Krishna Sanghavi Warns: Micro Caps and Small Caps Face High Valuation Risks Amid Market Optimism

Krishna Sanghavi from Mahindra Manulife Mutual Fund has shared his views on the current state of the market. He notes that while there are concerns about overvaluation, especially in micro caps and small caps, this situation is not new.

Historically, certain segments of the market have always traded at high valuations that might not be immediately supported by earnings. Sanghavi mentions that we are seeing a similar pattern now. He believes that the market’s optimism is evident, with investors willing to pay higher prices based on future growth expectations rather than current earnings.

Current Market Dynamics

Despite various challenges like budget announcements, taxation changes, and earnings disappointments, the market remains upbeat. Sanghavi suggests that rather than a bubble, the current market conditions reflect an increased visibility period for investors.

This optimism is driving higher valuations, particularly in the micro and small-cap segments. However, he acknowledges that in the larger market caps, such as those in the Nifty index, there is a more balanced mix of valuation and earnings support. The larger stocks are offering better value compared to the smaller, riskier stocks.

Automobile Sector

On the subject of autos, Sanghavi observes that the sector has performed well recently. However, he points out that valuations might be slightly ahead of the current business momentum. From an India-specific perspective, he suggests that the passenger vehicle segment may not have a great year.

Therefore, he advises being cautious and selective within the auto sector rather than adopting a broadly bullish stance. He indicates that a more conservative approach or a selective investment strategy might be prudent in this sector.

Insurance Sector

Turning to the insurance sector, Sanghavi sees potential for recovery now that regulatory issues are starting to clear up. The sector had been underperforming due to regulatory challenges, but with these issues diminishing, there is renewed comfort for investors.

Sanghavi mentions that some insurance companies are available at valuations similar to those seen two or three years ago, offering potential value. He notes, however, that investors should still be mindful of broader financial trends and the ability of consumers to continue investing in insurance.

Financial Sector and RBI Regulations

Sanghavi also comments on recent RBI regulations, including the draft LCR (Liquidity Coverage Ratio) regulation. He notes that the RBI’s focus on unsecured loans and liquidity risks is a sign of concern. Despite these regulatory signals, large private banks are currently reporting strong earnings and have had a good track record on asset quality over the past three years.

Sanghavi suggests that while the sector is performing well, potential rate cuts could impact margins. He points out that historically, high ownership levels in banks mean that while they offer value, they are also a heavily owned sector in the market.

Pharma Sector

Regarding the pharma sector, Sanghavi believes there are promising opportunities. He highlights that the sector benefits from strong domestic demand and has performed well internationally. He notes that diagnostics and pharma companies are benefiting from structural changes and increased consumption. Sanghavi suggests that the pharma sector is worth considering for investment and that being overweight in pharma could be advantageous given its potential for growth.

Investment Strategy

Finally, Sanghavi acknowledges that finding new investment ideas is currently challenging due to high valuations. He notes that while there are many investment ideas available, those that meet valuation criteria are harder to find. For now, he recommends focusing on large-cap stocks that offer solid earnings profiles and have not experienced excessive valuation increases. This approach is suggested as a more balanced investment strategy during the current market conditions.