Rather than increasing exposure to mid and small-caps, investors should consider rebalancing their portfolios, especially if their allocation to these segments has exceeded their target risk levels.

It is also prudent to focus on quality stocks within these segments, as they are better positioned to withstand potential market volatility and corrections.

With breadth indicators at historically high levels suggesting that the rally may be peaking, now could be an opportune time to book some gains in high beta names and protect against potential drawdowns.

A strong influx of retail investors is among the biggest factors that have kept the market up. What is fuelling their bullish sentiment?

The recent market rally has been significantly fuelled by strong domestic inflows, with domestic investors now playing a more dominant role than foreign investors—a stark contrast to a few years ago.

This shift has contributed to a sustained market rally with minimal corrections.

A key reason behind this trend is retail investors' tendency to chase past returns. Post-COVID, the markets delivered strong returns, encouraging more investments.

Additionally, the low-interest-rate environment following the pandemic made equities more attractive.

Although interest rates have since risen, potentially moderating some inflows, the mutual fund route, particularly through SIPs, has gained popularity among retail investors.

This approach has not only increased investor confidence but also allowed them to better manage market volatility by steadily accumulating wealth over time.

Furthermore, there is a growing recognition among investors of the long-term wealth creation potential of equities, as opposed to short-term gains.

Coupled with a broad bullish sentiment about India's economic future, this optimism is driving sustained investments in the market.

As investors increasingly view equities as a vehicle for long-term growth, this trend is likely to continue supporting market stability and expansion.

Could the surge in retail investors pose a risk to the market, particularly during periods of volatility and in response to news events?

There is a common belief that when retail investors flood the market, it weakens the market's resilience due to their tendency to panic during sharp downturns or high-risk events.

While this is often true, particularly for new and inexperienced investors, the dynamics are shifting.

Many retail investors now enter the market through the SIP route in mutual funds, which are inherently long-term in nature.

This approach makes them less likely to panic and more inclined to stay invested across market cycles.

However, the rise of younger investors, especially millennials who entered the market post-COVID via digital platforms, presents a different scenario.

These investors often chase short-term gains and speculate, making them more vulnerable to market volatility.

In the event of significant market disruptions, these participants could contribute to volatility and panic selling.

What sectors are you positive about for the next two to three years?

Several key investment themes are emerging as strong contenders for medium- to long-term growth.

Consumer discretionary: Driven by India's favourable demographics, rising per capita GDP, and urbanisation.

Although this sector has underperformed in recent years due to a sluggish post-COVID recovery and weak rural demand, signs of improvement are now evident as inflation eases and interest rates decline.

This trend is expected to push discretionary spending from 25-30 per cent to 40 per cent of the consumption basket within five years, offering significant opportunities in retail, consumer durables, apparel, and quick-service restaurants.

Financial services: The insurance industry stands out, having rebounded from regulatory setbacks related to taxation.

With growing penetration and stable profitability, the sector is poised for mid-teen growth, supported by reasonable valuations.

Industrials: Industrials and power also present promising prospects, driven by large-scale investments in both renewable and traditional energy sources, alongside a revival in private sector capital expenditure.

Corporate balance sheets are strong, and manufacturing incentives should fuel this growth.

IT and digital: Despite recent underperformance, are set for recovery. With global momentum in digital transformation and the rise of AI, these sectors offer steady growth, robust cash flows, and attractive dividend yields.

Is there some steam left in the defence, PSU and railway sectors?

The PSU theme has emerged as one of the best-performing segments over the past year, driven by a strong government focus on key sectors such as defence, railways, and power.

This emphasis has propelled a significant rally in many PSU stocks, particularly in defence and railways, where robust demand and a growing order book indicate a strong outlook.

However, these sectors are now trading at valuations considerably higher than their long-term averages.

While growth prospects remain solid, the significant run-up in prices suggests a potential period of consolidation.

On the other hand, sectors within the PSU space, such as utilities, oil and gas, and energy, are still at reasonable valuations with improving profitability, offering the potential for further upside.

What should be our investment strategy at this juncture?

The risk-reward profile for equities appears to align more closely with average returns, suggesting limited upside potential in the near term.

With other asset classes, such as fixed income and gold, becoming increasingly attractive on a risk-adjusted basis, it’s essential for investors to adopt a well-structured asset allocation strategy.

This approach can help optimise risk and return while mitigating volatility across various asset classes.

Given the recent sharp rally in equities, it may be prudent to reduce exposure to riskier segments, favouring a greater allocation to large-cap funds over small- and mid-cap strategies.

Additionally, hybrid funds present a compelling option, as they combine both equity and debt, offering lower volatility while still providing growth opportunities.

This balanced approach can enhance portfolio stability in uncertain market conditions.

Ultimately, adhering to established asset allocation principles and being cautious in the current market dynamics can help investors navigate potential fluctuations, ensuring their portfolios remain resilient while still capitalizing on opportunities across diverse asset classes.

How should we play the Indian economic growth theme?

The Indian economy is poised for significant growth, driven by multiple levers that promise to sustain its momentum. 

One key component is consumption, which is finally recovering after a slow post-COVID rebound and is now trending above pre-pandemic levels. 

This resurgence in consumer spending and a revitalised investment cycle across real estate, infrastructure, and industrial sectors paints a positive picture for the economy's future. 

As these growth drivers continue to strengthen, investing in Indian equities is one of the most effective strategies to capitalize on this economic expansion. 

Given the diverse nature of the growth levers, it’s not reliant on a single theme, making it imperative for investors to consider a large, diversified equity fund. 

Such funds can navigate various segments of the economy, ensuring that investors can benefit from the multiple pockets of growth that are likely to emerge. 

By leveraging a diversified equity approach, investors can position themselves to participate fully in India’s promising economic landscape, capturing the benefits of sustainable long-term growth.

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Disclaimer: The views and recommendations above are those of the expert, not Mint. We advise investors to consult certified experts before making any investment decisions.