'Small-Caps Represent Best Opportunity In India'

'The real money in India over the coming period is likely to be made in small-cap stocks rather than in the large-cap benchmark names.'

Global markets heaved a sigh of relief amid reports of US-Iran peace talks.

Shankar Sharma, founder, GQuant Investech, tells Puneet Wadhwa/Business Standard over a telephone conversation that once the immediate geopolitical concerns fade, market's attention will shift to other issues, particularly the US-India trade deal.

Do you expect the risk-on rally across global financial markets to sustain in the backdrop of the West Asia peace talks?

The rally has been underway globally irrespective of the conflict. Even during the war, there has not really been any major disruption in terms of market behaviour.

In fact, global equities have continued to rise almost since the conflict began. And almost every market in the world except India and the Philippines, has been enjoying a fantastic bull market in the last 12 and 24 months, whether they had AI or not.

But many experts have attributed the strength in global markets purely to the artificial intelligence theme.

That is a very narrow interpretation. Countries and regions that have little or nothing to do with AI have also delivered strong returns.

Latin America has done very well, Central Europe has done very well, and markets such as Poland and Greece have performed strongly despite having no obvious AI angle.

The larger point that people often miss is that this has been a broad-based global bull-market, last 12-24 months.

The data simply does not support the view that only AI-driven markets have rallied. With the exception of a few markets such as India and the Philippines, most major markets across the world are in bull territory.

Whether they have an AI story or not has not mattered much.

As far as India is concerned, has the major overhang from the West Asia developments been removed? Could we see a correction once an actual deal is signed, possibly on June 19?

First of all, it is premature to assume that a deal will necessarily be signed on June 19. There are still many uncertainties and several moving parts.

More importantly, India's relative underperformance predates the West Asia conflict. It started nearly two years ago and it has nothing to do with the West Asia crisis itself.

So, I want to be very clear that the war has been only an additional factor and not the primary reason behind India's weak performance.

Even before the conflict, India was underperforming global and emerging markets. The absence of a meaningful AI theme, slowdown in corporate earnings, one of the two worst currencies in the world over 12 months, on the ground slow economic growth have all contributed to this.

Therefore, it would be incorrect to attribute everything to geopolitics.

Having said that, if the conflict moves towards a resolution, there could certainly be a relief rally.

In relative terms, India's underperformance versus world markets has been among the worst I have seen in the last 25 years. That itself creates room for a rebound/relief rally.

Will that relief rally be sustainable?

Sustainability of the rally is quite another matter. Once the immediate geopolitical concerns fade, market's attention will shift to other issues, particularly the US-India trade deal.

In my view, that agreement is likely to be much more favourable to the US than to India, and that could once again become an overhang for the market.

I am crystal clear on one thing: The sole purpose of the trade deal is to reduce India's trade surplus towards America.

Given the the implicit Indian commitment to buy $500 billion from America over five years, I am very certain that we will not have much of a trade surplus left versus America.

This scenario is something people are not focusing on, but I see this becoming a major pressure point on the Indian rupee as America is our largest surplus partner.

If that surplus disappears all our trade and related balances will enter a period of very high stress, across CAD, BoP and currency.

Apart from that, corporate earnings have not been particularly encouraging and GDP growth has also not inspired confidence.

Therefore, while there could be a meaningful bounce, I do not believe the main Nifty constituents are likely to deliver extraordinary returns on a sustained basis.

That said, I remain extremely bullish on Indian small-cap stocks. I publicly stated on in March, at the peak of the conflict, that small-caps represented the best opportunity in India.

Since then, they have performed strongly and I continue to believe that this segment offers the most attractive opportunities.

Is the bigger challenge for India now how corporate earnings and growth evolve over the next couple of quarters? Could that trigger a correction?

Absolutely. The impact of these developments is not immediate. There are lagged effects, which eventually show up in corporate earnings and in the broader economy.

GDP growth, corporate profitability and business sentiment will all have to be monitored closely over the coming quarters.

If these indicators disappoint, they could certainly trigger bouts of correction in the market.

Therefore, investors need to remain mindful of these risks rather than assuming that the worst is completely behind us.

Which sectors should investors focus on?

I would not necessarily approach the market from a sectoral perspective. My preference is clearly for the small-cap space. In my view, the real wealth creation opportunity in India lies in small-caps.

I am very clear on that. I do not believe investors are going to make outsized returns from the mainstream large-cap universe.

What about foreign portfolio investor (FPI) flows? Do you see selling easing as the war approaches an end?

FPIs had begun selling even before the conflict started. So I do not think the war has had much to do with their decision-making. In fact, if markets witness a relief rally, that could provide foreign investors with another opportunity to reduce their exposure.

Selling pressure may moderate somewhat, but I do not expect a dramatic and sustained reversal in flows.

The structural reasons that prompted FPIs to turn cautious have not disappeared. Therefore, expecting a sudden resurgence in foreign flows would be unrealistic.

So, what's your message to investors?

The most important point is that investors are unlikely to generate exceptional returns from the benchmark index. The real opportunities, in my view, lie in the small-cap segment.

Another factor that works in favour of small-caps is that foreign institutional ownership in that segment has historically been low.

As a result, there is relatively little risk of heavy dumping or large-scale selling by overseas investors.

The overhang from foreign selling is concentrated primarily in the large-cap and benchmark Nifty stocks.

That issue is likely to persist because overseas investors still own significant positions there, and no one really knows how much more they may eventually choose to sell.

Therefore, if I had to summarise my message, I would say this: There may well be a relief rally in the broader market, but the real money in India over the coming period is likely to be made in small-cap stocks rather than in the large-cap benchmark names.

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Feature Presentation: Aslam Hunani/Rediff