Mid-cap valuations, China trade key risks for the market: Jefferies’ Wood

A near-term correction in India remains an obvious risk, given the valuations in the mid-cap space, Jefferies’ equity strategist Christopher Wood, said in his latest newsletter Greed & Fear.

• Also read: Exchange-agonistic weighted average price will make slight difference

Wood believes that if China trade remains the current focus in Asia, dedicated emerging market foreign investors may shy away from India. This is the context where more expensive mid-caps have continued to outperform bluechips and why private sector banks and IT services — two prominent high-profile sectors traditionally owned by foreigners and historically accounting for a large share of the Nifty — have underperformed in the recent past.

There is a growing narrative, which is probably correct, that the private sector banks have seen their best days, said Wood. Recent regulatory pressure from the Reserve Bank of India to slow loan growth in the retail segment, particular in the area of unsecured loans, and to “manage” loan-to-deposit ratios has been an overhang.

“Private sector banks are not without merit as investments. Indeed for value-orientated investors they are approaching a level of valuation which makes them finally appear interesting,” said Wood.

Domestic triggers

There are two potential domestic triggers for a correction. The first is a surprisingly bad outcome for the incumbent BJP government. But a shock defeat like the one seen in 2004 remains unlikely in the extreme, said Wood. Even if the BJP wins by “only” the number of seats in the last general election held in 2019 that is quite enough to run the government as the past five years have demonstrated, he said.

• Also read: Mastering Derivatives: Modified dispersion trade

A bigger risk for the stock market is changes in the capital gains tax regime — either tax rates being raised or the period to qualify for long-term gains extended, or a combination of both.

A few days back, however, Finance Minister Nirmala Sitharaman had taken to platform X to deny reports of plans to change the capital gains tax structure in case the government is voted back to power.

“The reason that such proposals are apparently under consideration is growing evidence of retail speculation, most particularly in the options market where India has options for individual stocks. Such paper speculation is unlikely to be viewed as healthy by Modi, or indeed the BJP. Greed & Fear’s probably correct assumption is that the Indian prime minister has a natural suspicion of those making money out of money, most particularly in a zero-sum game like options,” said Wood.