This year you may actually end up underestimating the earnings and this quarter till now has demonstrated just that, says CIO, ValueQuest Investment Advisors. How do you think this market will manage to climb the wall of worry?As long as the worries persist I guess. The way I think about this market is that the broader Indian market was in a bear phase since 2018. It has been quite a long bear market considering that in the past two decades, the longest one we had was about 15 months during the global financial crisis (GFC). So for nearly two years, midcaps have been in a bear market. We are beginning to recover. Post the corporate tax cut, the markets had started to recover, when the Covid happened and again it went for a capitulation move. March actually marks the bottom of the market in terms of valuations, sentiment and probably even in terms of economic growth and corporate profitability. If that is the case, then we are just three months into the recovery in terms of markets, not talking economic terms and if that is the case, then we could not be so worried about the next maybe 5-10% correction lurking at some point of time. But it does not look like this is going to stop any time soon. Historically, every time markets have got excited about a positive rate of change -- whether it was 2017, 2018 or even beginning of 2019 -- in terms of earnings recovery, markets have got it wrong. Why do you think this time around history may not repeat itself and markets and consensus could get it wrong again.You are absolutely right about the market being forward looking and looking at the rate of change. Covid has seen a global synchronised policy driven slowdown, but what it also did is it brought about a global coordinated monetary and fiscal stimulus provided by the central banks and added to the corporate loan guarantees and asset purchases, it reset the expectations to a new low. You know that in the last 8-10 years, analysts have continuously got the earnings wrong but this time there has been a 30% cut in earnings expectation. So let us hope they are wrong this time as well and this time probably on the other side because expectations have been set so low now. This year you may actually end up underestimating the earnings and this quarter till now has demonstrated just that. The fall in the top line has been slightly lower than expected; the fall in operating profits is not there. Lots of companies have seen increase in operating profit margins that tells you that their ability to manage the cost is very much there and the corporate world is actually in a fine shape, lot of the inefficiencies have been wedded out. The only thing we need is a little bit of growth to come back and the numbers will look fantastic because both operating leverage and financial leverage will play out. The odds are stacked in favour of being surprised on the positive side in the earnings over the next two-three-year period, that is how I would look at it. The market price is a function of EPS and PE so let us split that into two; EPS is a function of earnings and growth. What do you think apart from pharma can give EPS and growth?Before I get into this EPS and PE, I would just like to say that a lot of people are worried about market being at a PE multiple of 26-27 or even higher, but this entire PE looking high is more because of earnings being low and this earnings being low is a 10-year trend, it is not that it has started yesterday or something. Since 2008, the corporate profitability to GDP has dipped from 7% to closer to 1% and in that period the GDP has actually doubled. So the profit pools have shrunk for the last 10 years and for the corporate world as a whole. Clearly, PE is looking expensive but the operating margins are at a low, profit margins are at a low, growth is at a low, from here to bet that profits are going to collapse is a little silly. Now having said that, the recovery is not going to be immediate and the recovery is not going to be even. There are some sectors where we believe the recovery has already started and over the next 18 to 24 months we will keep seeing some or the other sectors that will keep reviving. Frankly the sectors that have clearly taken the lead in terms of revival are agri and rural focussed sectors. Over there, agrochemicals, two wheelers, tractors, equipment, any business that caters largely to the rural economy is going to do well and that part of the economy actually did not do that badly and is going to recover faster. Second is, of course, pharmaceuticals that we spoke about, I am not going to dwell too much on that but the revival in US generics is leading the recovery over there. Then there is telecom where we see that the competitive intensity has reduced because from a 15-player market, it has become a 2.25 player market and the recent flows that have come into the largest player in the sector have come on the promise of an increase in ARPU. Of course there is a large pool of consumers available and it is going to be profitable for them hopefully at some point of time. The intensity to decrease ARPU has reduced, if fact there is a pressure to increase the ARPU so I think telecom is another sector that is going to lead the recovery. Also, with Covid striking, telecom actually saw the least amount of disruption in the business so that is another one. Then chemicals, speciality chemicals besides the agrochemical is also another space where the trends were firmly in place before the COVID struck and they have not been disrupted because they are largely again rural and agri focussed. So broadly these are the sectors. There might one or two more like healthcare and diagnostics but these are largely the sectors which are going to be lead the recovery and because the market is abundant with liquidity, the markets are not going to wait and provide you with an excellent entry point six months, 12 months down the line, when the clarity emerges that things are recovering the stock will be much more expensive than they are today. I would rather focus on the sectors that are recovering and we position ourselves over there and let the market do its own thing. What are the chances that when the actual recovery happens, markets may not rally because markets already have moved in anticipation of a recovery? It happened in 2014, when Narendra Modi became Prime Minister. We saw that even happen when UPA-2 came to power, the market hit a double circuit and did not go anywhere?True, but as you said markets are forward looking and respond to the incremental change. If at that point of time, the market is still anticipating, let us say this year the expected GDP print is anywhere between 3% and 5% negative, but markets are not going to respond to that because we are already looking through that and in 2022 the GDP print is likely to be between 4 and 6%. The market will keep rallying until we get that print. And after that, we will re-evaluate whether this 4-6% is going to go to 8% or is it going back to 2-3%. At that point of time, we will evaluate if the rate of change is still on the positive side or not but at this point of time, it is too premature. We have got a very polarised large cap market. When you see an asset like Reliance getting created in the largecap space, does that worry you as suddenly one largecap stock accounts for 14-15% Nifty weightage? First off all, I do not really comment on a particular company but if there were fears about Reliance that was six-12 months back when they had a huge gross debt book. Now they have got rid of that and now the survival risk has gone. The real question on Reliance 12 months back was whether they will be able to deleverage or not, That question is out of the window now. Now the focus is on whether they will be able to monetise the assets that they have created. As I said, in telecom if the ARPUs are going to rise, then I do not think Reliance is going down anytime soon. The weightage can come down with the rest of the market performing. The market breadth is widening and that is very heartening because there are few sectors that are leading the recovery. Besides, it has not been a sectoral move, it has more been a leader in a particular sector which is taking away majority of the market share. That was leading to this polarisation. To some extent, polarisation in terms of the market will reduce because there are more sectors participating. However, within a sector, the strongest balance sheet will attract the most capital and it will attract the most market share also. The other companies are still fire fighting and fighting for survival. That is what is playing out but what you need besides the sector, in which the leader is taking away market share is a tailwind to the sector and if you can find a few sectors with tailwinds that is going to be double bonanza and that is exactly what we witnessed in pharma that a small change from 8%-10% kind of generic price erosion to 3% to 5% kind of generic price erosion which was happening for the last four-five quarters led to such a huge rally in pharma. You need to be very sensitive to the positive change and markets will actually ignore the negative change, I feel there is only one sector where there is still a lot of uncertainty left. Otherwise the majority of the market has factored in most of the earnings for FY21. Do you think financials which account for 30-35% weightage will be market performers now with the downward bias?They are the underperformers. It is actually one of the only sectors left where there is still uncertainty. Just to give a broad perspective, Covid is going to leave a lot of one-time losses in revenue for most of the corporate world. Now these losses are going to be distributed amongst government, consumers, corporate and lenders. The government has very limited ability to absorb those losses. The consumers are bearing the brunt of that through the fuel price hikes. Corporate will bear some losses but the bulk of it, PAT is the balancing figure which we do not know is what is going to be borne by the lenders. That is why this uncertainty still remains. We do not know the extent of losses that the lending sector will have to bear. Whether the moratorium is going to be extended or if there will be a one-time restructuring once we get some certainty around it. That tells you that there is a large capital erosion coming for which they are preparing themselves and RBI is right in trying to prevent a systemic risk. If you are going to have higher NPAs and you are rising capital, both the things will depress ROEs. In that kind of a scenario, financials are likely to remain an underperforming sector until we get clarity on what is the way forward in terms of restructuring or moratorium or what is the extent of the losses. If I were to go by what Mr Uday Kotak says and the losses are going to be around Rs 4-5 lakh crore, then they will have to raise enough capital to take care of those kinds of losses. That Rs 4-5 lakh crore will have to be spread over a long period of time. There is no choice. We need more than Rs 1-1.5 lakh crore of capital to absorb those kinds of losses. This is a sector you can safely stay away for the next 12 months until clarity emerges. Everybody is saying retail investors are coming in large numbers and that get rich quick syndrome has hit the market. What are your thoughts based on market experience because the word on Dalal Street historically has been that jab retail aata hai market top hota hai (when the number of retail investors rises, market goes to the top)?I find this talk about the bubble in the market really ridiculous. If somebody has lived through a bubble they would not make a comment like this. The corporate earnings have been falling for five years, markets have not given any kind of returns for the last five years and the CAGR is 3-4%. The retail participation is okay. Because of this lockdown, over last two-three months some participation has come in but there is a combination that leads to a bubble kind of a formation. Sure, easy liquidity to begin with but easy liquidity, usually a bubble, is preceded by three to five years of such good earnings growth that the optimism is all around and everybody tends to make a mistake after that kind of a run. Corporates tend to overcommit on the capex, central bankers tend to underestimate the risk, traders, investors everybody is high on optimism. This is not the case at all at this point of time. We are in if anything near close to pessimism and we do not want anything to do with equities kind of scenario. If you had asked me this question in March, then I would have told you that this is the point of maximum pessimism. In that kind of a scenario, are retail investors taking money out of their businesses and putting in for the long term or any such thing or are they doing day trading and options trading? In the latter case all they are doing is providing liquidity and having fun for themselves. I would not be overly concerned about anecdotal evidence of a bubble forming. There is no direct correlation as to what is happening in FAANG stocks versus what is happening in India. Bubble happens when there is optimism, more cynicism, low liquidity, surge in earnings and over ownership, That will apply to an Apple, an Alphabet, Netflix even for that matter other US companies. What happens if these US Tech stocks reverse? If anything, that is where the strongest bull market is at this point of time and when I say bull market and not bubble at this point of time because bubble is when you stretch things to the sky. Clearly market caps of $1-1.5 trillion are very high and they cannot keep growing at double digits because sooner or later they will be bigger than the whole planet earth. It cannot be stretched to the sky. Having said that, what Covid has done is it has crunched their timeline and the kind of growth rates they were anticipating. Let us say they will achieve some kind of numbers in digitisation in three to five years. Then the timeline has been crunched to one year and two years So, the near term outlook for these companies have actually gotten even better. We are in a very liquid awash world, we are in a very polarising world and in that, these polarised companies are seeing acceleration of their earnings. This strong bull market could convert into a bubble before it bursts, but at this point of time you can say there is optimism and a bull market, not a bubble.