2025 to be a year of volatility with shifting global dynamics: Ashwini Agarwal

"The small and midcaps are also trading at valuations which are significantly ahead of largecaps because largecap stocks have not done as well. Like you said, I mean, we are up 10% on the Nifty versus say 25% on the small and mids," says Ashwini Agarwal, Founder, Demeter Advisors.

The first question, the most important question, year 2024 is towards its close, what should one expect when you talk about the year 2025? Do you think this one also will be with lot of volatility and ups and downs because when we started the year 2024, you expected it to be as healthy as the previous two years were?
Ashwini Agarwal: 2025 is going to be a very interesting year because you are entering the year with the backdrop of significant global changes in terms of political leadership, in terms of how trade globally is expected to work. There is going to be a lot of upending. Let us see if it turns out to be more disruptive than people are already bracing for or not.

Closer home in India, we will probably see a turn in the interest rate cycle after a couple of years hopefully and we will also see earnings sort of picking up a little bit of a pace in the second half as compared to the first half of this financial year and then we have to see whether the investment demand picks up adequately or not because that has been lagging for the last one year or so, especially on the government side. So, it is going to be a very interesting year. Let us see how it turns out.

But while we are just around the corner to celebrating the new year, give us a sense of what the broader markets are expected to do going ahead. They have outperformed the benchmarks and recently we have also seen a trend that every time the market is looking a little shaky, you have either the midcap or the smallcap that are saving the day for the markets on an overall basis. Give us a sense of what the broader markets are expected to do going ahead and do you believe this kind of 20-25% rally that we have seen across both midcap and smallcaps continuing for next year as well?
Ashwini Agarwal: A very interesting question and what is happening in the broader market is more a determinant of what flows are coming into the market and from whom. So, if you think about it, 2024 has been a year when you have seen not much support from foreign institutions, but there has been a significant amount of inflow from domestic retail and directly into the market. Now that tends to be a little more bottom up, a little more stock specific, a little more determined by recommendations that work on a hearsay basis, etc, and that has been very good for the smallcaps.

The small and midcaps are also trading at valuations which are significantly ahead of largecaps because largecap stocks have not done as well. Like you said, I mean, we are up 10% on the Nifty versus say 25% on the small and mids.

So, I think that level of outperformance is difficult to sustain. Over longer periods of time smallcaps, midcaps, largecaps, they all converge. So, the starting point of valuation is very high.

So, you cannot expect that kind of outperformance to sustain. Also, my personal view is that there is a massive supply of paper that is coming into the market via IPOs, via offers for sale, and so on and I think that will necessitate some breathing, some absorption capacity of the market, it will test the absorption capacity of the market and in that context it is going to be very hard for the broader market to continue to outperform the narrow frontline market indices.

I want to understand your take when you talk about the metal space because the last three to four months the action or the renewed focus has actually been on the entire metal space, owing to what everyone has been expecting that the Chinese government would do, be it the stimulus or the fact that to pump up the economy, but that is not the way how it is transpiring. I think a lot of optimism was built around it, but that is not the way how it is actually transpiring when you talk about the Chinese government moves or the economy. What is your take when you talk about the metal space? Should you look at that in isolation of what is happening, the Chinese government or the Chinese government move, which is very difficult to do otherwise because given the fact that they are the largest consumers in the world and the producers?
Ashwini Agarwal: Yes, that is right. So, let us divide it in two buckets. When you look at metals, first is steel. Steel, there has been a lot of discussion around imposition of a 25% import duty, especially to protect against cheaper Chinese imports. Personally, I am not in favour of this kind of intervention.

But we decide to do so, you will probably have a positive outlook for steel companies, your EBITDA per tonne, which is currently quite depressed, will expand as a result of this protection. Coming to other base materials, whether it is aluminium or the others, I think there is a lot of pessimism that has already set in.

And I do not think you will see meaningful deterioration in outlook for other metal stock from where you are. Whether you will see a rebound or not is very difficult to call. It is also a function of how the dollar behaves in response to unorthodox policies followed by the US if at all and what happens to dollar denominated prices of these metals.

I personally stay away from base metals because these are global variables with far too many drivers, just not supply and demand, even if it were possible to analyse demand and supply on a global basis, which is not easy at all. But outside of that, there are several other factors and I prefer to stay away from this sector on the whole.

Also, give us an outlook of what you are making of the pharma space going ahead. It has been a strong defensive for 2024, second highest sectoral gainer, and very close to the first one that has been Nifty Realty. Give us a sense of what you are making for pharma headed into next year if you had to play this theme, would it be via healthcare, would it be via diagnostics or pure play pharma companies?
Ashwini Agarwal: So, my preferred space within the healthcare space is the hospital's healthcare space because I think there you have significant drivers for long-term growth in this country and you have industry consolidation also playing as a theme, so I think that will continue to do well.

And valuations are okay, they are not very-very stretched. The other place I would play it is upstream pharma, the API and the intermediate space, because that is where the margins got compressed over the last two years. In a post-COVID reshuffle where there were excess inventories created in the system and some of the companies had to contend with high raw material prices as COVID wound down. So, a lot of the compression in margins that you have seen over the last two years will come back to normal.

So, those are the two spaces I would play it with. On a broader basis, the realignment of margins to long-term averages is also palpable in the speciality chemical space, which is similar to upstream pharma or the API pharma space or the intermediate space and that could be another place that one can find some ideas.

I think the maximum of the market participants, I am not sure if you are also one of them, have been cheerleader for the entire banking space saying no matter what, this sector will perform, will perform well, will lead the market higher going ahead and one of the biggest names that everyone talks about is the HDFC Bank. And year after year, whenever you ask what is your bet for the next year, it will be HDFC Bank, has to feature in that list. But that is not the way how it is transpired. For the last two to three years, this one has not moved. No doubt the weight of this one in the banking index is pretty high. So, even a percent move makes a huge difference. But what is your take on the banking index as a whole, not talking about stock specific, but what is your take now? Do you think that the year 2025, again, you will place your bets on the banking sector and this time it will perform?
Ashwini Agarwal: So, there are two aspects to it. What is happening fundamentally to banking earnings and what has happened to flows? Now, if you think about it, the largecap banks is where a lot of foreign investors have invested in since inception. So, it is the largest sector in the MSCI indices and it is very well owned. So, in a year like 2024 where foreign investors were largely on the sidelines or were net sellers episodically, you cannot expect the banking sector or the banking indices to do so well. In addition to that, if you look down the cap curve in the banking sector, you had issues relating to credit cards, you had issues relating to rising defaults in personal unsecured borrowing space so that also hurt.

In 2025, you will see normalisation of credit growth coming in line with deposit growth and hopefully, as the interest rate cycle turns, which is what I had said in my initial opening comments, you will see a very benign earnings environment for the banking system. But again, technical factors like who is buying, who is selling will play a big role. Large banks will be driven by foreign institutional activity, whereas the smaller banks and microfinance and so on might get driven by local flows and by bottom-up themes as they emerge.