While macro-economic parameters are favourably poised to give the stock market a high in the New Year, some major worries stare us in the face, says Hemant Kanawala, head of equities at Kotak Mahindra Old Mutual Life Insurance. In an interview with Bijoy Sankar Saikia, he, however, says the market has turned attractive for investors. Excerpts:



We end the year 2011 on a depressing note even though there are signs of slight improvement in conditions. Does the New Year look much more promising? On what do you base your optimism/pessimism for the New Year?

Inflation, policy uncertainty, a slowing economy and a deteriorating global macro environment were the main concerns in 2011, which led to contraction in market multiple. Also, there were substantial earnings downgrades for many companies. The Indian market is now trading around 13 times its FY13 estimated earnings, which is close to the long-term average for the market. There are early signs of stability in inflation with food price inflation coming down significantly. Any surprise in the form of policy action, better fiscal management, monetary easing or a rally in risk assets globally can trigger a rally in our market. However, the near-term market outlook remains challenging with expectation of weak earnings for the December quarter, elections in five states and lack of clarity on the European situation.

There is a strong fear that the real impact of high interest rates, high inflation and capex slowdown will start showing in the bottom lines of Indian companies over the next two quarters. How do you view this? If at all, how bad is it going to be?

High interest rates and capex slowdown are likely to impact earnings of companies with high financial leverage and players operating in the infrastructure space. Banks can also get affected because they can have asset quality issues from these companies and there could be a slowdown in credit growth. This is already reflected to some extent in the results of companies in the past quarter, but the next two quarters can be much more challenging for companies in these sectors. However, the rest of the economy in terms of consumption and export-oriented sectors, such as IT and pharma, are expected to do well.

If I were to ask you about the five big worries you have for the New Year, what would they be?

Among global factors, first is hard landing of China, which can lead to a deterioration in global growth outlook. Second is the crisis in the euro zone because it can paralyse financial markets globally. Among local factors, first is a fresh pickup in inflation in the second half because it can seriously restrict RBI’s ability to carry out monetary easing. Second is fiscal deficit remaining above 6 per cent of GDP because it can have serious macro-economic implications. Third is lack of progress on the policy front by the government, which is needed to boost investment in the country.

n And what will be the positive triggers that you feel should work in favour of the bulls in the market?

The main concerns for India at present are high inflation, high fiscal deficit and a slowdown in the economy. There is already softness in agro commodities over the past few weeks. If this gets supported by a correction in industrial commodity prices, it will ease inflation concerns materially. Also, if the government announces policy measures that can kickstart investment, it will improve the growth outlook for the economy. The above events can also improve FII inflows to India, which can work in favour of the bulls.

So, what should be the approach to equity play in the New Year? Would you advise investors to stay with large caps or get a little adventurous with even mid-caps and small-aps?

The approach to investing remains the same. One needs have at least three years time horizon while investing in equities. Companies with strong cash flow and leadership in their respective sectors will continue to do well over the next year. As there are fears of a slowdown in the economy and interest rates are also high, mid-cap companies should be avoided due to their limited ability to manage such an environment. In such conditions, a bottom-up approach to investing with a focus on large-cap companies should do well.

And if you were to take a sectoral call at this point, which sectors would you favour and which ones are you going to avoid and why?

One should avoid taking sector calls and have a bottom-up approach to investing. Investors should focus on companies with strong cash flows and low operating and financial leverage till there is visibility of a more stable environment.

Given the outlook for interest rates, one would possibly be tempted to look at some banking and realty stocks. What’s your call on them? One still needs to be cautious?

The real estate sector can be avoided because most of the companies have high operating and financial leverage. Banking is an interesting sector as it will have tailwind from monetary easing and headwind from asset quality iss­ues. After huge underperformance last year, valuations for many banking stocks are very attractive now and, hence, they make interesting investment ideas. Investors should look at banks and NBFCs, which are going to benefit from a drop in interest rates, but have less exposure to infrastructure and SME sector where bulk of the asset quality issues are likely to emerge.

Given the fluctuations on the forex front, do you think it will continue to haunt the market for most part of 2012? When do you expect things to look up on this front? Which are the sectors to keep a watch on from this front?

There is expectation of the US dollar strengthening against most currencies next year. Hence, volatility in the rupee against the dollar is likely to continue. Since a large part of India’s current account deficit is due to commodity imports, mainly oil, any significant correction in them will help stabilise the rupee. Traditionally, export-oriented sectors, such as IT and pharma, with significant revenues in US dollars, will benefit from a depreciation of the rupee.

Do you expect FII behaviour towards the Indian market to change drastically in the New Year after a rather lacklustre show last year? That too, when we have some real fundamental problems like a ballooning fiscal deficit and policy inertia still haunting us?

One should remember that emerging markets had redemption of around $25 billion till November last year, out of which, India’s share was around $250 million. Hence, on a relative basis FIIs have not withdrawn from India in CY11, compared with other emerging markets such as Taiwan and South Korea. This indicates their long-term positive view on the Indian economy in spite of near-term challenges. If there is a correction in commodity prices due to a slowdown in the global economy and there is an improvement in macro parameters, such as inflation and fiscal deficit, there can be revival in FII interest in India. After more than 20 per cent correction in the stock market and 15 per cent depreciation in currency, the Indian market will now look much more attractive to them.

We will have two mega events coming up over the next two months, assembly elections and the budget. How are these factors going to dominate market sentiments?

Between the two, the budget is more critical. At present, there is a fear that the government’s deficit for this financial year as well as the next can be in excess of 5.5 per cent. If the government is able to contain it below that, the market will be positively surprised and it will improve sentiments. Election results normally do not have any long-term implication on the market. As long as the government do­es not announce populist measures, the market sentiment will not be affected much by these elections. zz

bijoysankar@mydigitalfc.com