“This positioning has protected us from recent drawdowns and volatility. Megacaps, which include not only big tech names but also companies like Eli Lilly and Costco, have been bid up to extremely high valuations because of their growth and certainty around earnings delivery. Closer term,” says Arindam Mandal, portfolio manager at Marcellus Investment Managers.
Edited excerpts from the chat:
How has your Global Compounders fund fared amid all the turmoil globally?
The last month has been volatile for global equities. The turmoil in US markets began with a momentum reversal in mid-July, where megacap stocks saw a pullback while the bearishness lifted, with the Russell 2000 (small cap) outperforming the S&P 500 by about 12% over 12 trading days – a rare occurrence. Over the past 25 years. Following this, weaker-than-expected US jobs data further depressed the broader market. Oil prices fell despite weak demand signals, particularly from China, despite rising tensions in the Middle East. The Federal Reserve’s hint of a possible rate cut in September provided some relief, but an unexpected rate hike by the Bank of Japan disrupted the “yen carry trade.”
Despite market volatility since early July, the Global Compounders portfolio has held up relatively well, staying flat compared to the S&P 500’s decline of more than 4% and the Nasdaq’s decline of more than 8%. It’s reassuring to see that the portfolio has not only withstood this recent volatility but has outperformed our benchmark, the S&P 500, by nearly 900 basis points since its inception—achieving this without holding some of the hottest stocks like Nvidia.
How are you dealing with the stress in the megacaps on Wall Street? Will the likes of Nvidia make a comeback?
Our exposure to megacaps is limited. The Global Compounders portfolio is heavily weighted towards “non-megacap” stocks. If we define megacaps as those with a market cap of over $250 billion, the S&P 500’s allocation to these stocks is around 55-60%, while ours is below 30%. This position has protected us from recent drawdowns and volatility. Megacaps, which include not only big tech names but also companies like Eli Lilly and Costco, have been bid up to extremely high valuations because of their certainty of near-term growth and earnings delivery.
Interestingly, the S&P midcap index’s valuation discount relative to the S&P 500 is similar to what it was in the early 2000s—a period in which midcaps outperformed large caps (S&P 500) for the next 12-24 months. While history doesn’t repeat itself, it often does, and in such circumstances, Global Compounders is in good shape thanks to its significant allocation outside of megacaps.
As for Nvidia, it’s hard to predict whether it will bounce back, but it will likely remain extremely volatile. Nvidia’s long-term thesis is attractive, but at its recent peak share price (~135/140), it was trading at a ~20x FY26 EV/Sales multiple. Paying such a premium for a growth business offers a limited margin of safety, albeit a cyclical, secular one that may be at “peak growth” and “peak margins.” In a momentum-driven narrow market, stocks can reach incredible prices, but sustaining those levels is challenging. It is possible that some future growth is already priced in.
A segment of the market is calling AI stocks, particularly Nvidia, in a bubble phase. Would you agree that the pick and shovel opportunity was overrated?
We may be at a point where companies investing in “picks and shovels” for AI need to demonstrate their ability to monetize the hundreds of billions of dollars spent building infrastructure. This monetization can come in the form of revenue generation, cost savings or productivity improvements. The speed of this monetization will likely determine where we are in the cycle, or what Gartner calls the “hype cycle.”
While the applications of AI will undoubtedly be widespread (like the Internet in the late 1990s/early 2000s), adoption of enterprise uses at scale will take time, and cycles. That said, today’s Nvidia is very different from Cisco’s in the 2000s, but it’s not surprising to see the adoption process go through some quiet periods compared to the current fervor. This is not a denial of AI’s role in the future – it really is the future, just like the Internet was 25-30 years ago. However, a profitable monetization engine needs to be built over time to justify the current investments, which will likely happen, but not overnight.
Do you think the effect of the reverse carry trade is largely over? JPMorgan said that 75% of mango trade has been closed
It is challenging to know for sure. Different broker houses have their estimates, but in reality, it is difficult to quantify or “know” for sure. Estimates of the “yen carry trade size” being circulated range from hundreds of billions to a trillion dollars. This trade undoubtedly created some gains, and it is likely that most of them have been unwound by now.
What is your base case scenario as far as Fed rate cuts are concerned?
It’s likely a matter of “when,” not “if.” Real-time inflation data is slowly declining. However, one surprising aspect of this rate hike cycle has been the resilience of US home prices, which have held up better than expected. This resilience has probably brought some comfort. The magnitude of rate cuts will depend on unemployment data as the Fed continues to make data-driven decisions. We expect a 25-50 basis point rate cut in September, which aligns with consensus unless there is significant weakness in the data.
Changes in the budget have made foreign investment more attractive from the perspective of capital gains tax. Do you expect global investment in India to become more popular?
The attractiveness of global investment is likely to increase. As Indians become wealthier and more successful, their investment approach will evolve to account for the impact of diversification—geographic and thematic—as well as volatility in wealth allocation and long-term wealth generation. Gift City was a major step towards making India a global financial hub. Enabling two-way traffic – both inbound and outbound – is the best way to do that. Recent changes, which simplify and align long-term capital gains tax with domestic equity and allow resident Indians to open foreign bank accounts in GIFT City, reduce friction significantly. We are grateful to the regulators and the Ministry of Finance for these changes.
In your opinion, is a 10% allocation in international equities good enough for someone with an aggressive profile and long-term horizon?
10% allocation is likely to be on the lower side. I would suggest somewhere between 20-30% as more appropriate. An interesting point to consider is that, over the long term, the returns of the US market, which is a primary component of the global markets, is similar to that of the Indian markets. However, these returns come with much lower volatility and drawdown. Additionally, during global crises, the INR depreciates against the USD, as the USD is considered a safe haven. Investors who regularly access new money will benefit more from investing in similar return but lower volatility assets. A 10% allocation may not move the needle significantly in terms of diversification, while a larger allocation will better capture the value proposition.
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