Kotak Mahindra Old Mutual Life Insurance chief investment officer Sudhakar Shanbhag says the market

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has the potential to head towards 20,000-21,000 range during this calendar year. In an interview with Bijoy Sankar Saikia, he says global factors remain the biggest downside risks at this stage. Excerpts:

Nifty has finally dropped bellow 5,500, but the market still looks hungry. How are you reading the Street signs? Do you think it is a case of too much, too fast or are you comfortable with the rally?

Foreign institutional investors inflows for calendar year 2010 to date have been to the tune of $12 billion (this flow may not be necessarily in the secondary market). If the inflows continue at the same speed, there is no reason to believe that the market cannot head higher. However, we should remember that when inflows reverse for any reason, for instance global risk aversion, the impact can be equally telling. India’s GDP growth for FY11 is expected to be in the vicinity of 8.5 per cent. From a fundamental perspective, the domestic economy, which is largely consumption-driven, is on a strong footing and hence the market could head towards 20,000-21,000 range during CY11.

Don't you find valuations overstretched? Above 5,500 we were probably the costliest in the emerging markets basket. What kind of a Sensex EPS would you look at for FY11 and FY12?

If one draws a comparison, the Indian market has done exceptionally well compared with other emerging markets and a large part this has been due to the opportunity invest­ors see in the Indian growth story. The Sensex EPS is expected at about Rs 1,050 for FY11. At around 18,200-18,400 level, the market would be at over 17 times FY11 earnings, which is above the historical average. A 20 per cent increase in earnings for FY12 is possible and, hence, we believe a range of 20,000-21,000 is possible during CY11.

My next question would be what next? Do you expect the rally to resume with the same momentum or do you see some more downside risk? If at all there is a downside, where will you put a limit to it?

We have seen a good growth in the Sensex over the past 17 months from a low of about 8,000 in March 2009. A correction at this stage (18,200 level) would be desirable and healthy for the market to move on to the next level. Downside risk can come from global factors, which may be issues like possibility of sovereign defaults or bank defaults and risk aversion. Based on these factors, up to 10 per cent correction in the market cannot be ruled out.

On the domestic front, most macro factors appear to be in the comfort zone. Even inflation is easing. In such a scenario, what could be the downside risks for the market?

Factors such as GDP growth, path of reforms, management of growth and inflation through appropriate monetary policy and a large domestic consumption story, give a lot of confidence to market participants. Factors that we need to watch out for are current account deficit, oil above $95 (if that happens), final guidelines of DTC (long term capital gains related) and the impact of reported profitability due to the implementation of IFRS.

Recent macro economic numbers from US, including the housing sales numbers, have been a shock for the market and talks of double-dips is gaining ground again. How real are these fears?

From the US market perspective, these numbers would definitely have an impact since they add to the uncertainty from a recovery perspective. Bond markets in the US are also signalling a deflationary trend. From a broader perspective, markets could move from fundamentals to liquidity based on any further quantitative easing that the US Fed may undertake. From an Indian market perspective, a sluggish world will help FII inflows to the Indian market.

How do you expect corporate earnings to pan out in the later part of this financial year? How happy were you with the Q1 numbers? Are you comfortable with the top line figures and margins? If not, which sectors worry you the most?

Q1 earnings were largely in line with expectations, though there have been some good performers in the banking and pharma sectors and some laggards in power and cement. Overall sales increase of about 25 per cent and profit increase of about 20 per cent is fine. For FY11, an earnings growth of 20-25 per cent looks like a possibility. Sectors such as metals and telecom continue will continue to be under pressure.

The recent market rally was more stock and sector-specific. Which sector/sectors do you see emerging as the leader/leaders of this rally?

We are overweight on the consumption and outsourcing themes (which includes information technology and pharma). Within consumption, we are underweight on telecom due to competition and regulatory concerns, and overweight on media primarily due to corporate spends. In the global commodities theme, we are underweight on metals due to the slowdown in China and euro zone, and have lately moved to relatively lesser underweight than earlier on oil and gas due to the price deregulation. Fertiliser companies within commodities look attractive. In the infrastructure space, we are overweight on capital goods, engineering and construction as we believe investments will pick up. We remain underweight on real estate. We are largely neutral on the BSFI (banking and financial services) segment due to the overall weight the segment attracts in the benchmarks. Within BFSI, public sector banks offer relatively better opportunities.

What's the call on the laggard sectors? Is there a case for contra bets in some of the laggard sectors?

At present, we are not comfortable taking contrarian bets on any of the laggard sectors unless we have reasonable comfort of turnaround in them. Cement looks like one sector that can be considered at this stage, but risks remain on the pricing front.

There are concerns that DII inflows will be slow this year, from insurers because of new Ulip norms and from mutual funds because of lower inflows. How significant will be this shortfall, if at all, and what kind of impact this is going to have on the market?

During CY11 to date, mutual funds have been net sellers in the market to the tune of $3 billion. However in the same period, other domestic institutions — including insurance companies — have been buyers. For FY10, insurance companies will have invested an estimated $14 billion in equity markets. The new regulations in the insurance industry will impact the business model. While the industry is aligning to the change, it may not be prudent to assume the same level of investment for FY11. The industry normally has a large share of business inflows in the second half of a financial year. DII support becomes critical for the market at large in the event of a reverse in FII inflows.

Looking at the performance of last few IPOs, do you feel the primary market has revived?

Good quality issues with reasonable valuations will get support from domestic as well as overseas investors. However, the quantum of primary market supply is expected to have an impact on secondary market. We have seen good participation from retail in the past few issues because of the one-day extra time given to retail investors to evaluate QIB participation before applying.