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Jul 06, 2017 04:10 PM IST | Source: CNBC-TV18

Emkay's Karwa says market may stay benign for 2 quarters; IT, pharma good contra bets

Krishna Kumar Karwa believes that market is in consolidation mode right now and expects second half of the year to be flat.

The market could stay benign for the next 1-2 quarters, while the third quarter will be very crucial in terms of expectations versus delivery, according to Krishna Kumar Karwa, Managing Director at Emkay Global Financial Services in an interview to CNBC-TV18.

Valuations have run up in anticipation of earnings and there stands a risk of mismatch in some cases, he said.

"We have seen reasonable amount of profit taking and sector/stock rotation is the order of the day," he said noting the market is in consolidation mode.

Elaborating on the developing pattern of market participation, he said direct retail participation was muted and largely through mutual funds or portfolio management services (PMS), or specialised advisory. HNIs, though, continued to remain positive.

Speaking on Q1 earnings expectation, Karwa said there could be a lot of movement. Some auto companies should show decent numbers, he said.

On GST impact, he said nobody was able to figure out how corporates tried to protect market share in the past one month and the cost they will be taking.

Are there any contra bets investors can take? Karwa believes one could look at sectors which are not preferred right now—IT, pharmaceuticals and telecom, for instance. “Domestic stores are still in flavour and tailwinds are in their favour,” he told the channel.

Below is the verbatim transcript of the interview:

Anuj: Is the retail, high net worth individuals (HNIs) sentiment back to where it was two months back because the market endured a bit of a phase where we saw a bit of profit taking in midcaps, the market also corrected a bit. Your sense of where we are right now?

A: In the last one month the market seems to be in a consolidation mode and there has been a reasonable amount of profit taking in stocks and sectors and some kind of a sector rotation or stock rotation seems to be the order of the day.

As far as retail investors are concerned, I believe more and more of retail participation is through mutual fund route or through the portfolio management scheme (PMS) or specialised advisory. So direct retail participation has been relatively muted versus the kind of rally that the market has seen. General HNI sentiment continues to remain positive. They all understand that there could be short-term hiccups in the market post goods and services tax (GST) implementation etc, but the benefits of that over the longer timeframe in terms of improved tax to gross domestic product (GDP) ratios and the benefit to the organised sector versus the unorganised sector in the longer run, I think all of them understand and appreciate that and also the fact that probably for the short-term maybe most of the gains are kind of priced in. So now investors are waiting to finally hear commentary from corporate in the coming result season and how it finally pans out over a slightly longer term timeframe.

Surabhi: What is it that you are expecting from the first quarter? It's been pretty much factored in that this was the GST quarter, at least the last months, so fair amount of de-stocking but roughly speaking in terms of earnings growth or a flattish trend or maybe a contraction in some sectors?

A: Its early days in terms of yes, we are in the process of collating the numbers etc but general expectation is that for the full year as such if you are expecting earnings to grow anywhere between 12-14 percent on overall basis, so in Q1 etc, there would be a whole range of movements in terms of the corporate numbers, some of the auto companies etc, should show decent numbers but nobody is able to exactly figure out that in the last one month in terms of how every corporate has acted in terms of protecting its market share or pushing its sales in the dealer network etc, and what kind of cost they are going to take for that. So it will be slightly challenging to be able to figure out what kind of numbers are going to be and that could be surprises. Some commentaries from jewellery companies etc have been very robust in terms of their sales growth etc. So it is going to be a mixed bag.

Reema: In this context how are you allocating money to generate alpha now?

A: That is a big challenge because if you look at on traditional parameters and valuations etc, there seem to be a kind of price to perfection and so on an overall basis it's time to be careful and we already had good run up in the last six months, so possibly second half of the year or rather the next six months looks like it could be a flattish kind of an environment, but within that it all depends on what kind of an investor you are. If you still believe in momentum investing and growth is then these sectors are very obvious in terms of the whole government thrust on rural upliftment and infrastructure. So those are the segments which cater to that segment should be positively impacted and should continue to do well. So whether it's the consumption, whether it is the auto companies, despite the run up that we have seen, they should still continue to deliver but if you are a contra investor and willing to look slightly beyond then the sectors which are not liked today or not discussed today which is the IT, pharmaceutical and possibly even telecom where we are in the last phase. Those are the sectors where value possibly is there and where contra investors with a slightly longer term perspective could do well. So basically domestic stories are still in flavour and they have tailwind in their favour and they should still deliver.

Anuj: Looking at your top buys, its consumption across the board from the biggest of them like Hindustan Unilever to the smaller ones like Prabhat Dairy or couple of others like Varun Beverages. In this particular space how much is the risk because valuations could also play a part and we have seen that earnings momentum is still not there, at least in some of them. Is there a risk of a big correction here?

A: As you rightly said yes, we are factoring in that numbers will deliver. The valuations have already run up in anticipation of number, so wherever valuations are very high versus historical averages, there you run the risk that if numbers do not deliver then the corrections could be very sharp. So that is where I said that the margin of safety in many of these growth stocks, I mean domestic consumption stories, they seem to have priced in the next 6-12 months kind of growth and analysts have also factored that in and if those numbers do not deliver, market will be benign because there is decent amount of local liquidity etc. So maybe for one or two quarters market will be benign but beyond that market will not be able to justify the high valuations probably the October-December quarter is the one where you will have the benefit of the base impact because of demonetisation etc, in the last year. So that is the quarter which is going to be very critical in terms of expectations versus actual delivery. If in that quarter, companies do not deliver then there could be problem. I think till September quarter market is going to be hopeful, positive and will give the benefit of doubt to the corporate.

Surabhi: Going back to your point on being a bit of a contrarian in this market, you mentioned IT, pharma and even telecom. I want to take up pharma. How are you going about selecting companies because not everything is moving back or bouncing back strongly from the lows? There are certain types of companies which the market is ascribing more value to right now. How are you going through that differentiation?

A: Looking at what is coming out of the US in terms of accelerated approvals for products and approval in pipeline, I think corporate which are having huge amount of products filed for approval etc, they would possibly be the beneficiaries if the US Food and Drug Administration (US FDA) is in the process of giving accelerated approvals. So maybe the timeframe over which those products - earlier they used to enjoy the benefits in terms of pricing etc, that may come down but the filing cost etc and the recoveries would be much faster.

We have seen some of the companies in the pharma sector which have not had too many major issues in terms of US FDA plant approvals and which have a very robust pipeline. They have done very well in the last one-one-and-a-half months and appreciated by 25-30 percent. No doubt they have come down by 40-50 percent from earlier highs but market is looking to invest or give better valuation in those kinds of opportunities.
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