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Strategy: Gathering momentum; midcaps/smallcaps outperform

* Nifty maintains its winning streak: The Nifty closed higher for the fifth straight month in Sep'21. The index oscillated ~900 points before closing at 486 points (or 2.8%) higher MoM at 17,618. The Nifty is up 26% in CY21YTD. Midcaps/Smallcaps outperformed largecaps by 4.1%/3.3% in Sep'21. FII inflows were robust at USD1.1b. DIIs saw inflows for the seventh consecutive month at USD0.6b. In the last 12 months, midcaps have risen 79% v/s a 57% rise for the Nifty. In the last five years, midcaps have underperformed by 8%. The Nifty Midcap100 P/E now trades at a 10% premium to largecaps.

* Macro rebounds - higher-than-expected Current Account Surplus in 1QFY22: India reported CAS of USD6.5b (0.9% of GDP) in 1QFY22 v/s deficit of USD8.1b (or 1% of GDP) in 4QFY21. A lower merchandise trade deficit drove CAS higher - it reduced to USD30.7b (or 4.4% of GDP) in 1QFY22, against USD41.7b (or 5.4% of GDP) in 4QFY21. Net foreign capital inflows rose to USD25.7b (or 3.7% of GDP) in 1QFY22, against USD12.2b (or 1.6% of GDP) in 4QFY21. This was driven by huge net Foreign Direct Investment (FDI) inflows of USD11.9b in 1QFY22 (v/s USD2.7b in 4QFY21).

* India among the best performing markets in Sep'21: In Sep'21, key global markets such as Japan (+5%), India (+3%), Indonesia (+2%), Russia (+1%), and China (+1%) closed higher in local currency terms. However, Brazil (- 7%), the US (-5%), MSCI EM (-4%), Korea (-4%), Taiwan (-3%), and the UK (-0.5%) ended lower. In the last 12 months, MSCI India (+53%) has outperformed MSCI EM (+16%). In the last 10 years as well, MSCI India has outperformed MSCI EM by 175%. In P/E terms, MSCI India is trading at a 93% premium to MSCI EM, well above the historical average of 58%.

* Media, Real Estate, Oil & Gas, Telecom, and Utilities - top performers: Among the sectors, Media (+34%), Real Estate (+33%), Oil & Gas (+13%), Telecom (+11%), and Utilities (+9%) were the top performers in Sep'21. Metals (-2%) was the only laggard. Coal India (+27%), NTPC (+22%), ONGC (+20%), Tata Motors (+16%), and Kotak Mahindra Bank (+14%) were the top performers. On the other hand, Tata Steel (-11%), BPCL (-8%), Divi's Labs (- 7%), Tata Consumer (-6%), and UltraTech (-6%) led the laggards. In this edition, we dive deep into the valuation metrics of the NBFC sector.

* Stratospheric valuations for QUALITY: The markets have been rallying and how! A segment of the market has taken off and is now discounting earnings well into the future. (a) Liquidity, (b) benign sentiment, (c) declining COVID-19 cases, (d) upbeat corporate commentaries, and (e) low cost of capital have lifted the valuation multiples to stratospheric levels for many desired high-quality names across sectors. Rising energy and commodity prices, disruptions in global supply chains and speculation around the US Fed Taper and the eventual normalization of the interest rate environment sometime in CY22 could keep the markets volatile, in our view.

* The Nifty trades at 12-month forward P/E of 22.1x, at a 16% premium to its LPA. P/B, at 3.3x, is at a 30% premium to its historical average. India's market capitalization-to-GDP ratio has been volatile, reaching 56% (FY20 GDP) in Mar'20 (from 80% in FY19). It has rebounded to 115% presently (FY22E GDP), above its long-term average of 79%. In this environment of buoyant demand, upbeat sentiments and near-term margin headwinds, earnings delivery vs. elevated expectations is important for the markets to sustain these rich valuations.

* Top ideas: Largecaps: ICICI Bank, SBI, Infosys, HCL Technologies, UltraTech, HUVR, Titan, Divi's Labs, Hindalco, SBI Life. Midcaps: Max Financials, SAIL, Deepak Nitrite, L&T Technology, APL Apollo Tubes, Chola Finance, JK Cements, Indian Hotels, Orient Electric, ABFRL.

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